Picking exit points using valuation

There’s been a huge amount of talk recently about how overvalued our stocks are, and some were talking about exiting Zscaler or Okta because of their high EV/S ratios, so I thought I’d see how good those exits a week ago would have been on some of my stocks under discussion.

Zoom - The stock with the wildest EV/S of the bunch, was up the most this week, up 13.1%…

Zoom was followed by three other overpriced stocks, each of which was up over 7.0% this week: Zscaler up 7.1%… Mongo up 7.4… and Trade Desk (which a lot of people sold off), up 7.9%

Then I have two stocks up 4 to 5 percent: Twilio up 4.5% and Okta (Okta had the highest over-valuation except for Zoom and many people couldn’t understand how it ever could have gotten so over-valued), up another 5.0% and hitting another all-time high, again.

Then of course I had three companies with small losses of 1.0% or less. They were Alteryx, which had the best rating as I remember on the Oomph EV/S scale, but which was down 0.1%… SMAR, which I’ve never heard anyone accuse of being a top overvalued stock, down 0.3%, and Square, which is about as far from being a high flyer recently as you can get, down 1.0%.

What does this little experiment tell me? That making short term exiting or entering decisions based on over-valuation, instead of learning about the company, what it does, how well it’s doing it, and what its prospects are, was not going to get you very far, not this week at least.

Best,

Saul

81 Likes

“What does this little experiment tell me? That making short term exiting or entering decisions based on over-valuation, instead of learning about the company, what it does, how well it’s doing it, and what its prospects are, was not going to get you very far, not this week at least. “

Yep short term means nothing.

It seems to me that the names with the most momentum are being pushed up higher and higher and that list of names is becoming more and more narrow regardless of valuation.

These few names are being chased by fund managers that are underperforming I suppose. I suppose that the computer trading has something to do with it as well. Possibly.

At some point is there a P/S number that gets too high? Too ahead of itself?

If ZS for example ran up to a P/S of 50, would that be a reason to at least trim?

I trimmed my OKTA position at the close in my IRA today as it was growing a bit too large over the other names. Glad I didn’t sell two weeks ago, but felt it was a good time to take some profits.

2 Likes

I like to use the run rate of the last quarter x 4 for valuations.

I do this because,for a fast growing company, 4 quarters ago is forever.

A forward P/S requires guessing at what the growth rate is for 4 quarters.

When I do this for ZS, I get a P/S of about 33. seems very high.

ZS is accelerating growth.

Here is the Q/Q change sequentially since 2016 for ZS.

$ (millions)

2
3
3
2
4
4
3
5
4
7
7
11

So if they do 11 Million more in revenue the next 2 quarters sequentially, you have growth of over 70% the next 2 quarters and P/S back down to 25. Maybe a little higher from some dilution from more shares.

Still high but doesn’t seem bad for a 70%+ grower.

If they keep accelerating it could be even better.

Point is, they are growing like crazy, and accelerating. If they keep doing that, it won’t take long for the valuation to come down.

ZS is also my first stock to be up over 100% this year.

Jim

15 Likes

One can gather a lot of insight as to what weight valuation should have in investing with this study, and apparently many others agree.

My gratitude for Saul and his insights far exceeds my ability to express it. Same for others in this group, everyone keeping each other on check.

2 Likes

Good point Saul. Everytime I have trimmed purely because of valuation in the past I have lost money. I am curious to know if anyone has made money consistently doing that.

I’d imagine if you trim holdings based on valuations during a bull market, you will leave money on the table.

3 Likes

12k said: I’d imagine if you trim holdings based on valuations during a bull market, you will leave money on the table.

Possibly, but not necessarily true. I trimmed in Q1 and Q2 of 2018 all the way up to end of September, 2018. This resulted in more than 1/3 of my portfolio in cash. Then I held onto that cash. I plowed most of it back into the market on December 24 (Merry X-mas!!), 2018. This is when I built the majority of my positions in SaaS stocks, which before that were valued a little too rich for my liking. The results have been game changing for my portfolio (thanks Saul< TMF and all!). All of this happened within the decade long bull market we are experiencing. The key to this was easily understood probabilities based on MARKET values (not individual company valuations), which were historically high by the end of Q2 2018 and had dropped a little over 20% by 12/24/18 (the S&P, that is; Small cap index dropped 25% by that date). The S & P drops 20% on average about once every 4 years. If it happens, that’s a good time to start putting your cash into the market! (Can you say “understatement”):slight_smile: Market timing does actually work, if you get it right… (Sacrilegious, I know…)

As I stated before: there is more than one way to solve a problem. Blanket statements about what works and doesn’t work in investing are usually too general to be useful or accurate.

Just my 2cents,

Swift…
Long Saul’s board!

27 Likes

CMFSwift, You displayed uncanny timing in 2018 using valuations as a guide. What metric were you using since by most standards the S&P were valued higher in 1993 and 2000?

In my experience valuation is a horrible indicator for short term price performance, especially only 1 week.

1 Like

You displayed uncanny timing in 2018 using valuations as a guide. What metric were you using since by most standards the S&P were valued higher in 1993 and 2000?

A seriously blunt tool. God bless Mr. Shiller: :slight_smile:

https://www.multpl.com/s-p-500-price-to-sales

(Check out the "see also links. I look at them all)

One has to believe in the concept of a return to mean in order to act on this info.

I do. Many don’t. That’s cool. I’m an amateur, at best…

Swift…
Long Shiller… (?) lol

5 Likes

In my experience valuation is a horrible indicator for short term price performance, especially only 1 week.

Totally agree.

Swift…

I don’t think we should use short term price movements to confirm or refute anything. I’m pleased that many of my stocks are way up in a short period of time but in the short term that is nothing but noise. Stocks ebb and flow. The companies underlying performance is what matter.

Lets look at a couple of our stocks.

ZS- Its previous all time EV/S was 35. Today it hit 39. If you assume that next quarter will be around 60-70% growth over last year then once ZS reports in a few days they should be back down to an EV/S of 35. Personally I just see the market taking that into account and we are getting our price appreciation a little bit early. I think ZS has gotten a little ahead of itself but not horribly so.

OKTA- OKTA’s previous all time high EV/S was 26 when it was growing 60%. It is now growing 50% and its EV/S is up to 31. Lets say it has a solid beat next quarter and does a 130 million dollar quarter, its EV/S will still be around 28. Personally I think OKTA will need to accelerate its growth to or suddenly start throwing off tons of cash for it to justify that EV/S. I think OKTA is pretty overvalued right now unless it can do either of those two things.

MDB - Mongo’s high ev/s was 29, the stock price had fallen recently down to 130 which brought its EV/S down to 26.5. I see Mongo that has another couple of quarters of easy comps so it is going to put up some impressive revenue growth numbers. I bought more when its ev/s was at 26. I’m guessing next quarters growth will bring the ev/s back down to 26.5 so I personally think the stock has more room to run.

TWLO - TWLO’s high ev/s was 26, stock recently had a little rough patch which brought its ev/s down to 22. They were just getting to with in a range that I was interested in buying them as next quarter would have brought their EV/S down to the 20 range. I had a busy few days and missed buying them. Their price appreciation was just making up lost ground.

AYX - AYX has a high ev/s of 25, it is now 18.5. A little hard to compare because their old high was under ASC 605. I know some have worried aloud about slowing growth but so far we haven’t seen anything of the sort. We will see more variability in quarter to quarter numbers. I’ll take a 50-55% grower with 90% gross margins for an ev/s of 18 any day. Next quarter would bring their EV/S down to the 16 range. I’d buy more if I didn’t already own so much.

Finally, i think both SMAR and ESTC are good deals right now too. If ESTC continues its growth then its EV/S will drop to 22. It has been as high as 29 in the past which I think it will regain if the fears about amazon prove to be unfounded.

best,
Ethan

Anywho, buy the companies that are rocking their businesses. The numbers don’t lie for the most part…but they don’t look forward very well.

best,
Ethan

75 Likes

Believing in reversion to the mean is one thing. Being able to time it is quite another.

If one had sold out of stocks every time their charts said it was overvalued they would have missed some serious up moves. Valuation are always easy to spot in hindsight.

As far as I’m concerned the best strategy is to stay fully invested at all times. We saw two runaway bulls that had excess participation and valuation in the market as a whole in the last 150 years minimum, 1929 and 2000. Which was anyone’s guess as to when they would have ended.

So if you can routinely use your valuation charts to predict secular moves within a bull market you’re better than 99.99% out there. In other words most shouldn’t try this at home.

The best strategy I know of is to just stay invested at all times.

My whole question is to just disregard valuation altogether on individual stocks and just add if/when they become cheap since I’m still working.

But statistics say odds are against us buying high priced stocks. So we’ll have to be good spotting the ones that can outgrow the high price or get out in time.

5 Likes

I too read Robert Shiller and he was one of the few economists that sounded alarms in both the tech bubble and the real estate bubble. He is a behavioral economist.

I read more books than I can remember but was thinking about Shiller today because I’m reading another book by Richard Thaler that keeps referencing him, who is also a behavioral economist.

Economists can fall into two camps, traditional economists who believe in EMH and everything is the correct price because people are logical in their financial decisions or behavioral economists who study what people actually do. What people should do and what they actually do are often two different things. I’ve been studying this for 20 years and one of the things I keep reading about to this day.

I believe you were looking at CAPE which is Shillers 10 year moving average of the earnings and current price. That’s the ratio that is at multi year highs but not all time highs.

I don’t know why the CAPE ratio is so high compared to current PE ratio but I think it has to do with current earnings compared to the big losses in 2008-09 during the recession. Which are soon to fall off by the way. So CAPE should fall even if prices hold steady. Unless we get another huge recession this year!!!

But the timing of all this, one week, even one year is so difficult to do. If last week was a down week would it have changed our perception of what weight we should put on value? Are we getting another recession this very year that will keep the CAPE high and a signal to sell based on valuation? What I’m getting at is what you did last year was remarkable and great timing. If you can do that every year hats off to you but I’m inclined to think there was a bit of luck involved. After all we have people like Robert Prechter that can time the stock market successfully based on hocus pocus then fall apart later because their system does not really work.

11 Likes

“I’d see how good those exits a week ago would have been on some of my stocks under discussion.

Zoom…”

I can’t wait to read the month end portfolio summary to see what changed Saul’s mind into buying into ZM

2 Likes

If you can do that every year hats off to you but I’m inclined to think there was a bit of luck involved. After all we have people like Robert Prechter that can time the stock market successfully based on hocus pocus then fall apart later because their system does not really work.

Hey 12x, I’m going to respond once realizing this is getting OT for Saul’s board. Happy to continue off board. Yes, there was, no doubt, some degree of luck. I am a long time poker player, so I have a working understanding of how skill (i.e. preparedness) and luck can combine at times for big pay offs. :wink:

You are correct CAPE was central (although it is not all I was looking at among those charts I linked). In addition to Shiller index data, the economy was heating up. I assumed that meant FED would act. You do realize, I hope, that if the FED raises rates consistently over 2-3 quarters our hyper growth stocks (and the market as a whole) are toast for a while, right? So that is what actually began to happen (as I thought it would). In 2018, Mr. Powell got a little too big for his britches, raised rates once, thought that he would do it again. And eventually got taken down (after a while). Meanwhile as the market tanked on these fed actions, on December 23rd Treasury Secretary What’s His Face called the biggest banks in the US to innocently inquire about their liquidity (DOH!)…By the 24th, it was game on.

So yes, I pulled a 1/3rd of my funds into cash when the market got over heated (i.e. paying attention to the Shiller and other economic data), then got lucky in Q4 with a combination of the FED acting as I supposed it would (a well grounded guess from paying attention) and a certain administration official pushing the panic button on the market (this was blind luck-- I could not have predicted such a fortuitous --and downright foolish (small f)-- act as that of the Treasury Secretary…calls made, by the way, reportedly from his vacation location somewhere in the tropics…lol).

I don’t think it is possible to make a move like this every year. Conditions have to line up, as they did in 2018. The FED is now clearly completely subservient to the President. That was not the case in mid-2018. How the Fed acts and the policy pronouncement they make has a great deal to do with how your and my portfolios performs. I know we want to think we are brilliant here, but there are system level forces at work that provide the enabling conditions for all of this frothiness–you doubt that at your peril, IMHO. And you fight the Fed at your peril, as well. I am not at 30% cash now, even though the Shiller data suggests we are almost back to where we were in Sept. of 2018. Why not? The Fed is not likely to even ponder raising rates at this point, or even make noises like that might, IMHO. This means the market and our stocks will continue to be puffed up (to use a technical term)by FED policy.

If I get a chance again to do what I was able to do in December, 2018 in my investing career, I will be surprised. But there is always the ability to pay attention to the regular ebb and flows of the market and respond accordingly.

And yes, as Saul noted at the start this thread, understanding the fundamental workings of the businesses we are invested in gives us the greatest edge in attempting to achieve market beating results. I agree with this wholeheartedly.

That’s all I got on this. Not going to continue an OT on the board here.

Best, Swift…

12 Likes

12k said: I’d imagine if you trim holdings based on valuations during a bull market, you will leave money on the table.

Swift said: Possibly, but not necessarily true. I trimmed in Q1 and Q2 of 2018 all the way up to end of September, 2018. This resulted in more than 1/3 of my portfolio in cash. Then I held onto that cash. I plowed most of it back into the market on December 24, 2018. This is when I built the majority of my positions in SaaS stocks, which before that were valued a little too rich for my liking. The results have been game changing for my portfolio.

Hi Swift, I think you are missing a huge piece of the puzzle. I stayed essentially fully invested, as I advocate. In overpriced SaaS stocks. In the Oct to Dec crash, my bottom was also Dec 24th, but at that point I was up 48.5% for the year. I then rode the same wave you have ridden since then, but mine was compounded on top of that 48.5% gain while yours had been in cash. Clearly 12k was correct and you left money on the table. (A lot of money). Plus, I’m sorry to say, if you think you will have the good fortune to happen to buy in at the exact bottom of the next descent the way you did on this one, I’m afraid you are deluding yourself.

Best,

Saul

And I’m sorry to have started this OT thread, which now has 17 posts on it. It’s a harmless pastime for the end of the week but lets cut it off at a maximum of 20 posts. Thanks everyone, for your cooperation.

23 Likes

Saul bought into ZM? Did I miss a post on this?

2 Likes

I understand what you are saying Saul. And agree if all things were equal.

But what you re not understanding is I used the opportunity of a rising market and then a falling market to completely rework my portfolio from early 2018 to end of 2018. That was the game changer, moving from a ton of stocks that were barely beating the market into a SaaS dominated portfolio when most of those stocks had shares cut down by 40-50%. I went from close to 50 stocks to around 15 by selling in the first 2 quarters of 18 and then buying the vast majority of my positions in SaaS stocks in late December. I continue to reorder positions into early 2018, so that now my portfolio of 14 stocks is dominated with hyper-growth. It was fortunate timing no doubt and as I mentioned in my previous post, I do not expect to do it again. It was a perfect storm of specific circumstances that worked out well. Coming back to the original theme of this thread: I am fairly sure I would moved so aggressively in SaaS in December if valuations were where they are today. Overall, the price being offered is much less attractive, IMHO.

Is that post #20? I’m done, I promise…

Swift…

12 Likes