Marginal thinking

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Square’s PE of 185 or so got me thinking…they’ve only begun to show a profit. What if they had the margins of Arista? What would it look like then? Arista’s net margin was 29% this last quarter.

So I asked myself, what if all the companies I own had a 30% net profit margin? Hear me out – I realize that’s not likely for most of them any time soon. And I realize that even at 30% they should still command pretty high multiples (as Arista does) because of stellar growth, but I just thought it might be an interesting data point. So I did a little math and calculated what I’ll call the hypothetical PE for each company I own.

Here’s the results:


**ticker   HPE**
SHOP     59.3
ANET     41.0
HUBS     28.5
SQ       63.7
WIX      22.1
TLND     29.1
INST     23.4
TTD      26.2
HDP      18.3
ALRM     22.7
FB       48.5 (they're at 34.8 now...30% would be a big fall for them -- it was 46% this quarter)

It immediately strikes me that HUBS and WIX could have a lot of appreciation potential when they start to show some profit (as HUBS has started to do, but not yet for the TTM). TLND, INST, and HDP are a lot farther from profit, and TTD, ALRM, and FB are already profitable. This shows that if TTD and ALRM could push toward a 30% margin, they would start to look extremely cheap. I think ALRM will. Not as sure about TTD, but they are growing faster.

Lastly, SHOP and SQ do look expensive, but it’s all about the growth and likelihood of more growth. And even these hypothetical PE’s of ~60 don’t look completely crazy. ANET’s is upper 40’s now, and it seems like a bargain to me.

Conclusion

For the most part it’s simple: it’s still all about growth. The ability to scale must be there – if there are doubts about that, I will cut a stock loose so fast…well, see Twilio. But as long as that’s in place, then keep growing. Because frankly, if SHOP has 65% more revenue this time next year, all things equal, that hypothetical PE would be about 35 (far too cheap for a company growing so fast). And we could see the profit margin actually pushing up by then – maybe not near 30% yet, but the market is forward thinking.

Anyway, kind of a weird exercise, but I enjoyed taking a look.

Bear

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I’ve done something similar by estimating cashflow minus the amount invested in growth. The specifics vary for each company. That gives me a potential P/E of 40 - 102 for Shopify (like you said, a couple of years of growth make that look great) and 35 for Amazon.

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I’ve done something similar by estimating cashflow minus the amount invested in growth. The specifics vary for each company. That gives me a potential P/E of 40 - 102 for Shopify (like you said, a couple of years of growth make that look great) and 35 for Amazon.

thecompounder,

How do you calculate the amount invested in growth?

Bear