Update: the fragility of our overvalued stocks

Investment Analysis Clubs Saul’s Investing Discussions
21

An even finer company like AMZN hit $100 in 2000. Its stock has grown 20x since then but between 2000 and 2010 the stock didn’t go anywhere even though its revenue went up from 3B to 30B.

If only AMZN’s stock didn’t go anywhere it would have been much easier to hold. Instead, it fell to less than 7 in November, 2001. From 100 to less than 7. I read somewhere that even the Fool sold half their holdings near the low.

LTBH is tough and this board is definitely not about LTBH. Most people who invest in the stocks discussed here have probably held them less than two years. That’s not LTBH, that’s momentum investing.

Nothing wrong with momo investing, just be aware of what it is and don’t pretend it’s something else.

14 Likes
22

I have learnt ZS, MDB have no competition.

No competition is not true. Today, Intel owns something like 90%+ market share in the data center still no one says Intel has no competition and these companies market share even in a niche area is nowhere closer to that.

Does that mean that even in a bear market their services are irreplaceable?

Bear market is for stocks. In a recession, will companies buy new IT services? Yes, but the rate will come down a lot. Will they continue to use existing IT services? Yes.

23

When someone says companies like this will lose 75% (!) of their value “between now and the next recession”, he really hasn’t bothered to learn anything about the companies being discussed

We are in a great bull market, economic conditions are great, IT spending are great. So the companies are investing/ spending in new technologies. Now, in a recession, the first thing a company does is cut its IT spending.

Now, one of my holdings AYX, is valued at $3.6B for $163M revenue, i.e., 22x sales, not profit, just sales. So in recession if the sales growth crawls to low single digit, what kind of valuation this stock will trade? $20, $18? $15? At $15 that will be $1 B valuation for a company doing $250m revenue and losing money at operating level is rich valuation.

I could be wrong my math tells me that is about 72% decline in stocks. I am not saying it is going to happen, but it is possible.

7 Likes
24

Will take this opportunity to say that the best stocks – the very best of the best – will experience wild volatility on their way to life-changing returns. That is the nature of the beast.

Monster Beverage (NASDAQ: MNST) was the best-performing stock from 1995 to 2015. It increased 105,000%, turning $10,000 into more than $10 million.

But this isn’t a retrospective about how you should wish you owned Monster stock. It’s almost the opposite.

The truth is that Monster has been a gut-wrenching nightmare to own over the last 20 years. It traded below its previous all-time high on 94% of days during that period. On average, its stock was 26% below its high of the previous two years. It suffered four separate drops of 50% or more. It lost more than two-thirds of its value twice, and more than three-quarters once.

That’s how the stock market works.

This is a classic column from Morgan Housel that should be required reading: https://www.fool.com/investing/general/2016/02/09/the-agony-…

Drops will happen. Sometimes they are irrational, sometimes they are results of recession, sometimes results of perceived high valuations, etc. They do happen. They can also be wonderful buying opportunities.

Matt
Intuit (INTU), MasterCard (MA), PayPal (PYPL), and Square (SQ) Ticker Guide
See all my holdings at http://my.fool.com/profile/TMFCochrane/info.aspx

33 Likes
25

I agree with Saul that SaaS companies on this board are not speculative (at least any more than other good tech companies) but at the same time big losses in the future seem not only possible but probable. Stockcharts shows MSFT went from 39.77 in 2000 to 13.35 by 2001; in 2007 from 28.76 down to 11.74 in early 2009. IGV, the software ETF, went from $154 in 2000 to $18.57 in 2002; from $52.70 in 2007 to $25.79 in 2008. Oh yes, they both recovered to their previous highs of 2000, but it took a long, long time. IGV in 2018; MSFT in 2014.

I see the “speculative” problem is not so much with SaaS but with underlying markets, especially tech with its boom and bust history. When people panic and funds sell, all the market gets crushed. When there is an overall psychological aversion to tech, no one will care about the underlying “great” fundamentals of SaaS companies.

6 Likes
26

Justified, but a waste of effort. Your results Saul stand for themselves, and your analysis is spot on. I recommend that you just let the trolls talk and ignore them. Who cares they come and drop bombshells. Those that follow you, trust your analysis, and no number of trolls with worthless comments will change our minds. You, Bear, GauchoChris and many others have materially increased my families wealth and for that I solute you. Let the naysayers spew their BS. Stay on course. Thank you from the bottom of my heart.

8 Likes
27

Hi all,

and thanks for sharing your link to the ARBA story, karthiko. I think it’s good you brought up a concrete example because it illustrates something:

  1. It supports the view from many board members here, that you have to look at the concrete situation in every case and not jump straight to conclusions like “they will fall 50+% because it happened before”.
  2. There is a huge difference between now and the 2000 tech bubble in terms of valuation.
  3. You should always look for improving fundamentals in „high-valued“ stocks, otherwise they don’t deserve the premium.

To the ARBA story: In the article you can see that at their peek they had $400 mil revenue and a market cap of $40 billion. That’s a P/S of 100. I know we often discuss stocks being overvalued at 20 to 30 times sales (you even brought that up yourself). But a P/S of 100??? Everyone knows that there is a huge difference between a P/S of 20 and a P/S of 100. It has been stated numerous times on this board by many great investors: Valuations at the time of the 2000 tech bubble cannot be compared to valuations today - it’s a totally different story.

Furthermore it’s easy to see that ARBA’s fundamentals were deteriorating very quickly after their IPO. Their gross margins were falling, they started to spend heavily on marketing and their revenue growth fell apart. No wonder they fell like a rock after all was said and done.

Bottom line is, probably no one here on this board would ever have invested in this company in the first place and even if they did, they would have sold as fundamental deterioration became apparent. Of course ARBA’s case is a nice story about a stock falling from glorious heights to dusty lows. But it has nothing to do with any stock discussed here. It just feeds into that general suspicion that what goes up must go down; connecting dots that shouldn’t be connected and giving general caution that doesn’t help anyone. I know people have good intentions and just want to help save the novice investor from losing his money. But everyone is smart enough to put his own hard earned money into stuff he actually understands - and if not, he will learn it. Please everyone, stop cautioning a straw man, it leads to nothing except the same old discussions. What we actually want and need on this board is talking about high growth companies: ie their financials, quarterly reports, conference calls, competition, news, etc.

Best wishes,
Niki

15 Likes
28

So many posts that really boil down to this:
During a recession, pretty much all multiples will contract, and hence our stock prices will decline. Surely no one can argue against that? All this thread is doing is debating by how much in general our tech stocks will decline, which is pretty useless. Let’s get stock specific if we want to discover how robust our stocks are.

Comparing a stock price at the peak of a bubble with the depth of a crash is disingenuous. If you went all-in with your entire wealth/life-savings on Amazon in 1999, if would’ve taken you over 10 years to break-even. Talk about lost opportunity costs and value lost! But what happens if you invested just one year earlier? Big difference isn’t it.

During the dot-com crash, Amazon’s revenue still increased. They took on a lot of long-term debt and a disciplined approach to investing in fixed assets, allowing them to survive longer. And every year they increased revenue and took more market share.
A lot of these tech stocks have very little fixed assets. It’s the software that counts. Even NVIDIA outsources the fabrication of their chips.

It is worth discussing the likely growth rates of these companies in the event of a global recession. A lot of these stocks are doing so well because they save money for their customers. Disrupting their industry. It’s oft said that the first thing to be cut are cost centers, which includes IT. I don’t think that will happen in the digital age we are in. These are operation critical software that companies are based around. You can’t just cut out a crucial bit of software. That just doesn’t happen.
However, it might be harder to make new sales because people will be a bit tighter with their cash.

Attributes we want:
Saves money for customers
Provide essential, operationally critical services that can’t be cut.
Manageable debt vs cash on hand (our companies may not be making money, so can they survive a few years?). What’s the cash burn rate.
Large SAM and greenfields in front of them

In regards to MDB, part of the thesis is the growth in Atlas. We have to remember that Atlas is scalable on the fly. During a recession, will enterprises utilise atlas less? Atlas definitely makes it easier for them to spend less. Possibly. In my opinion, I just can’t see overall global data usage do anything but increase yoy for a long long long long time (I just don’t think it will ever not increase every single year during our lifetimes). That’s just the megatrend we are in and riding.
So no, a recession will not cause MDB to have a negative growth in revenue (I do understand we aren’t really thinking they’ll have negative growth rate, just a reduced growth rate that will affect the P/S and hence stock price). If a snap-recession were to happen tomorrow, MDB will continue to increase revenue and take more market share. The only threat is disruption by a competitor, which according to the last conference call, they are seeing none.

10 Likes
29

They will lose 75% of their value between now and the next recession? What a joke. of course nobody knows how much they will lose. But likely it will be “a lot”, even if not a precise number in advance. And since bear markets usually precede recession, much of it will indeed come before the actual recession.
But almost everything will go down, and as Saul has pointed out the huge gains during the good times softens the actual dollars lost during bad times. Dollars are what we save and spend, not percentages.

I do suspect the huge wave of innovation as companies shift from their 1980’s and 1990’s thinking will persist a long time past the next recession. If so, most of these stocks will eventually recover. Like AAPL and AMZN did.

Some people are just not cut out for this style of investing and the likely volatility, so they should just go elsewhere

5 Likes
30

For me, as someone who has 100% of my equity investment portfolio in the companies discussed here all of the discussion boils down to this.

  1. Live below our means & invest 25% + of our gross income
  2. Keep 6 months living expenses in cash (emergency fund)
  3. Don’t have any money invested that we plan to use for big purchases in the next 5 years (house, car, college, etc)

For us, those 3 things being in place give us the ability to succeed as investors…through recessions, depressions, bear markets, bull markets, etc.

I can’t control macro economics or market sentiment. But I can try to find the best companies in the world and from what I’ve learned (articles like Matt posted links to) in order to have life-changing and improving returns, we have to be able to absorb wild swings. The best companies will stumble many times on their way to incredible gains.

Having those 3 fundamentals in place help me put some of the troll/bear/negative comments into perspective. Those types of drops are irrelevant…and probably healthy if our foundation is in place to let us invest through bear markets, recessions, etc.

No bull or bear thesis can stand on it’s own. Investors have to have their own foundation in place to allow them to prosper (or force them to fail).

In my opinion, that’s where these negative/bear posters fall short. They will gladly drop disruptive posts in about the possibility of bear markets, but spend no time discussing how an investor who is able to invest before, during, and after these bear markets can be incredible successful.

This is what makes Saul and this board so different. He’s documenting his thoughts and performance…providing real-life examples of how he applies his methodology.

15 Likes
31

ajm101 wrote:

Saul, you keep saying this:

“if you knew something about the companies and realized that there is nothing speculative about companies growing sales at 50% or more year after year, and whose revenue is almost all recurring, and who have loads of deferred revenue that is already in the bank”

________________________
First, is it really in the bank? Do they sign a 3 year deal with payment up front but recognize it monthly? In the case of a painful recession, this is very relevant to customers that reorganize or go bankrupt.

I believe Saul was quoting figures from a 10Q/K balance sheet, so yes, that means payment has been received. That is the only way it would be reported as “deferred revenue”, which is a GAAP term. I suppose there may be an option for customers to cancel and get a refund, that wouldn’t impact the accounting treatment as deferred revenue.

3 Likes
32

AdvocatusDiaboli,
I was tempted to jump in when I read your post. But, I thought it prudent to first read all 31 posts in the thread. And, the thread is already a few days stale, so my post won’t get much attention anyway (I’ve fallen behind as I was travelling for many hours to China and suffering some serious jet lag, 16 hours time zone disruption).

Nevertheless, I’m trying to be objective. It might help your case if instead of posting a fear provoking generality, or maybe supplementing your post if you could post your annual returns for something like 20 years as Saul does. Of course,Saul was not invested in tech stocks for the last 20 years, but he has been for the last few years. He’s not a novice. His returns speak for themselves. If you read his Knowledgebase and his posts over the last couple of years, or even just his monthly portfolio reviews you will see he is one of the most astute business analysts to actually contribute a written body of reasoning for the investment choices he makes. You will realize that he is far from being a “speculator” in any rational definition of the word.

You might also offer some alternatives if you feel that the investments discussed on this board are so risk prone and more likely to suffer loss upon the owners, taking into account the present outsized gains. What investment strategy do you recommend? What companies do you own right now?

It’s one thing to come to this venue and cast FUD about as a warning to the novices that might blindly follow this advice. What, specifically, advice do you recommend the novice to blindly follow instead? I’m not being cute, a novice, by definition, is going to blindly follow some advice. Once they gain knowledge and experience, they are no longer novices.

In other words, I am asking that add some value to the discussion. After all, the board is named “Saul’s Investing Discussions.” I think you kind of missed the “Discussions” part. We mostly discuss stocks here. Yes, we also discuss strategies and even some off topic stuff (Saul will tolerate some OT discussions, but no politics).

So please, how about contributing as opposed to just a negative interjection?

2 Likes
33

this thread finally died. Why re-engage?

13 Likes
34

https://finance.yahoo.com/chart/PANW#eyJpbnRlcnZhbCI6IndlZWs…

This is Palo Alto vs. Proctor Gamble since 2014 (when Palo went public). 380% vs. 3%. A market disaster can hit, chop Palo Alto down 90% (to a market cap less than their annual revenues) and Palo would still be up 38% vs. 3%.

But you know what, P&G might only fall 1 or 2%.

Nuff said. We are all aware that markets go up, markets go down, that there have been multiple horrific crashes, 1929 the grandest of all. Got it.

Now PANW blew away earnings yet again. Not my pick in security as Zs is of course, but PANW has been the best risk/reward security company in the market over the last 5 years even though its growth is now in the mid-20s but with $2 billion or so in deferred revenues. A cash flow machine.

Tinker

3 Likes
35

This is Palo Alto vs. Proctor Gamble since 2014 (when Palo went public). 380% vs. 3%. A market disaster can hit, chop Palo Alto down 90% (to a market cap less than their annual revenues) and Palo would still be up 38% vs. 3%.

And PANW - a great firm - has done half as well as Amazon.

Amazon has a stronger competitive position and has half the P/S valuation as PANW.

So now that we’ve done a more apples-to-apples comparison, why would you own PANW over Amazon?

but PANW has been the best risk/reward security company in the market over the last 5 years even though its growth is now in the mid-20s

Amazon is growing just shy of 40% QoQ.

4 Likes
36

Najdor,

Both PANW and AMZN are “overvalued” “radical” “risky” “fragile” growth stocks. The issue was these are fragile stocks, unlikes what else? I assumed defensive stocks that have been around for a century so I picked P&G. I could have picked Hunts or any other staple, would not matter.

Even if the world practically ends, PANW loses 90%, AMZN loses 90%, both stocks will still have outperformed the “non-fragile, non-overvalued stock” by 10x or more.

I believe that puts the entire premise of this thread that the stocks most of us have invested in for the last few years are fragile, dangerous overvalued, and stupid to invest in as a projection of our arrogance, which started this thread, into context. The clear objective answer is the premise of this very long thread is in error to begin with.

Each to their own.

Tinker

4 Likes