Thoughts on traditional EV/S

Thoughts on traditional EV/S, and why it has little to do with our companies.

I posted this last near the end of last year, but it’s time for a new post as we have so many new members

Some who are new to the board seem almost personally offended that I don’t calculate EV/S on any of my stocks, and that I don’t pay much attention to it, or to the fact that all our stocks usually have EV/S ratios which are very high by traditional EV/S standards.

I don’t have the answer to what is “overvalued,” but I know that traditional EV/S ratios have LITTLE OR NOTHING TO DO with our companies! Our companies are profoundly different than the companies that traditional EV/S is used for. Why? Here are some reasons:

First of all, a company with 70% to 90% gross margins is worth a much higher EV/S ratio than a company with 30% or 40% gross margins because each million dollar of sales is worth so much more to the company in take home dollars.

Just think about this for a minute. If you have 85% gross margins, a million dollars in sales is worth $850,000 to you. If you have 42% gross margins (still quite acceptable), the same million dollars in sales only brings you $420,000. Now really think about that! On that basis alone our company with an 85% gross margin is naturally worth twice the EV/S of a normal company with a 42% gross margin, other things being equal.

And a company with a 28% gross margin (believe me, there are plenty of those too, in the real world) only keeps $280,000 out of that million in revenue. How can you put the same million dollars in revenue in the denominator of the fraction EV/S? Our company with 85% gross margin is naturally worth three times the EV/S sported by the 28% gross margin company, other things being equal… But… other things aren’t equal!!!

Our companies are mostly SaaS companies. These are companies that are leasing software that becomes integrated into the core of the customer’s business, and with a subscription model that brings in recurring revenue, so that each million dollars of sales today is not just for this year. It’s for next year too, and the year after, and the year after that, and…. pretty much forever. No one, simply no one, is going to tear out a system that is core and essential to the smooth running of their business, and that would disrupt their entire business to pull out, to save a few dollars. It ain’t gonna happen folks!

Okay now, you have a million dollars of sales this year that will, for all practical purposes, be there next year, and the year after too, and new sales next year will be an extra bonus added on. When you put that million dollars into the denominator of the EV/S equation, what do you have to multiply that million dollars by to take into account all those future years of recurring revenue? By three? By four? By five? That sure brings down the real EV/S for our SaaS companies, doesn’t it?

Compare it to a clothing manufacturer (just for instance). It sells 100,000 coats this year, but has no idea if it will sell 100,000 coats next year, or even 50,000 (maybe another brand will be in fashion). Recurring revenue on a subscription sure beats the heck out of that, doesn’t it? At first glance that clothing company example may seem irrelevant. But no, the EV/S of maybe 3 or 4 that it carries, has helped to shape the idea in your head of what a EV/S normally is. But if the clothing company’s EV/S is 3, if one of our companies has the same revenue (the same S in the denominator), what should its EV/S be? Four times that? Six times that? Ten times that?

But wait! Our companies also have a dollar-based net retention rate maybe averaging 125% or so. That means that this year’s sales revenue isn’t just going to recur next year, but it will be 25% bigger next year, and bigger the year after that. Well of course a company with a 125% dollar-based net retention rate of recurring and growing revenue will have a higher EV/S ratio, than a normal company with the same revenue, the same S value, down there in the denominator, which may not even be there at all next year … (duh!)

And then there is growth rate! Well, of course a company that is consistently growing revenue at 50% to 80% is going to have very high EV/S ratios, because in just two years a consistent 60% growth rate means they will have more than two and a half times as much revenue as they have now. That’s in just two years!

And in three years, more than four times the revenue they have now!

And in four years, more than six and a half times the revenue they have now! That will sure bring that EV/S ratio down, won’t it? I won’t go beyond four years but that’s enough. (You won’t believe it but a fifth year will bring the revenue to more than ten times what you started with. Obviously they don’t need to keep a 60% growth rate to really push up their revenue! That S in the denominator is going to grow rapidly.)

And finally, of course a company that is leasing a software solution that every enterprise on the planet needs, and that the vast majority don’t have yet, and that all those companies will keep indefinitely once they install it, will have a higher EV/S ratio than a company selling a product that anyone can put off getting a new model of, or stop buying for the duration of a recession, etc.

Here’s the key to this: You can live another year, or two years, or three years if necessary, with your old cell phone, or computer, or car, or raincoat, or refrigerator, or kindle, or ski jacket, or your old factory, or whatever, without buying a new one, but once you lease this software, you keep leasing it indefinitely, no stopping for a year. If you think about that and understand it, you’ve gotten the message!

And of course, of course, of course, companies that have ALL these features…

70-90% gross margins AND
A subscription model with recurring revenue AND
125% net retention rates AND
Is growing revenue at 50% to 70%, AND
Is selling products that all enterprises need …

are going to have very high EV/S rates (… well, duh!), and I don’t know what is high, but I will NEVER sell out just because the price has gone up, and because some people think the EV/S is too high. I just don’t know where these guys will ultimately end up.

Here’s an example: On July 11th, Goldman Sachs came out with a Buy rating on Upstart. The current price was $120, and their one year target price was $147, up $27.

Yesterday, two and a half months later, Upstart closed at $336, up $216!!! That’s up $216 versus up $27!!!

Trying to guess where the express train will stop is a thankless task!

My decision about my confidence in a company is based on revenue growth rates, gross margin, recurring revenue, dollar-based net retention rates, necessity to their customers, dominance in their field, and how all that looks to me for the future. Traditional EV/S simply doesn’t enter the equation. Just too hard to figure out what is reasonable after taking all those factors into consideration.

I hope that this was of help.



Saul, for the most part you have convinced us that EV/S is not all that relevant when comparing very fast growing stocks to more traditional slow growing stocks. We’re then just comparing apples to oranges.

But I think the ratio is helpful when comparing similar fast growing stocks to one another. Everyone brings up SNOW with its very high EV/S, but its other metrics make it an attractive purchase. Sure, it has a sky-high EV/S ratio, but so too are its sequential and YoY increases in revenue. I think this is the point you often make. But when you compare its EV/S to UPST’s and their projected growth rates, UPST comes out looking better. Of course, there are other factors to consider such as the the fact that UPST is not a SAAS stock and doesn’t year-to-year revenue built in.

So EV/S is just one factor to look at along with gross profit margin, sequential growth, yoy growth, fcf etc. To me it’s at least worth taking a look; but not determinative.

I note you don’t say you completely disregard the EV/S ratio so I don’t think we really disagree. I just thought it might help to have another viewpoint about this ratio.

I hope no one thinks I’m trying to replace your judgment with mine. For the most part, except for investing all out after the financial collapse in 2008, I hadn’t been all that successful until I started to follow your ideas. Even then, I was stubbornly slow to appreciate your wisdom, but lately I’ve tended to follow your ideas more completely and certainly have reaped the benefits.

So thanks a million!! That’s not a million dollars - I haven’t done that well; but I’ve beaten the standard indexes handily and feel grateful I’ve become less stubborn.


Well, I think Saul nailed it and I also don’t think you can have it both ways.

I paid very close attention to various growth valuation metrics 2020-21 and I saw zero correlation between that and stock performance. Not a proper study, mind you, but my own money on the line nontheless.

I bought BAND in early March, my last purchase based partly on valuation. Good thing I dumped it shortly later at 128 because it is now even cheaper and at even lower valuations.

The cheap companies got just as badly hammered as the pricey ones in Spring. But who recovered? FSLY AYX and BAND? Or DDOG NET and SNOW?

In fact, I pivoted to where I ask myself why a stock whose performance I like is cheaper than my other ones. Mind you, I am NOT seeking high valuations, but I am asking myself, say, why ZI is cheap on growth adjusted metrics vs other ones like ZS or DDOG or NET.

In that specific case, I hope it is cheap because people misunderstand the business as evidenced by discussions here. I worry it may be something I am not seeing. I don’t assume I know better than the market which is traditional value investing. So I don’t need to care about the efficient market hypothesis either.

I just seek to learn here how to buy winning tech and leadership teams.I get product knowlegde from muji and Beth and methodology from Saul. Not trying to outsmart the market. But slowly learning to pick the best horses.

What you want to do is to buy a portion of a winning race team. You will take any discount you chance to get but you cannot seriously ask for one. You are competing for the Formula 1 crown, not in the neighborhood drag race. You cannot hire the best driver for peanuts.

So I think 2020-1 totally proved Saul right. And I am writing this here because I was a skeptic.

Whatever your favorite analogy, you cannot have the best and then also want to pay an average price.