Too bad the thread got derailed!
The 40% rule is interesting but it has a flaw. All my stocks are to the right of the 40% line or very close to it but they certainly exclude the highest earner, ADBE. Here is why: four of the stocks at the top of the 40% chart (highest earners) are the four lowest yielding stocks (to the right of the 40% line) in the market
Denny Schlesinger
Every rule has a flaw, including “Growth rate trumps earnings”. The “market” will generally give SaaS companies a pass on producing earnings and even cash flow for a relatively long period of time but that occurs only because of the belief that one day the company can one day achieve both positive cash flows and profitability but if the belief ever goes away that the company can eventually scale to profitability, then look out below!!!
There are some SaaS companies that some people might think could be around forever, that if a recession ever happened, well, they might disappear…gobbled up by the Google’s, Amazon’s, Oracle’s, Salesforce’s of the world, bought out at bargain basement prices precisely because such companies are not profitable or have low/no cash flows. While some people don’t believe a recession will happen, many people didn’t believe the Great Recession in 2008-2009 would happen either. I remember a lot of people buying on the dip at the beginning of the Great Recession until they ran out of money and the dip went straight down into Davey Jones locker.
I also remember when people recognized US stocks were doing horrible and to get “Alpha”, a lot of Fools piled into the gold rush of Chinese smallcap stocks which wound up being fools gold. It sounds ridiculous now but many Fools were enamored with a small cap Mongolian fertilizer company and was bidding up the stock like it was a company that cured cancer, while completely ignoring any and all risks of investing in the Chinese market. Some people were bragging about having virtually all their money in some Chinese small caps too: https://discussion.fool.com/ggs-yongye-international-yong-119653…
That is why I don’t simplistically only follow one investor or follow one rule. When I made the post of the Invest In The Right SaaS article on the Fool paid boards, one thing that BrianKnittel did not mention was that I said this at the bottom of the post:
I found the article pretty informative but I would not treat it as 100% Gospel. Some of the companies the author identified as laggards have actually been great stock performers for awhile and some of the companies identified as “overvalued” could possibly continue as “overvalued” for quite some time
https://discussion.fool.com/4056/invest-in-the-right-saas-342259…
The article should be used as a very rough guideline on how a investor can categorize SaaS stocks.
When it comes to “rules”, there is always exceptions to the rule and the wise investor learns to understand when and where the rules might apply and where they might not.
The rule of 40% came about as a general rule to understand the health of a SaaS stock and it mostly applies to the SaaS stocks that have not yet reached scale yet. Meaning that the rule of 40% applies less to companies that have already scaled like Salesforce and Adobe, while applying more to a company like Twilio, Paycom or Zendesk.
The SaaS companies that do not satisfy the rule of 40% might also be the types that could become very shaky in a recession too…shaky enough to disappear.
Starrob
Who hasn’t made mistakes? Peter Lynch and Warren Buffett have admitted to making mistakes. Even I have made miskates!
Denny Schlesinger
Which is why I don’t “follow” other investors. I want to be responsible for my own mistakes. On the paid Fool services, most new investors simply follow the Fool Analysts picks and then later become dismayed when the Fool Analyst get found to make a mistake. I have watched many a fool berate Fool Analysts for investing in a company that the “offended” investor, with the benefit of hindsight bias, claims that the Analyst should have known would fail.
That is why I believe everyone should investigate things for themselves and be responsible for their own mistakes and not place the responsibility on others.
Starrob