As we approach the end of the year and soon begin a new annual scorecard I wanted to post a few thoughts about our investing activities. I’ve been an adherent to this board nearly since its inception. Knowledge and thought processes freely given by Saul and many others shared on this blog have been the primary source of investment information for me over the last several years. I am indebted to the many experienced and intelligent folks who post here. I am deeply grateful, even to the occasional detractor who feels they must post in order to protect us from us. The rebuttals often carry valuable information for those of us who adhere to an investment strategy centered on companies with high revenue growth. But that leads me to my primary subject.
That subject being investment analysis based on the financial reports and the ability compare likely future performance across different companies based on mathematical functions.
There is great comfort to be gained from financial analysis. Math is remarkably consistent and reliable. We can argue about assumptions, will growth taper in eight quarters or twelve? Will SBC remain at the same level or be reined in sooner rather than later? Etc, etc. but you can’t argue about the math (not at this level anyway). At best you might point out a mistake. That’s not an argument, either a mistake was made or not.
Here’s the thing. Financial analysis has never been wanting for mathematical treatment of financial reports. Quite some time ago, before Saul started this board I was attracted to the notion of mathematical treatment as a guide to investment decisions. As noted, I found a level of comfort in mathematical analysis. Due to the fact that math never fails I gained a false sense of certainty in mathematical analysis of financial results. But the more I read about and studied financial analysis with respect to investing the sense of certainty began to fade as things became ever more bewildering. It’s not hard to find methodologies that employ 2nd and 3rd order derivatives of certain aspects of financial reports. It was not that rigorous mathematical analysis was difficult to come by, it was rather that it was difficult to understand how certain techniques provided useful information and what to make of it if one ratio appeared to contradict a different derivative. I could follow the math easily enough, but I struggled with the relative importance and value of the different indicators.
Then I came across Saul’s relatively new board. I think there were fewer than 1,000 posts when I first started following this board. Mind you, this was long before SaaS was a thing. At the time, Saul relied heavily on the simple old P/E ratio in his analysis.
Two things initially attracted me to Saul’s approach and made me an early adherent to his approach. The first things was his documented history of spectacular success. I suppose I might have worried that it was a fabrication, but I never seriously entertained doubts regarding his trustworthiness and candor. I mean why go to the trouble of creating such an elaborate hoax in order to establish a fee free information resource. Had he been selling a service and just had a board as a means of attracting potential clients an elaborate hoax might make some sense. But he was just giving it away and encouraging other to do the same. So I took it at face value. Establishing trust was a vitally important first step. The next thing that attracted me to his methodology was it’s apparent simplicity. Saul had (still has) an uncanny ability to ignore the unimportant. That sounds obvious and trivial. It’s neither.
I think Saul would agree that with the SaaS companies we entertain as investment opportunities, there are more meaningful variables than companies of the “old” economy. We never looked at ARR before because it didn’t exist. But given the somewhat more complex financial picture, Saul most often looks at the simple reports and 1st order derivatives (i.e., rate of change of a given variable). I may be wrong, but I don’t recall Saul presenting a complex multi-variate formula as a key financial analysis tool. He just doesn’t go there. To the best of my recollection, the most complex indicator Saul ever proposed was the 1YPEG (remember that long time members?). And he’s repeatedly demonstrated that it’s unnecessary to go there in order to have success as an investor. Most certainly, Saul is capable of performing analysis of greater depth and he’s done so on a few occasions in order to reveal “hidden growth” or just the opposite, but it’s not a routine part of his analytical methodology.
So as we round the corner into a new year I just want to put forth a reminder for us long time followers and maybe a notification for the more recent followers that Saul’s method does not rely on a lot of sophisticated mathematical techniques. It’s all based on simple arithmetic utilizing the company numbers as reported. If there’s any secret sauce, IMO it would be that Saul always seeks to understand why unexpected results occur. The primary reason Saul always uses adjusted reports is to eliminate the influence of financial outliers that are the result of one-off events that mask business operations. But given that, if there’s a sudden departure from an established pattern, Saul always seeks to understand what happened and why. He’s never satisfied with just recognizing the disruption, he needs to know the reason.
Complex numerical analysis might be an interesting intellectual exercise, but for the most part it’s just not necessary.
KISS - - - and happy holidays. And deep thanks to the many contributors here who have literally helped to enrich my life.