OT: Valuing SaaS stocks - more interesting now?

Stocks A to Z
1

You might understand that I am asking this here and not on Saul’s board where it would be much more OT to ask such than here.

As you probably know most SaaS stocks did lose 2/3 or 3/4 of their price the last 6 months (f.e. our very own Snowflake from $400 to $166). There is no more posting about them here (apart from DTBoojum re Upstart) as if they are “dead” now.

Are they? Or are they au contraire interesting now? Thinking along the lines “buy when … canon thunder … blood on the streets”. Because something did fall far it does not mean it necessarily is cheap now, so the question is: Are they cheap or not? How to value them? How to see their current price, their future etc.? If allowed at all on Saul’s board the answer naturally would be “Great future. Rosy.” - which is exactly why a discussion HERE makes more sense.

Maybe a discussion now is even more worthwhile for the esteemed members of this board than 6 months ago, at a time when there actually were heated discussions about SaaS?

8 Likes
2

Are they cheap or not? How to value them? How to see their current price, their future etc.?

I recently bought a bit of SNOW. I traded CRWD for a small profit. I’m looking at ZS, DDOG, and MDB. One values them (or ought to) exactly the same way one values any investment: in terms of estimated future cash flows. As Saul notes, these companies generally have very good prospects for enjoying predictable, fast-growing, high-margin revenues. If you do the math, a price/sales ratio in the range of 20 or so is not a terrible place in which to dip one’s toe. They’re not there yet, although MDB is getting close.

Unlike most of the “investors” on Saul’s board, I remember how it turned out when fintech geniuses, whether artificially or organically intelligent, made loans to sketchy customers, bundled said loans, and sold them to folks who should’ve known better. So I’ll pass on UPST, thanks (as has Saul).

Look, Saul’s basic argument is that if you can identify these kinds of companies when they’re still small and flying under the radar, you can make a tidy profit without concerning yourself about whether you should pay $25 versus $28 per share. It’s not an unreasonable argument. Unfortunately, many of Saul’s current followers piled in at $250 a year later, after the companies had been discovered and the prices had gone berserk.

6 Likes
3

They’re presumably much more interesting now than they were then.
The boring question is whether they are more interesting that other hunting grounds.

Or less work.
There is something attractive in the notion of waiting for a two foot hurdle.

Jim

5 Likes
4

One values them (or ought to) exactly the same way one values any investment: in terms of
estimated future cash flows.

What are the future cash flows you estimated for SNOW that triggered you to buy and how did you
estimate them?

As Saul notes, these companies generally have very good prospects for enjoying predictable, fast-
growing, high-margin revenues.

He notes high gross margin. He doesn’t address net margin. Other than statements to the effect that
they could make money anytime if they stopped investing in growth. What would happen to these firms
if they stopped growing?

If you do the math, a price/sales ratio in the range of 20 or so is not a terrible place in which
to dip one’s toe.

I’d be interested to see your math.

Unlike most of the “investors” on Saul’s board, I remember how it turned out when fintech
geniuses, whether artificially or organically intelligent, made loans to sketchy customers, bundled
said loans, and sold them to folks who should’ve known better. So I’ll pass on UPST, thanks (as has
Saul).

Upstart isn’t in the business of making loans. Their business is software which they sell to
businesses that make loans.

It’s not an unreasonable argument.

Yes, many of his arguments have the same appeal as a chain letter.

Best,
Ears

11 Likes
5

“earslookin is already one of your favourite fools.”

2 Likes
6

In the “old” days, when Buffett and Munger were more visible in the media, I often heard them say things like:

-Just because a technology is good for humanity, doesn’t make it a good investment.
-I prefer stepping over a two-foot hurdle to doing the high jump.
-There’s lots of ways to make money. [meaning they aren’t interested in a lot of them and don’t care if others make it those ways.]
-Get rich slowly.
-stay inside your circle of competence
-don’t risk something you need for something you want.

Someone quoted Charlie in a post the other day, that if Warren had to use a pencil to figure out whether an investment was a good deal, it was too hard and he probably didn’t do it.

None of this has anything to do with future cash flows, et al, however it does have something to do with Charlie’s concept of having a lattice work of concepts.

Can any of these be applied to those “Saas” companies as filters? Forest-for-the-trees-like? That, with what earslookin just posted should give you a good answer.

This is the Berkshire Board, after all, so speaking for myself, I’m trying to stick with the concepts used to make Berkshire the success it is and learn from them.

My fomo about making money fast caused me to pull the trigger on some things that were based on nothing but fomo. Oops! Not a big problem, but made me ill after I did it.

Being able to sleep at night is a great concept as well–not the for the live fast and break things crowd, but the tortoise did much better than the hare. JMO

5 Likes
7

I’d be interested to see your math.

Here’s a not unreasonable recent example using MDB:
https://finance.yahoo.com/news/calculating-intrinsic-value-m…

M* does the standard DCF and estimates fair value for ZS at $265. (It’s at $208 now.)

And apparently someone at Berkshire thought SNOW was a good deal at a price above where it is currently. You might ask them.

In any event, I’m not trying to convince you of anything, or do your DD for you.

2 Likes
8

Before Powell said what he said SaaS stocks were DEEP in the red, -5% to -10%. Many other stocks were in the red too, FB, BABA etc. Now the same SaaS stocks are mostly up those +5% to +10%. FB also is up 5%, our very own BRK 2.5% etc.

It completely turned around 180 degrees because of Powell essentially saying that while 0.5% increases will continue to come there won’t be 0.75%. Does this market reaction really makes sense? I see it just as a sign that the markets are crazy, completely irrational currently.

And this from Powell: “It’s a very difficult environment to try to give forward guidance sixty, ninety days in advance” also is not exactly reassuring. Guidance for just 60 days can’t be expected, is too much asked?

3 Likes
9

Upstart isn’t in the business of making loans. Their business is software which they sell to
businesses that make loans.

Well, there’s this: “Financial institutions can partner with Upstart and use its platform to originate and retain loans on their balance sheet. But most Upstart loans are still coming to the platform organically, and the company still sells most of its loans to institutional investors while it continues to ramp up its bank partnership model. It does this partly through ABS, which are financial instruments that allow a company to pool loans together and sell them to investors. The investors are essentially paid from the cash flow of borrowers paying off their loans.”
https://www.fool.com/investing/2022/04/28/potentially-huge-c…

Either way, the business depends upon either Upstart or the financial institutions to which it sells its services being successful at making loans to heretofore risky applicants, and then the bulk of those loans will be bundled and sold. To which I repeat: no, thanks.

2 Likes
10

I started a thread about Upstart not too long ago when it was tanking down into the lower $70 range. I know they aren’t strictly SAAS, but kinda similar in some ways in terms of lightweight business model, rapid growth, big TAM, etc …

https://discussion.fool.com/ot-upstart-upst-35096007.aspx?sort=w…

Stock is back into the low $90 range today, so it’s not the same value, but in the lower $70s it was trading at PE ~52, and with expected growth this year of 65% and a huge and growing TAM, it seemed like a reasonable place to buy into the business to me.

I didn’t do a DCA or anything, but it’s not too hard to see if the growth keeps up for long, my purchase should look good.

The SAAS stocks that aren’t profitable yet and you’re paying 30*sales or more aren’t too interesting to me, but UPST with similar growth and robust profits did grab my attention.

I understand some aren’t as interested in UPST for whatever reason. Saul says he didn’t feel comfortable that he knew what was going to happen with their earnings at any given time, too opaque, less automatic than the best SAAS. MisterFungi is concerned about their involvement in loans to riskier segments of the population. I see a market that appears highly amenable to being disrupted by their approach bringing deep machine learning to loan qualification, and I see a great management team, a great record driving to robust sales and profitability in personal loans, now doing the same with auto loans, with early indications that’s going great, and even bigger markets to come.

I’m not buying here, but I like my entry points at $73 and $75 last month.

3 Likes
11

And apparently someone at Berkshire thought SNOW was a good deal at a price above where it is currently. You might ask them.

I may be wrong, but I believe Todd/Ted established the position at the IPO price of $120.

2 Likes
12

I may be wrong, but I believe Todd/Ted established the position at the IPO price of $120.

Righto. Today, you could’ve bot SNOW @ ~$168, so about a 40% gain in approx. 1.5 years from the IPO price. That’s a solid gain, but I’d submit that, particularly since SNOW now has 1.5 years of very good execution as a public company, today’s price is high but not absurdly so.

SNOW reports in 3 weeks.

1 Like
13

You are correct, sir.

14

Here is my model for MDB


	        2018	2019	2020	2021	2022	2023	2024	2025	2026	2027
Revenue	         166	267	422	590	874	1311	1966	2851	3991	5389
Growth %	        61%	58%	40%	48%	50%	50%	45%	40%	35%
shares	          24	52	56	59	65	70.2	75.114	79	83	87
Growth %	        117%	8%	5%	10%	8%	7%	6%	5%	5%

You can see past 5 revenue, share count and their growth numbers along with next 5 year assumption.

Assuming 20% net profit margin (which is generous) and the share price has no appreciation for next 5 years,


Net Profit at 20% of revenue	1078
EPS				12.282
Today's price			$360
PE				29.32

You are assuming MDB can grow at very high clip for the next 5 years, still with no share price appreciation and 20% net margin (which I highly doubt they can achieve), still you are seeing 30 PE after 5 years.

I like MDB as a product and I am sure they will continue to grow, unless you have a historical cost basis, it is not worth buying now.

Today is the first hike, we know Fed has plans for many more hikes, when they will stop, how QT is going to play out needs to be seen. If Fed manages to engineer a mild/ moderate recession what it will do to MDB revenue?

1 Like
15

I’m not buying here, but I like my entry points at $73 and $75 last month

IF you think UPST will survive the recession (if and when it comes, and whether it is mild/ moderate/ severe) then $75 or $95 doesn’t matter, it is a buy. If you are someone who is worried that the model has to go through a recession and survive then even $75 is a high price.

3 Likes
16

If Fed manages to engineer a mild/ moderate recession what it will do to MDB revenue?

MDB is 40 to 60% cheaper than Azure and Amazon for nosql databases, maybe they’d pick up some business. My company didn’t find the savings compelling to switch from 100% azure to like 10% MDB and 90% Azure, but if costs become more of an issue maybe it would go for it, I doubt the pressure to control costs is high right now so IT just says no thanks to another project. OTOH the cloud pricing is such so that you tell Azure you’re moving stuff out and they reconfigure what they charge and it looks good so you don’t switch then your total spend is the same as it was 3 months ago because they are raising rates on something else. Also you can just put your mongodb on your own server and pay nothing, although devops doesn’t really do on prem anything anymore most places, better to blame Azure for your failings.

My guess would be they continue to grow at a rate better than their peers, whether the group continues to grow at a similar rate seems less likely, alot of this IT stuff is hype and doesn’t generate revenue or even save money.

1 Like
17

You are assuming MDB can grow at very high clip for the next 5 years, still with no share price appreciation and 20% net margin (which I highly doubt they can achieve), still you are seeing 30 PE after 5 years.

I basically agree, which is why I offered 20x revenues as a roughly right valuation. That works out to $280-$290 vs. today’s $360/share. So, I’d need around a 20% drop from here, with the underlying business unblemished. Certainly could happen.

18

Re MDB, last night I wrote: That works out to $280-$290 vs. today’s $360/share. So, I’d need around a 20% drop from here, with the underlying business unblemished. Certainly could happen.

Well, half of that’s happened in a matter of hours!

FWIW, I’m not an aggressive investor. I’ve been ~60% cash (real, actual cash) for at least a year, waiting. At least now I can get a better (nominal) return on the cash while I wait. But I’m warming up in the on-deck circle.

19

You are assuming MDB can grow at very high clip for the next 5 years, still with no share price appreciation and 20% net margin (which I highly doubt they can achieve), still you are seeing 30 PE after 5 years.

…

I basically agree, which is why I offered 20x revenues as a roughly right valuation. That works out to $280-$290 vs. today’s $360/share.

The problem I see is that the range of possible futures for the business in which this is a good investment all range from very good to extremely good. There are outcomes that are simply good for the business (rather than very/extremely good) but aren’t good for the investor.

For example, if this company goes on to earn $10 billion ten years from now, that would be an extremely good business outcome. It would mean the company has grown to where Oracle is today. In that scenario, with a 25 P/E, the company would be worth $250 billion, which would be more than a 10-bagger from today, at least 26% annualized for the investor.

But if this company earns only $1 billion ten years from now, on a 25% net margin, that would also be a good business outcome. It would mean the company has become highly profitable, with sales of $4 billion, compared to being highly unprofitable with only $874 million in TTM sales. That would translate to 16% annualized revenue growth over the coming decade along with a big pivot to profitability. But at that same 25 P/E, it would only be worth $25 billion, less than 20% improvement from today’s prices after the big decline, or less than 2% annualized as an investment.

So the range of possible futures are something like this:

  1. Extremely good business outcome, very good investing outcome
  2. Good business outcome, inadequate investing outcome
  3. Poor business outcome, permanent loss of capital

To put this in price terms, if you think option 1 is very likely, you would be very willing to pay the current price against a $21 billion market cap. The mungofitch model would say you could actually pay up to 5 times the current price and do well. (That model says you can pay, today, up to 10x the earnings that you expect 10 years from now, so if we pencil in $10 billion for those earnings, you’d value the biz today at $100 billion, or nearly 5x the current $21 billion).

But, if you want to require a higher margin of safety so that you get an acceptable return even if option 2 plays out, then you’d pay no more than $10 billion for the company, or half current prices.

Lastly, if you think option 3 is a possibility you should account for, you either avoid it completely until you have reason to believe differently, or at least, you demand a much lower price.

You might also want to discount all of the above scenarios to account for the steady dilution - it looks like shares outstanding have risen from 500 million to 650 million in three years, or about 9-10% per year.

Rob

5 Likes
20

The mungofitch model would say you could actually pay up to 5 times the current price and do well.
(That model says you can pay, today, up to 10x the earnings that you expect 10 years from now, so if we pencil in $10 billion for those earnings,
you’d value the biz today at $100 billion, or nearly 5x the current $21 billion).

FWIW the rules I use:
Pay under 12 times the “pretty darned sure” average EPS 5-10 years out, you’re not overpaying and you’ll probably do fine.
Pay under 10 times the “pretty darned sure” average EPS 5-10 years out, you’ll almost certainly do quite well.

I think of it as the average 5-10 years out rather than a 7.5 year outlook because it’s not just cyclical adjustment,
but also the assumption that growth rates taper over time, fading to “boring” at or before the decade mark.
The multiples are picked based on the assumption that no firm is so predictable that you can
forecast with reliability that it will have an above-average value growth rate over a decade later.
You can hope for it, but not count on it.
And as growth rates fade, so do terminal multiples.

The “pretty darned sure” part is important…
The multiples assume that the earnings estimate is conservative enough to carry part of the margin of safety.

The only cool/interesting thing about this approach is that it applies to almost anything that might one day have a stream of earnings.
Flatline cash cows, slowly fading businesses, solid growers, or zero-earnings high growth money losers.
And Beanie Babies.

Jim

14 Likes