Bear and Saul have recently written about multiple expansion and valuation:
SHOP also now has 15% more shares outstanding than it did at the end of 2016. Other than accounting for that, Chris’s math is correct as far as I can see, but hopefully my addition here illuminates how this works in the real world. We have enjoyed such crazy gains the last two years, because in late 2016 and all through 2017, things were crazy underpriced. Things have changed.
Saul often says that he can’t time the market. I can’t either. So I’m not going to cash, because big a correction may not come. Sure we’ll have little corrections like we have all along, but who knows when? Our stocks may go up 30% from now before that happens. Or it may happen tomorrow. Either way, in the long run, stock appreciation will approximate each company’s revenue growth, adjusted for dilution. That’s still great…even comforting. The difference now is, we probably can’t expect multiple expansion on top of that.
The huge, even enormous, relative number of gross profit dollars that our companies have, and will have in the future, for each current dollar of revenue, because of their growth rates and high gross margins, compared to the relatively small amount of gross profit that a conventional company has, and will have, for the same current dollar of revenue, is what gives our companies the much larger EV/S ratios. Simple as that!
And don’t bother telling me our companies are not making any profit. Any company with 75%, 85% or 95% gross margins can make a profit whenever they decide to! All they need to do is slow down their enormous S&M spending, whose purpose is to grab every new customer they can grab while the grabbing is good. Personally, I’d rather they keep grabbing all those customers now, because revenue will keep flowing from them for the indefinite future.
So this is an entirely different set of facts we are dealing with. That’s how I see it anyway. And I hope that I made it clear for you.
One thing is in agreement and a fact: EV/S multiples of most/all of the SaaS companies discussed on this board have increased. No dispute there. Bear and some others doubt that we can count on further multiple expansion from here. Saul, on the other hand, does not say whether multiples might expand further, contract, or stay the same. However, Saul spells out that past multiple expansion was highly deserved and he seems to suggest that additional multiple expansion may be warranted. Saul provided the reasons why the business model of SaaS deserves a higher valuation multiple than so called traditional companies. That argument is certainly compelling.
So one question is: were SaaS companies as a category severely undervalued 2 years ago or are the current multiples awarded to these companies an anomaly? It’s an important question because each of our answers will lead us to make position and allocation decisions. To say that simply because multiples have expanded over the past 2 years, SaaS must now be overvalued and no more multiple expansion is possible is not the right argument. The underlying premise to that argument is that SaaS companies were previously, roughly fairly valued which would make them overvalued now. Bear is of the opinion that generally the companies in his portfolio are not great bargains. The ~25 cash position and decision to trim supports that.
I have reached a different decision. I suspect, as Saul has pointed out, that the SaaS companies in general were very much undervalued 2 years ago. Will multiples expand, contract, or remain the same from here? I do not know. But I think it is possible for them to expand further. If I want the growth that these companies offer then I need to remain invested. I follow these companies closely and the business results continue to be very compelling. I think that we have chosen the very best publicly traded companies available. I don’t want to sit out and miss the upside. The revenue growth (assuming it continues) offers a large amount of protection because it leads to multiple contraction when the stock prices don’t move. If multiples remain constant we are looking at 60% annual returns. If we see a small contraction then we can still get very good returns when these companies growth revenue at 60%.
We have such good recent reports from CMF_muji, stocknovice, and Saul:
These are all great write-ups and worth a read. There are some great explanations of the companies owned. Therefore, I’m not writing about the companies specifically.
Here is a summary of my portfolio through the first half of the year (for those of you who are interested):
2019 end of month returns (YTD):
Jan +26.9% Feb +39.8% Mar +49.4% Apr +57.1% May +53.2% Jun +72.0%
Weekly Portfolio Performance Compared to S&P500(TR)
GC Port S&P500 Delta 1/18/19 23.3% 6.6% 16.7% 1/25/19 25.2% 6.4% 18.8% 2/1/19 27.3% 8.1% 19.2% 2/8/19 30.6% 8.2% 22.4% 2/15/19 31.8% 11.0% 20.8% 2/22/19 38.6% 11.7% 26.8% 3/1/19 35.1% 12.3% 22.8% 3/8/19 30.2% 9.9% 20.3% 3/15/19 44.0% 13.1% 30.9% 3/22/19 49.6% 12.3% 37.3% 3/29/19 49.4% 13.6% 35.7% 4/5/19 43.4% 16.0% 27.4% 4/12/19 49.2% 16.7% 32.5% 4/19/19 40.5% 16.6% 23.9% 4/26/19 54.4% 18.0% 36.4% 5/3/19 57.5% 18.3% 39.3% 5/10/19 54.0% 15.8% 38.2% 5/17/19 60.2% 15.0% 45.2% 5/24/19 54.8% 13.5% 41.4% 5/31/19 53.2% 10.7% 42.5% 6/7/19 73.6% 15.7% 58.0% 6/14/19 75.0% 16.3% 58.7% 6/21/19 79.9% 18.9% 61.1% 6/28/19 72.0% 18.5% 53.4%
Portfolio peak was reached on 6/20 at +84.5% YTD. The delta between the S&P500 and my portfolio has expanded fairly steadily throughout the first half of 2019. The high returns to some others with similar stocks can be explain by my use of options. Since the beginning of 2017, options have contributed about 25% of my total gains (including realized and unrealized).
ALLOCATIONS AS OF 6/30/19
6/30 5/3 6/30 shares only % gain per % move AYX 21.7% 23.0% 21.7% 1.0% TWLO 19.0% 19.8% 14.8% 1.4% MDB 16.3% 14.1% 13.0% 1.5% ZS 11.4% 10.8% 10.4% 1.3% OKTA 6.0% 8.5% 6.0% 1.0% ESTC 5.8% 4.6% 5.4% 1.9% SQ 5.3% 7.2% 5.3% 1.0% TTD 5.1% 7.6% 4.0% 1.6% CRWD 4.7% 0.0% 4.7% 1.0% SMAR 3.6% 1.9% 3.6% 1.0% options 8.7% cash 2.6% 2.7% 2.6%
Mostly my allocations are ordered from highest to lowest in a way that reflect my confidence in the business AND my thinking the stock company (and stock) will appreciate going forward. For example, SMAR is the smallest allocation because I do not have confidence that their offering to their customers is as sticky as the offerings of my other companies.
The column on the far right represents the number of call option equivalent shares I own for each actual share. My call options positions are the following:
ESTC Nov19 $80 calls
MDB Jan21 $70 calls
MDB Jan21 $85 calls
TTD Jan21 $130 calls
TWLO Jan20 $45 calls
TWLO Jan20 $65 calls
ZS Jan21 $65 calls
In aggregate, my options positions (long calls less the negative value of short puts) is 8.7% of my portfolio.
CHANGES IN MAY and JUNE
I made some changes to my portfolio since my last update on May 3, 2019:
After MDB and OKTA reported earnings, I sold some OKTA to buy more MDB.
After TTD and SMAR reported earnings, I sold some TTD to buy more SMAR.
I bought CRWD as a new position on the day of the IPO. I initially bought some at $65 and bought a bunch more at around $58 on the same day. To pay for these shares I sold some OKTA, ZS, and SQ. I also used some cash that I later replenished by trimming AYX.
I added a bunch to ESTC by selling more OKTA and trimming AYX.