Market Cap Thinking

Investment Analysis Clubs Saul’s Investing Discussions
#1

This is just a theory on present valuations, but perhaps the market is thinking that some “younger” companies’ revenues are likely to quickly grow to levels similar to other SAAS companies? Take a look at the market caps of some companies with less than 200m in TTM revenue:

ZS (191m): $5.3 billion market cap
AYX (162m): $3.7 billion market cap
TLND (176m): $2.1 billion market cap
MDB (192m): $4.3 billion market cap
INST (185m): $1.4 billion market cap

Compare to some more mature companies with around 500m in TTM revenue:

WIX (513m): $5.4 billion market cap
PAYC (498m): $9.3 billion market cap
TWLO (493m): $8.3 billion market cap

The market isn’t always going to do what it’s always done. Three years ago Paycom’s TTM revenues were around 200m. Yet Paycom was valued at only about $2b. It’s now over $9b. The market has evolved and learned from this. If it thinks ZScaler will resemble Paycom 3 years from now, it’s not going to value ZS at $2b, but much higher.

There’s a range of outcomes, of course, and a discount. If ZS in 3 years = Paycom today, you wouldn’t expect ZS’s market cap today to be $9.3b, like Paycom’s. There’s a discount for the fact that the outcomes are unknown, and for the time value of money. But the $5.3b ZS valuation seems to suggest that it will look more like Paycom in 3 years that Wix, which has about the same revenue but much less profit…yet. (Growth rate is also a factor, as with Twilio, which is unprofitable, but growing much faster than Wix or Paycom).

Talend and Instructure aren’t being given anywhere NEAR as much credit as ZS or MDB. This may be warranted. In 3 years, I don’t think it’s likely that Instructure will be anywhere near where Paycom is now. Talend might. I believe that Talend’s trajectory will be more favorable than the market’s current expectations, and that therefore now is a good time to buy. Either I will be wrong, or the market will eventually catch on and Talend’s price will go up.

With ZScaler, there’s not as much room for the valuation to grow with the company’s results. That said, in three years it could easily be a much more valuable company (certainly there’s potential for it to double or better). I guess my takeaway is that there’s less margin of error there, since it’s already credited with so much of its potential value.

I’d love to hear others’ thoughts.

Bear

42 Likes
#2

Bear,

I’d be interested into the TAM for each of these companies. I struggle with that in my evaluation of EVGB as well. Ok, it has no competition, it’s growing well and expanding well, but how much market is left in front of it?

Thanks for everything,

Just a Fool

#3

Hi Bear,

That’s exactly what I was thinking. I think you can also add the fact that most of these companies had a record earnings results this quarter, with revenue accelerating etc.

#4

Bear,

How have you factored in investor expectations for eventual net margins in your comparisons?
Or are you thinking investors believe future margins are a constant for these businesses?

P.S., no criticism intended, just interested in your thinking on this.

Thanks.

2 Likes
#5

How have you factored in investor expectations for eventual net margins in your comparisons?
Or are you thinking investors believe future margins are a constant for these businesses?

For the back of the napkin math I’m employing, the companies I listed would all be fairly similar when it comes to margin potential. Gross Margin for these is currently between 70% and 90%, except for Twilio (~55%), but as I said, they have a higher revenue growth rate.

The observation I was trying to make in my post was perhaps poorly stated, but the gist is this:

For these companies which have similar sales in the last 12 months, we can see what the market is expecting by looking at their different market caps. Then we can compare our expectations to the Market’s.

I’m not sure how helpful that is (or maybe it’s just obvious), but I just wanted to share that market cap is typically what I look at (other than multiple) when assessing whether a company is expensive or not. Example: Strelna noted that MDB is a rather expensive “best buy now” at a PS of 20+. My response would be yes, the multiple is high, but it is still only a ~$4.3b company. It’s easier for a company to go from 2b to 4b to 8b than from 8b to 16b to 32b.

JAFbrblev made a good point about TAM…I think that plays into this as well. I don’t trust TAM estimates…I look at the market cap. Basically, The market is projecting all this (TAM, revenue growth, margins, etc) out and coming up with a value (market cap) for each company. It may look expensive or cheap, but it’s actually neither – it’s accurate based on what the market expects. But the market may be right or wrong.

Bear

10 Likes
#6

For these companies which have similar sales in the last 12 months, we can see what the
market is expecting by looking at their different market caps. Then we can compare our
expectations to the Market’s.

Assuming these businesses will all eventually have comparable net margins,
we can also look at implied P/Es and compare them to expectations for growth:


                                     Expected Future Net
                                     ------ Margin -----
                                     10%     20%     30%
Company  Mkt Cap     Rev     P/S     --- Implied P/E ---
-------  -------     ---     ---     ---     ---     ---
ZS          5300     191      28     277     139      92
AYX         3700     162      23     228     114      76
TLND        2100     176      12     119      60      40
MDB         4300     192      22     224     112      75
INST        1400     185       8      76      38      25

WIX         5400     513      11     105      53      35
PAYC        9300     498      19     187      93      62
TWLO        8300     493      17     168      84      56

Paycom (PAYC) has a TTM net margin of 18% and TTM P/E of 104.

12 Likes
#7

Paul/Bear makes the good point that there is a case for a long position in a company which is ostensibly a promising short in this new world of very high growth of companies supplying data use for business needs. Here is a simple attempt at it, done at speed, with reference to the humongous database (in which I have a very small position).

Cap. 4.22B, sales 192.20m, PS 22. Historical sales growth rate 55%, 52%, latest qtr. 61%

Assume a poorer outcome than hoped for, reversion to the mean but PS holds up reasonably well.

Future sales growth rate: 50% and PS 17; 40% and PS 14; 30% and PS 10.

Year 1: sales 288.3m x PS 17 = cap. 4.9011B

Year 2: sales 403.62m x PS 14 = cap. 5.65068B

Year 3: sales 524.706 x PS 10 = cap. 5.24706B.

After Year 2 would be the optimum time to move on with a 34% return on the price paid. (Have I here identified our old friend reversion to the mean as the reason for Saul’s high turnover? Clearly the trend of the growth rate is critical, to the multiple and therefore the outcome.)

However, it is interesting to see that holding on for another year, while it reduced the profit was in no sense a disastrous outcome, being a 24% return on the price paid, or say roughly 12% annualized.

It is also clear that real risk of paying such a price is a recession or collapse in the multiple of sales.

I am sure all this is wide open to criticism/comment and feel free to let rip! I expedited the math which I hope is right. For me, it is important to be able to make the case for going through the looking-glass, like Alice, into another and completely bizarre world!

3 Likes
#8

It’s easier for a company to go from 2b to 4b to 8b than from 8b to 16b to 32b.

There’s absolutely no evidence it’s easier to go to 4 to 8 than 8 to 16Bn.

Also, you would need to consider the risk that it’s easier to go from 4 to 1 than 8 to 2.

Both sides.

11 Likes
#9

There’s absolutely no evidence it’s easier to go to 4 to 8 than 8 to 16Bn.

I have no study to point to, but I pretty firmly believe that it’s always easier to double revenue from a smaller base than from a larger one

sure, some companies will get from 8 to 16 faster than they got from 4 to 8, depending on the circumstances of their business/industry/customers at that particular time, so maybe it was “easier” for that company at that time.

But all things equal, it’s easier to get from 4 to 8 than 8 to 16. Simply the fact that some companies get to 8, 10, 12b, but never reach 16b is evidence of that

-mekong

2 Likes