My explanation of our valuation expansion

Valuation matters. ZScaler is down 40% from this 5-month-old exchange. When expectations are high, results better come through.

This is NOT an “I told you so” because I didn’t get out of ZScaler. It’s just a warning (and a reminder to myself) that we need to think through the embedded assumptions that are priced into our stocks rather than anchor.

Assumptions > anchoring

For instance, let’s say a company became wildly overvalued at one point but is now 30% off from highs. Is that a good deal?

As with everything, it depends.

When I typed up this example with ZScaler, 35% growth for 5 years, with 25% margins and a 60 PE (with 5% dilution) came out to be an 8% CAGR.

Now, with those same assumptions, the forward returns are expected to be 22%. Sure, people can have differing opinions on what are reasonable assumptions, but that’s what we’re debating, the confidence of assumptions.

I do believe that analyzing the underlying business is more important than focusing only on valuation, but it is unwise to throw out economic reality.

Once again, this is not an “I told you so” but hopefully a lesson in checking assumptions when things seem to be getting euphoric. While this practice is obviously not perfect, I think it would serve investors well.