I wonder, however, why you put it this way when you seem to mean the exact opposite: for all the temporary overshoots and undershoots, the broad market fluctuations, and the post-IPO craziness, the market on the whole “gets it” while individual investors, funds, or talking heads struggle and refuse to buy a pricey stock until it is mainstream enough to do so (or for good).
That’s definitely not what I mean. If the market “got it” then we wouldn’t have Saul getting “ridiculous” returns. It’s not just undershoots and overshoots, or volatility, or even rewarding extra risk, these stocks are vastly exceeding market returns. If the market was efficient, these SaaS stocks would “hockey stick” during the period where they gain viability, but then achieve an extremely high valuation that reflects their future market dominance. Instead, the hockey stick is much more gradual than it should be, as the market takes much more “convincing” than it should. Thus providing a (fairly long) window where these stocks are vastly undervalued. But more on this later.
I feel like the “talking heads” don’t get it because it’s not in their interest to get it. They will, almost by definition, take both sides and talk “the controversy”. You can’t have stocks at these relative valuations without talking heads getting into a lather about it. They have no interest in getting people to buy stocks or sell stocks, they have an interest in having people watch them because they feel scared, or greedy, or intrigued.
But let me address Rob’s question first.
One concern that I have for companies that have no net margin is, how do you know the business model works? What if SGA always exceeds revenue?
Well there is the trillion dollar question. If it were obvious then everyone would do it and there wouldn’t be this evaluation discrepancy.
Because this, arguably, is the other half of the question above. Why aren’t there more funds that also take advantage of this? Because it can be hard to tell the Cloudflares from Nutanixes. Even this board, with its track record of success, has had some “swings and misses”.
I do think that a big part of the reason this evaluation discrepancy exists is fear. We can look at a Cloudflare and see that the business model works. We can see the future fairly easily. But it still isn’t making any money. There are still articles on SeekingAlpha that insist that it is “priced perfection”. It is very hard to have the discipline to hold in the face of dips. It is very hard to have the discipline to hold even in the face of gains!
And on the flip side, it’s also all to easy to get greedy and see these discrepancies where they don’t exist. (Thus the swings and misses.)
But, nonetheless, as evidenced by Saul’s returns, on average, I still think there is a gap between where the market is currently evaluating these companies at, and where they deserve to be. It may not be easy, but it can be done.
And, so, after much rambling, my only real answer to “how do you evaluate these companies” is to read the Knowledge Base and to read the analysis here.
The Gardner brothers coined this as Rule Breaker key trait (perceived as overvalued by traditional metrics) and turned it into a requirement.
I do think there are some strong similarities between Rule Breakers and Saul Stocks but also some minor differences. (I have been reading the Fool for an absurdly long time but do not subscribe to Rule Breakers.)
I probably shouldn’t express my opinions since my knowledge of Rule Breakers is so out of date, but I feel like Saul’s criteria are much higher in multiple dimensions.