For me sales growth is probably the most important thing to look at for picking stocks over the long run. I just listed to David Gardner’s Rule Breaker podcast from a couple of months ago where Tom Gardner was on and talked about sales growth and gave a couple of nice data points with AMZN and NFLX. He said that since AMZN went public, their sales have grown 43% per year and their stock has grown 36% per year on average. NFLX has grown 35% per year and the stock has gone up 45% per year on average since going public.
Obviously, profitability is important but revenue growth is probably the best determinant of the stock price over the long term. If a stock is expensive at 10 times sales, but grows 50% per year for 3 years while the stock does not move, then the stock will trade for 3 times sales at that point (assuming minimal dilution). A stock that was expensive at one point would be insanely cheap if they grew at that rate for 3 years while the stock stayed flat (not dropped). Imagine if the company can grow 40% on average for 10 years. It’s obviously very difficult to predict sales growth with any accuracy beyond 1-2 years. That’s why I like to look at the following, which is similar to what others on this board have discussed:
- Strong sales growth guidance over the next year (40% plus) – many of our cloud/software names have this
- A large addressable market (TAM) – think MDB and the DB market
- A TAM that is expected to grow significantly – our cloud/software names have this
- A product that customers love – customers (Boeing, Air Force, etc) love PVTL as they help them save money and be more profitable
- A strong dollar expansion rate (over 100%) – PVTL leads the way here with 156%. This demonstrates how much customers really love the product.
- A lot of recurring revenue – most of our cloud/software names have this with their subscription model
These points focus on lasting sales growth, but other areas I focus on include the following:
- A smaller market cap, preferable less than $10B – obviously it’s much easier to have a $2B company grow into a $20B company than a $200B company grow into a $2T company
- High margins - our cloud/software names have this
- Growing profitability – not only do we want to see strong margins, but increasing margins. This also demonstrates pricing power and scale.
- Light asset models – no way to have really high margins with a lot of fixed assets on the books. Software companies have this and as they get larger, they become more profitable as their variable costs decrease per product sold (scale)
- Little or no debt – most of our cloud/software names have this
- Not a ton of stock comp – it’s tough to have the UBNT model where there is hardly any stock comp, but I prefer not to see dilution over 10% per year
- High inside ownership – love to see founder led companies with larger ownership of stock. This obviously aligns their interests with fellow shareholders.
This listing is just off the cuff, so I may be missing some points. I have normally been a very value focused investor, preferring low PE ratios over expensive tech names, however, I have slowly transitioned and am now more heavily focused on companies that are growing quickly. Thanks to Saul and others who have helped me in this progression. Part of what limited me to invest in these high growth companies in the past was valuation and price anchoring. Paying too close attention to valuation limits your opportunities if you are investing over the longer term. Who cares if you are buying something that is a little overvalued (based on normal valuation metrics) when the company is growing at 40% plus per year. If they sustain the growth, then they will grow into the valuation as I described at the beginning of this post. Also, seeing stocks rise quickly in a short time span while you are not invested makes it very difficult to invest at the current lofty price. This is a VERY DIFFICULT bias to get over. I made this mistake when I did not buy NTNX when it was discussed here last year. It had a huge run and I could not bring myself to buy because I missed out buying it in the 20s. With the recent market swoon, I finally corrected this and picked up a 5% position.