SaaS valuation

I have been following this board on and off for a while, amazed at the success everyone here has had. Some of the returns I see posted in monthly updates are mind blowing, congratulations to all of you!

My goal following this board is to challenge my own investing beliefs and to learn. I understand the key themes - SaaS companies should be valued differently due to recurring revenues, 70-90% GM etc. and they make sense.

But how differently or how high can the multiples be? It’s not limitless, that’s the argument given for dotcom companies in the 90s and that sentiment only got louder as the bubble peaked (pretty much true for every bubble since the tulip days as it was in some way or form rationalized). The absurdity of the valuations became apparent only after. When YTD returns for not one stock but a basket and even an industry are >200%…you might be in a bubble or close to a peak.

Please read my post as a viewpoint from someone outside and I hope it’s helpful. I’m not an expert in SaaS as many of you are, so would definitely like to know where I’m wrong.

Using CRWD as an example, a company with amazing growth. Here’s their EPS (over the past 10 quarters) I took from another thread …

"Non-GAAP EPS Growth:
EPS $(0.73) $(0.69) $(0.64) $(0.60) $(0.47) $(0.18) $(0.07) $(0.02) $0.02 $0.03 $0.08 "

It’s hard to sustain this growth over the next 10 quarters (law of large numbers) and if somehow they do, you’re looking at a $1 EPS quarterly. That’s $4 / yr 3 years out, if CRWD doubled from here it’ll have a P/E of 82 and a market cap of $75B. Few questions

  1. Do you believe that PE would be justified for a company that surely won’t be growing at 80% (or even 40%) a year forever?

  2. Am I wrong in assuming EPS would be $1 / quarter 10 quarters out. Are you expecting that to be a lot higher due to higher net margins?

  3. None of these companies have the reach of an Amazon / Google. With their focused nature, I assume we’re not looking at multiple $100B market caps. Is this not a correct assumption?

One last thing, capitalism is inherently brutal and this gaudy growth will inevitably attract well funded competitors (there’ll always be someone willing to do what they do for say 50% GM). And technological change is only accelerating which means some of their core advantages could be obsolete in a few years.

-T2SP

13 Likes

My short answer is to read the Knowledgebase, as it will thoroughly address your concerns.

13 Likes

But how differently or how high can the multiples be? It’s not limitless, that’s the argument given for dotcom companies in the 90s and that sentiment only got louder as the bubble peaked

There is a false assumption in comparing now to then. The real issue then was not just that valuations kept going up and up, but that the increase wasn’t based on anything. In quite a few cases highly valued companies didn’t seen to even have a business plan of how to make money, they were just exploring something that someone found interesting.

Now, the companies we discuss here have valuations which are going up and up, but so are revenues and free cash flow … at monstrous rates. Some of that is the SaaS business model which facilitates rapid growth, particularly if the business has limited capital requirements and is easily scalable, but not every business discussed here is SaaS.

7 Likes

"Now, the companies we discuss here have valuations which are going up and up, but so are revenues and free cash flow … at monstrous rates. "

I agree that SaaS companies should be valued higher based on their advantages such as high recurring revenue, GM etc.

I’m just trying to understand how high and what should be acceptable. Is 50 times price / sales good enough, what about 100? Clearly at some multiple every business, however good they are, will become egregiously overvalued correct…

Also, the very high GM could become a threat in itself. Eventually others might be willing to sell the same for less forcing the companies to reduce price or grow slowly (even with first mover advantage).

2 Likes

T2SP,

No offense, but we get a few folks like yourself every few months on Saul’s board doing what you’re doing (whether you know it or not), asking how we think what we’re doing could possibly continue working and warning us that we’re in bubble territory and it looks an awful lot like 1999. We’re big boys and we realize drops can happen and there’s no guarantee of the future, but we also don’t think the stocks we’re invested in are done growing (that’s why we’re invested!).

I noticed you posted a couple posts here in Aug regarding the valuation of DDOG (re: P/S and future fcf), and then a couple more today concerning CRWD (re: EPS!!) and overall SaaS valuations. But prior to that you posted a lot on a crypto board. Now I’m the first to admit I know practically nothing about cryptocurrency/blockchain stuff, but the last thing I would do is go onto a board that discusses those things and try to tell the participants that their investments are going to tank at some point and they’re all going to get killed.

Your last post was asking, “I’m just trying to understand how high and what should be acceptable. Is 50 times price / sales good enough, what about 100? Clearly at some multiple every business, however good they are, will become egregiously overvalued correct…” If you’ve read this board for any amount of time you would know that Saul does not consider valuation at all when making investment decisions. It comes up from someone every now and again and usually come to the same conclusion, “expensive” companies keep getting more expensive (if they’re good companies), and “cheap” companies are that way for a reason, and typically keep getting cheaper (Tinker’s theory, which seems to hold pretty true). Not everyone here is as cut and dry about not using valuation as Saul, Bear brings it up now and then, and just posted results YTD of a quadruple for his portfolio, along with holding around 25-30% cash right now (I think because he feels the valuations are pretty high for most of his holdings).

We had a good test of the “valuation” argument recently with SNOW’s IPO a couple months ago. It’s P/S has been over 200 since it’s IPO. I won’t touch it at that, but many have (and are up 60%!). We all don’t invest the same here, some invested in SNOW, many haven’t yet, Saul took a small position and ended up selling it because he thought he had better opportunities elsewhere. So to ask if 50, or 100 is too high, it’s different for every person, and different for every company. ZM is another you could look at that’s had a P/S near 100, DDOG and CRWD floated around 50 P/S. I think CRWD is perfectly justified around a 50 P/S with how they’re executing. But you’re not going to get one number that will work for every person and every company.

Then you state, “the very high GM could become a threat in itself. Eventually others might be willing to sell the same for less forcing the companies to reduce price or grow slowly (even with first mover advantage).” Of course we realize that could happen, but we’re not forced to hold these companies forever, again, if you’ve read enough of the posts on this board, you’ll realize that competition is being tracked and if it shows up as a threat to a company we own, or there’s an execution problem at one of our holdings, there’s a good chance many will cut that position or exit completely depending on the severity of the threat/disruption, while others (myself, usually) may take longer to come to that conclusion.

I am definitely not one of the best investors or contributors to this board, but I read every post and try to constantly learn and get better. Most of the great investors here have tripled their portfolios YTD, I just heard of the first to quadruple. I’m chopped liver compared to them, I’ve only over doubled my portfolio YTD, yet I am eternally grateful to this board and the members that unselfishly share their knowledge with others here (Saul, Bear, Gaucho, stocknovice, Muji, etc). They (and others) have changed my and my family’s financial life forever! I retired at the beginning of this year, yet YTD, I’ve made (on paper) approx 20X my yearly salary from 2019!

I’ve been on the board around 5 years, it took me awhile to fully embrace the philosophy, but I’m glad I stuck around and learned. And in that time, we’ve seen multiple drops of 20-60% in our stocks, some justified, some not, but you know what, the good companies just keep coming back, and the companies that appear to deserve being taken to the woodshed, we get out of.

So you don’t need to worry about us here, although you’re welcome to stick around and learn if you want, but nobody’s making you stay here if you think what we’re doing is dangerous/stupid.

125 Likes

How I explain it to friends who ask about valuation is that unless you can predict how the market is going to value a stock, buying based on valuation is just speculating. An undervalued stock can get more undervalued just as an overvalued one can stay highly valued indefinitely. Maybe there is a perceived floor but going from a P/E of 2 to a P/E of 1 is just as bad as going from 300 to 150.

I invest with the expectation that earnings will rise, and let the valuation fall where the market deems appropriate. The SaaS business model has simply made it much easier to predict rising earnings. Even the companies that fall out of favor on this board do so because they’re “only” growing 30%, whereas the traditional business models could rise or fall each year based on that year’s sales.

13 Likes

Jim Cramer said something recently about the cloud-stocks that sums it up quite nicely. It went something like “They are all priced like winners. Until they lose.”

This is precisely what is happening in the market and which can also be formulated as “winners win” or, on the flip side, “cheap gets cheaper”. Valuation does matter. But business fundamentals are so much more important. That’s why you have to watch high-growth companies in rapidly changing industries very closely.

Is there a bubble? You only know in retrospect. In my opinion, the financial crisis in 08/09 and now the coronavirus pandemic have profoundly changed the way public markets are valuing assets. This is because of unbelievably high liquidity flushing the markets and very low interest rates (read: zero) that will have to stay that low probably for a very long time. Both of these factors are inflating assets. If anything there is an “everything-bubble”: stocks, bonds, real estate, you name it. Stocks are not overvalued compared to other assets. And especially high growth stocks are not overvalued if they manage to grow at high rates for a long time. If you grow 30% a year for ten years your revenue is up 10x. Add another 5 years and revenue is up 5 more times or 50 times in total. Saul used shorter time frames and higher growth rates in his examples (50% for 4 years is 5x). The point is the same: Some companies will manage to grow like that and these will be undervalued today under almost any circumstances. Add to that high margins in winner-take-all/high-moat industries and you really have something.

28 Likes

Is 50 times price / sales good enough, what about 100? Clearly at some multiple every business, however good they are, will become egregiously overvalued correct…

The issue is not which value of which magic number is the upper limit, but that companies like these create an environment in which such traditional metrics are meaningless. A company growing at 50% or more a year is going to grow into any valuation in a remarkably short period of time.

Also, the very high GM could become a threat in itself. Eventually others might be willing to sell the same for less forcing the companies to reduce price or grow slowly (even with first mover advantage).

First they have to make the “same”. These companies are not growing at the rate they are because they offer some commodity item at an attractive price, but because they offer something uniquely compelling.

19 Likes

Foodles, I think you misunderstood the intention of my post. My goal is to better my own investments, I don’t waste time telling others they could be wrong and definitely not to a group who has had phenomenal returns.

For someone with a 200% ytd return, even if there’s a 50% haircut they’ll still be handily beating the market. But for someone thinking of getting in, that could be devastating and they’ll have to think 10 times harder about that investment decision. That’s where I was coming from.

I’m a bit surprised at the response though and judging by the recs, this is not a place to engage in discussion (unless you agree with the wider group I guess). Feels almost cult like where an outsider would be quickly attacked. I won’t be posting anymore about valuation…

19 Likes

If u really want to learn I don’t get why have u started this thread at all. Just go to Knowledge Base (and other links on the right) and absorb the tons of wonderful information. Read the board discussions, read the monthly reports posted by superb and generous folks around.

U’ve got all the information there. If the way this board invests does not fit into ur mental model of “EPS growth” I guess u are pretty rigid in ur mental framework and it will be possibly tough for u to learn, improve investment returns etc. But… hey, no folks around claim that our way is THE WAY to make money. There are literally thousands ways to make money in stock market - e.g. this board mostly did not participate in TSLA rally, this board did not buy CCL or SAVE in March selling those this week at 200%, we usually don’t day-trade, invest in bitcoins etc etc.

What we do - we invest in high growth (mostly SaaS) businesses. And we have a framework of doing it described in KB. U either try it for urself or say “it’s not for me” and move on to another way of investing/making money. What’s the point starting such threads and then getting offended by replies.

Best,
V

19 Likes

My goal is to better my own investments, I don’t waste time telling others they could be wrong and definitely not to a group who has had phenomenal returns.

For someone with a 200% ytd return, even if there’s a 50% haircut they’ll still be handily beating the market. But for someone thinking of getting in, that could be devastating and they’ll have to think 10 times harder about that investment decision. That’s where I was coming from.

I’m a bit surprised at the response though and judging by the recs, this is not a place to engage in discussion (unless you agree with the wider group I guess). Feels almost cult like where an outsider would be quickly attacked. I won’t be posting anymore about valuation…

To your first point about a new investor now being wary of a 50% drop, the same could have been said about things before this year’s 100-200% rise. Zoom was considered wildly overvalued, and of course they had a unique perfect storm that led to explosion in their business, but others were up 50-100% last year and the year before. So at any point, yes someone jumping in might pick just the wrong time and suffer some losses, but for the last few years at least they’re still well ahead.

As to the board, this one is particularly laser focused and expects that new members have studied the knowledge base. It’s much more of a true investment club than a random anonymous forum online. Its members accept the basic premise of growth investing, even if some have slight variations or differences in opinion, and try to keep posts on the topic of growth investing. It’s not meant to be a discussion of whether growth investing is right. Every once in a while when discussing a company the issue of valuation will come up, but that’s generally accepted to be a personal choice and not really a topic for the board.

To extend Saul’s favorite analogy, questioning the merits of growth investing and its associated high perceived valuations is like going to a French cooking board and asking whether people really think French food is any good. While it might be a valid question, the French cooking board really isn’t the right place to ask it.

40 Likes

This2ShallPass,

My approach to learning and addressing the questions you raise is to just try things out with smaller allocations. Use $5 partial shares if you like, but go ahead and take just a tiny a position in some of these companies. And then invest your time. Learn about these companies. I can’t predict what you’ll learn, but I can almost guarantee that you’ll learn something extremely valuable one way or another. You can end up with a world-class education in this stuff, for practically free. And with such tiny allocations, you’ll be learning with no material risk to your portfolio. There’s no hurry to go all-in with these companies or with this approach.

Or maybe figure out what 2% of your portfolio is, and divide that number by five. Invest that amount into five of the most frequently discussed companies here. I bet you’ll be glad you did, whatever direction(s) those stocks take.

Better yet, do what I’m planning on doing: find a Company that is new to this board that fits the criteria discussed here, and post an investment thesis, and learn from the responses.

–intjudo

10 Likes

For someone with a 200% ytd return, even if there’s a 50% haircut they’ll still be handily beating the market. But for someone thinking of getting in, that could be devastating and they’ll have to think 10 times harder about that investment decision. That’s where I was coming from.

First, that wasn’t at all evident in your first post, which talked about “valuation” and P/E ratios and, heck even the growth discussion was centered around P/E, not in growth in revenue nor any other business metric, just valuation. So, I concur with majority opinion expressed here.

I’ll even add to that the lesson of the “Dean of Valuation,” Aswath Damodaran, in valuing companies like Amazon. He’s a smart, honest man, and admits his failings in this blog post: http://aswathdamodaran.blogspot.com/2018/04/amazon-glimpses-…

…if you want to see some horrendously wrong forecasts, at least in hindsight, you can check out my valuation of Amazon in that edition… I have not owned Amazon since 2012, and have thus missed out on its bull run since then. Second, through all of this time, I have consistently under estimated not only the innovative genius of this company, but also its (and its investors’) patience.

So, in terms of “valuation,” you simply can’t use the same metrics that apply to more established and slower growing companies. It’s like using a SUV buying checklist when looking to buy a race car. Just doesn’t apply.

That said, it is a fair question to ask how people can get into these companies some safely, since many of them are volatile. I’ve been meaning to write a post on this, so I’ll take this opportunity to put down some thoughts.

As an example of what I think new growth company investors fear, we recently saw ZM shoot up to $589 and then drop into the high $300’s. People who got in “early” were either able to ride it out with profits still positive at all time, while anyone buying in the $500s might have a more sinking feeling in the pit of their stomach. So, how to overcome this?

What I recommend is:
• Look at your existing portfolio and decide which of those companies you’re willing to not own anymore. Sell them.
• Treat the proceeds as a separate entity. If not in a 401K, maybe even transfer the funds to a separate account, which can often be done for free within a brokerage or to a new brokerage.
• Now look for the growth companies that appeal the most to you. Read this board’s many discussions. Read the earnings call transcripts. Look at the 10K statements.
• Choose a couple or three companies and leg into them, in perhaps 1/3 of what you think your final position should be. The idea is to start smallish. Not tiny, just not more than 1/2 for your first buy. Since commissions are $0 or close, you can even spread out the buys over days or weeks.
• Now that you’ve got your toes wet, watch them over the next few months. Maybe some go up as the company is doing better and so buy more of them. Maybe some go down - figure out whether that’s justified or whether it’s a new adding opportunity for you.

And then, before you know it, you’ll find yourself invested in a few/several good growth companies, and hopefully will have profits providing that cushion to volatility you’re worried about today.

My penultimate thought is that the people most worried about volatility are those that have small profits they want to protect. When you’re invested in high-growth companies, the trend is decidedly more steeply up, so the gyrations in market pricing affect you less. When your company is growing over 45% a year, chances are the stock is also growing about that much. So when a 10% or even 20% “correction” occurs, you’re not panicking.

As an example, my portfolio dipped by over a third (33.8%) in late March this year, but that was down less than 10% from the start of the year, and was still up double digits from the end of the previous year. So I was able to confidently hold tight, make some slight adjustments as I saw new opportunities, and I am now up 255% since that March low. If you’re invested in companies based on valuation, chances are you didn’t have that cushion, nor the same possibility of increase afterwards. Think of a sine curve that’s angled up and to the right. Higher highs, and even higher lows. It’s bumpy, but after a while the lows are higher than some previous highs.

I’ll just conclude with an observation that most fund managers can’t do what we do here. First, the nature of most such funds is that clients can add or withdrawn their money at any time. When the overall market goes down, many people sell. Not only is that bad for them (closing the barn doors after the horses have left), it’s bad for the fund as it forces the fund managers to sell some of their assets at the worst time. Compounding that is that most funds have percentage limits as to how much of a single company they can own. Even high-flying funds like ARK Invest’s family have a 10% of portfolio size limit - and many people on this board often have a position or two that’s double that. Finally, the size of many funds means that investing in the smaller market cap companies that are more likely to be high growers is not worthwhile in terms of moving the needle for those large funds. So, when we say we beat almost all active fund managers, it’s not necessarily because we’re smarter, it’s because we don’t have the same hurdles fund managers have to deal with on a daily basis. We can concentrate on a smaller number of companies that we understand really well, can invest more when prices are artificially depressed, and can invest in companies of any size. That as a group we’re smarter, too, is just icing on the cake.

Note that the more successful investors here enjoy what they do. If you’re too worried about valuation to enjoy the ride, or just don’t feel like putting the time into investigating and evaluating companies, the kind of growthoriented investing we discuss here may not be for you. Nothing wrong with that, btw. And, if you’re indeed not ready for this, then perhaps just start buying some of ARKK, for instance, a little bit at a time. That’ll get you some diversification with good companies and good fund management, for far less time and effort investment and no worries about our “cult.”

93 Likes

For a long time when Cloud started to emerge as a technical strategy, it was considered risky, insecure, and was shunned by corporations that had sunk $millions into their data centers. Most of these corporations thought they had the best talent, the best systems, the most secure, blah, blah, blah. Then some early adopters started to move to the cloud, and not only where their solutions secure, but their systems were reliable, scalable, and most importantly their capex became manageable and predictable so those companies that moved to the cloud suddenly gained competitive advantage. That disrupted the entire entrenched IT/Data Center mindset, and turned the industry upside down. The transition took nearly 10 years before Cloud and SaaS became mainstream. Now corporations that are not taking advantage of Cloud and SaaS are the ones being shunned.

The problem with trying to assess valuation using a fixed formula such as multiples is you create a false ceiling on something that has no peer. That is a hallmark of value investing, not growth investing. Most SaaS companies that are followed on this board are still pioneers in this relatively young industry, they are revolutionizing the way IT and business is done. There is no one-size fits all, they are all different and each provides their own unique value proposition to its clientele. Subsequently, trying to put a pre-determined market cap on it, without assessing the TAM or the appetite of its customers is akin to throwing darts at a price chart. There is no comparison to the Dot.Com bust, because Dot.Coms were mostly smoke, with no real value to offer, they only measured clicks. These SaaS companies have real revenues, real customers, and they are growing their revenues and profits at enormous rates.

You might also note that many of these SaaS companies are very young, and still quite nimble and adaptable. They will inevitably reach a point of saturation if they don’t evolve their products and continue to add compelling features and expand their offerings. No doubt some are bound to start with a bang and peter out, or plateau, which will become evident in their growth metrics. Others will keep rolling out more value, more capabilities, and stay on a rapid growth track for years. Such is the nature of growth investing, you have to keep an eye on their growth metrics.

38 Likes

This is a bit late, but definitely appreciate the thoughtful responses by Smorgasbord1 and others on how someone new should approach this style of investing.

“First, that wasn’t at all evident in your first post, which talked about “valuation” and P/E ratios and, heck even the growth discussion was centered around P/E, not in growth in revenue nor any other business metric, just valuation.”

Just want to quickly answer this, I didn’t discuss other business metrics because I didn’t have any specific questions on those. Below is what I had said in my op…what are acceptable metrics for these superior businesses is what I’m trying to personally understand.

“I understand the key themes - SaaS companies should be valued differently due to recurring revenues, 70-90% GM etc. and they make sense. But how differently or how high can the multiples be?”

And yes, I’m taking it slow and making sure this will work for me. Just took at a small position in DOCU (this is a company I have always admired for it’s simplicity but also fills an absolutely critical need). Another is MGNI as it provides a good middle ground in terms of growth / price…

-T2SP

1 Like