If you’ve spent time on Saul’s board, you would know that high growth is one of the non-negotiable criteria for stocks on this board. This is for good reason. IMO, the faster a company grows, the faster it creates value for shareholders, all other things being equal.
In the past year, I’ve been coming to terms with what kind of revenue growth slowdown is acceptable (and what is not). It doesn’t help that analysts give mixed signals (in my opinion).
For e.g. DDOG’s Q3 of 61% YoY growth followed by a shocking guide of 38% for Q4 was considered great by many analysts on the call, while NET’s Q3 of 47% growth and Q4 42% guide (down from 50+% growth in previous quarters) was punished with a >20% price plunge. Go figure.
Not surprisingly, there has been more discussion on revenue growth on the board in the recent 1-2 weeks. Discussions include the appropriateness of using QoQ number and whether size of the company should be taken into account. Hence I thought it a good time to flush out some thoughts on the subject, using examples that our companies have unfortunately served up.
[Disclaimer: I understand there are factors other than revenue growth to consider when selecting companies. Given the importance of this metric in my own process, I thought it useful to consider it in isolation, if nothing else, just as a first level comparison between companies in my portfolio. All other factors are assumed largely similar in this discussion (which I know is not true). Please take this in mind when critiquing my thoughts below.]
First, absolute growth and change in growth rates. Absolute growth numbers should be a top consideration. A 40% grower will increase in value faster than a 20% grower, ceteris paribus.
However, looking at absolute growth numbers alone is not sufficient. We need to take into account what prior growth was, what it is expected to do going forward, what Wall Street’s expectations are and what is “built into the price” (whatever that actually means). In some respect, the change in growth rates may be as important as the absolute numbers.
For e.g., in 2020-2021, both MongoDB and Hubspot received a huge boost in share price when revenue growth accelerated from 30+% to 50+% and 20+% to 40+% respectively even though absolute numbers were not as high as some of our other hyper growers.
Second, what level of growth decline is acceptable? This is subjective; I think a 10% decline in YoY growth is acceptable but anything more than 20% is not.
For e.g., I am happy to accept NET going from 50+% to 40+% growth but CRWD going from 50+% to low-to-mid 30% worries me. (Both scenarios are not a given but we can only work with the guides we have for now.) As such, following Q3 results, I was happy to add to NET following the >20% price plunge but held back from adding to my small CRWD position.
Third, QoQ growth rates. I think these are important. One Q of poor/strong QoQ growth may not mean much, especially if there’s seasonality. However, 2 consecutive Qs of poor/strong QoQ growth and I may take action, especially if the 3rd Q’s guidance shows similar direction. Where appropriate, I use this as a leading indicator; it can sometimes allow us to act before the YoY numbers show up from lapping a full year.
Fourth, company size. It has been suggested that we should perhaps take into account company size when considering growth rates. For example, CRWD, one of our larger companies by revenues, guided for low-to-mid 30% growth for next FY. A couple posters thought that this was great growth numbers for a company for that size, and I totally agree.
However, this doesn’t mean we need to consider this when selecting stocks for our portfolios. (Otherwise, we could also extrapolate this to consider the mega caps at teens-level growth?) When selecting companies to invest in, the size of the company matters much less to me. Above say $1b market cap, growth rate (and hence rate of value creation) matters much more. IMO, $1 invested in a smaller and faster 40% grower is better than the same $1 in a larger but slower 30% grower.
With the uncertain macro climate, the above are simple guidelines to help in my decision making. Of course, investing is more art than science and there are no hard rules. For e.g., I exited SNOW because I felt the revenue decline was too drastic. It went from 106% growth last FY to an expected high 60% growth this year. It is then guiding for high 40% growth next FY.
However, I now find myself considering re-establishing a position because of SNOW’s greater visibility in revenue compared to other companies, the baseline for next year’s growth has been set, the low likelihood of only 20% growth 2 FYs from now, and I don’t have many companies expected to grow better than SNOW in the coming year.
I would love to hear any thoughts you have on this.