Understanding Exponential Growth
13 months ago, when the pandemic was kicking in, I listened to a podcast where Daniel Kahneman explained why we underestimated Covid-19. “We see things doubling every two days, three days, four days…and people, including myself, don’t seem to be able to think straight about exponential growth. I knew that there were a hundred cases in France, and I was about to fly to France. I also knew that epidemics are exponential. But I didn’t even consider the fact that if the rate of infection doubles every 3 days, then in a month it would increase by a factor of 1,000x. What we see today are infections that occurred 2-3 weeks ago. All of this is beyond the intuituitive comprehension – we’re in a situation that we’re simply not equipped to understand.”
I recently remembered Kahneman’s quote, when a friend remarked that despite the recent drop in Snowflake’s share price, he wouldn’t invest in it, as it is still valued at 100 P/S (LTM). I know that valuation is a contentious topic, but I do believe that it is one of the attributes that we ought to evaluate as part of our comprehensive analysis of hypergrowers.
The Guidance Game
As we know, companies generally provide conservative guidance so they can “beat and raise” every quarter and keep old-school investors happy. The average revenue guidance beat across a cohort of this board’s companies is 6.5%. 
Old-school investors are not that naïve to not fall into this game, so they incorporate modest beats to their estimates of a company’s future metrics. Regardless, this cohort tends to beat consensus estimates by ~2%. This may not seem like much, but let’s remember that companies report four times per year. So, annualizing 6.5% becomes 29% of growth unaccounted for in guidance. Similarly, annualizing 2% becomes 8% in growth unaccounted for in consensus estimates.
The Guidance Game & Exponential Growth
So, why does all of this matter if this is how “the game” has worked forever, and how it will likely continue working for the foreseeable future? Well, it matters because the effect of this "game” compounds as a function of growth. And if this effect is “beyond intuitive comprehension” for a Nobel prize winner, surely it’s way beyond comprehension for us mortals here. So let’s use an example to put it in perspective.
Company Consensus Rev Estimates (CY’21) Consensus Rev Growth Estimate Estimates Accounting for Beats (CY’21) Rev Growth Accounting for Beats Okta $1,321M 30% $1,177M 41% Docusign $1,932M 36% $2,093M 46% ZScaler $733M 37% $793M 48% Zoominfo $818M 41% $728M 58% Cloudfare $616M 43% $667M 55% Zoom $3,800 43% $4,113M 55% Twilio $$2,540M 44% $2,749M 56% Datadog $889M 47% $962M 59% Crowdstrike $1,319 51% $1,428M 63% Snowflake $1,093 85% $1,182M 100%
Now, assuming that the share prices from this cohort remain the same for the next year, this is how they would be valued on 10 May 2022.
Company May’22 EV/S (LTM) May’22 EV/S (NTM) Okta 24.0x 21.1x Docusign 16.2x 14.1x ZScaler 25.4x 21.8x Zoominfo 20.6x 16.2x Cloudfare 28.6x 23.9x Zoom 19.1x 14.4x Twilio 15.8x 12.9x Datadog 22.1x 18.1x Crowdstrike 25.0x 20.0x Snowflake 39.5x 32.2x
Tying it all Together
Here is where the realization comes into play. Snowflake might certainly look expensive today using conventional valuation techniques. But (1) visualizing the effect of compound growth, (2) reading into “the game” that’s played with old-school investors, and (3) knowing that these techniques are highly fallible for these companies yields a different perspective.
Do we really think that Snowflake will be valued at ~32x EV/S (NTM) next year when it’s expected to grow at ~85% the following year? For context, despite the recent meltdown in the share prices of these companies, Crowdstrike’s average EV/S (NTM) for 2021 has been 35x. And this is when consensus estimates for Crowdstrike are for 51% growth. If Snowflake expects >80% growth, we can only assume that “the market” would attribute a higher valuation to Snowflake – which would translate to share price appreciation over the next year. The same can be said about many (if not all) of the companies in this cohort.
This is NOT to say that Snowflake is cheap. Or any of these companies for that matter. This is also not to say that I can predict the future results of any of these companies better than others. I don’t have a crystal ball to read into the future, and I’m not going to pretend that I can be even mediocre at estimating it. Rather, the purpose of this post is to try to equip ourselves with an understanding of the effect that compound growth can have. It is important to understand these companies holistically – the technology, the financials, the management, the execution…and valuation is just one of those factors. The more we sharpen these, the better we will become.
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 CY refers to “calendar year” to normalize for the differences in company’s fiscal year-ends
 We could spend a lot of time debating what a “realistic” expectation is, but for simplicity I’ve assumed a 3% beat on each quarter to consensus estimates
 I know that this is unrealistic, but this helps explain the example
 Assuming growth continues at 85% the pace of previous year’s growth rate