Valuations ALWAYS matter - warning

When I hear ‘price doesn’t matter’ I give an involuntary shudder, review some debt levels and make some wild guesses at recession pricing-power and write down a desk-top stop-loss figure or two. It’s the only form of catharsis other than selling everything with a PE over 14. Price doesn’t matter and it’s a sellers’ market for the finest peanuts in the land at only $300 a nut. Roll up, roll up!

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Saul,

With all due respect, lets call a spade a spade.

In your earlier posts several years ago; you wrote that you ONLY ever invested in profitable companies and never dabbled in unprofitable story stocks. You also wrote that in those days, you ran a portfolio of anywhere between 25-28 stocks.

Today, your portfolio is comprised of 10 cloud/digital payment companies in the tech sector and if I recall correctly; apart from SQ, not a single one generates a profit! Furthermore, they are all trading at Price/Sales ratios of anywhere between 10-20!

The big moves in these stocks over the past 1-1.5 years haven’t been due to changing fundamentals (sales growth has been strong for many years); but due to momentum chasing traders bidding up these stocks; late in this 9-year old bull-market.

Cloud has become the new buzzword and anything related to it is being bid up in anticipation of future growth; which may or may not materialise for some of these companies. Essentially; these stocks are now priced for perfection and all the future growth has already been discounted. As soon as earnings (sales in this case; as earnings don’t exist) disappoint; these securities will get hammered.

In your recent monthly posts, you have also stated that often you trade in an out of the same company several times in a year. This isn’t investing; this is trading/speculation.

What you do works for you; but such a concentrated portfolio of such richly valued tech stocks in 1-2 sub-sectors may not be the prudent strategy for most.

Best,

GM

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If you read my earlier post carefully; you’ll realise that I wrote that over the next decade, I’m expecting a 15-17% CAGR return from SHOP, SPLK and WDAY; that is why I own them because in my opinion; these companies have a ‘moat’ and a long runway of growth.

I also wrote that although these businesses will probably grow at a much faster pace that 15-17% CAGR; shareholders won’t capture all this business growth due to current sky-high valuations.

Best,

GM

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Valuation to me seems simple.

  1. If it’s an existing industry it matters.

  2. If it’s disrupting the current industry, it matters less so, it will be a little ‘overvalued’.

  3. If the company is creating the market/industry it doesn’t matter at all.

  4. If its number 3 and 4 you found gold.(amzn,nflx, etc)

Merc

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Most punters think valuations don’t matter for AMZN and NFLX.

Yet, they don’t realise that for many years; AMZN has beautifully tracked its operating cash flows.

For about a decade; AMZN has traded at 28 times operating cash flow and only recently has it broken out and climbed to 32 times operating cash flow. If AMZN’s operating cash flows continue to increase at this pace and we don’t get a recession; by the end of 2020; at 28 times operating cash flow; AMZN stock will rise to $3,000 - this is not a prediction on my part; simple maths.

Best,

GM

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In the interest of full disclosure; I’ve been long AMZN for a long time but wouldn’t touch NFLX with a ten foot barge pole.

DIS is about to launch its streaming service next year and with all the shows/movies at its disposal; it might give NFLX a run for its money.

Best,

GM

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That would imply that Wall Street could never make a mistake because they have ultimate knowledge AND money.

I didn’t read that into the discussion. Mistakes happen due to unforeseen issues and prevarications. But those consequences are unlikely to be recognized here before they are reckoned by big money investors… unless you’re gifted with clairvoyance.

🆁🅶🅱

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If you read my earlier post carefully; you’ll realise that I wrote that over the next decade, I’m expecting a 15-17% CAGR return from SHOP, SPLK and WDAY

So why do you say we take no regard for valuation here? I’d understand if you wrote about a concrete company and why you think it’s overvalued, but the broad statements you presented are not very helpful…

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P.S. we aren’t just a buncha crazies who think “price doesn’t matter” David Gardner is a strong proponent of ignoring price, in fact he searches for “over valued” companies as part of his Rule Breaker

Wow.

To reiterate what I said two months ago:

The Gardners were very clear in 1999 and prior that ‘Price/valuation doesn’t matter!’ in the Rule Breaker portfolios. They thought that paying a ridiculous price for an RB now is okay, because several years later the stock would be worth even more.

Here’s what RB staff said in spring 1999 [before your arrival]:
Unlike some of the other portfolios in Folly, the Rule Breaker method does not worry much about current valuation. For those who love finding the disparities between current price and intrinsic value, let me suggest the Boring portfolio. Here in the Rule Breaker portfolio we look at valuation with some sort of vague interest...

The Motley Fool’s Rule Breakers, Rule Makers published 1999
In the book, they tell investors not to pay attention to earnings statements for Rule Breakers. It makes the point that for good companies, you should buy the stocks at any price. There is no discussion of valuation ratios and company fundamentals in the book.

At year-end 1999, they had 75% of their Rule Breaker assets in 3 stocks: AOL, AMZN, and Celera Genomics, mostly in the first two:
AOL fell from $80 to $11 in 3 years.

Amazon went from over $110 to $6 in less than 2 years. They advised selling half in the $11-11.50 range in March 2001! Even though it had crashed to only 6% of the RB portfolio at this point.

They also said this: We don't think that [Amazon] can achieve worthwhile appreciation over the next 10 years or so...Yes, we could have sold it at $100, or $75...We don't worry much about market pricing, however."

Celera was acquired in 2011 at $8 after Rule Breaker bought it at $80 in 1999.

5th biggest holding was At Home which went out of business less than 18 months later.

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GrowthMonkey,

I find if you cannot make your point in a few posts, then your point is not worth making. I will waive that general rule.

Why don’t you share your portfolio with us and its results over the last 3 to 4 years. Give us a basis to be corrected on our foolish ways.

I mean this sincerely, not derisively. It adds credibility to your points. Also, as they say in arguments like this, a broken clock is correct 2x every day, and such as that a bear will be correct eventually a bull will be correct eventually, and if someone invests in a manner to panic because of the bear, he will not do much better in a bear.

Tinker

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GM,

Thanks for imparting your knowledge and I hope you keep posting. It’s good to have another view point.

For long-term investors; valuation at the time of entry always matters and that is the point I’m trying to make.

Isn’t this another way of saying value investors? That really isn’t the point of this board. Although I do not disagree with you but a very different way of investing then this board employs.

Andy

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Let’s try to narrow this down. I feel GrowthMonkey has been all over the place here. He actually has a point, but he obscures it with tangential issues and unhelpful rhetoric, for instance:

Unlike many people on this board; I do not trade in an out of stocks often and ONLY sell under the following conditions:
i. If I’ve made a mistake and the business turns out to be a dud
ii. If the growth rate is slowing down or new management is questionable
iii. If I come across another high-growth multi-year ‘moaty’ opporunity available at a fair price

That sounds damn close to what Saul does. In particular the slowing down of growth rates. In reality, the differences are not as much in the selling, as in the buying. GrowthMonkey actually stated his criteria, but no-one has yet responded:

I focus on dominant long-term profitable compounders which are expected to grow their earnings by at least 20% pa over the next 4-5 years and only invest in these companies when they are trading at a PEG ratio of under 1.6 or a sensible price/sales ratio. With my method; I deliberately pass on some big winners (eg: Square); but this is a price I am willing to pay for my peace of mind.

There is much that could be discussed here. For instance, how does GrowthMonkey calculate PEG? Using last year’s earnings or next year’s expected earnings? A PEG “under 1.6” doesn’t appear to exclude companies with zero/negative earnings, but his posts here seem to indicate that they would be excluded. Does he use a 1 year growth rate or 5 year? More importantly, from what source?

I don’t believe that exclusively focusing on metrics like PEG or Price/Sales ratio is a good strategy. Don’t get me wrong - it’s useful to have those metrics to factor in to one’s investing decisions, but I would not include/exclude and especially not trade solely or even mostly on such metrics. The PEG might look good today, but what if the company doesn’t grow as the person who calculated the PEG expected? OTOH, the PEG might not look good, but if the company grows much faster than the analyst thought, it will likely turn out to be a great investment. There isn’t a magic formula to predict the future, and what seems safe may not be (just ask anyone previously holding GE).

It’s important to understand the drivers of the businesses in which we invest. GrowthMonkey’s note about Amazon’s stock price trading at 28 times operating cash flow is, in my view, coincidence. What really happened is that the company was able to create and lead a new growing market completely separate from its original and core business. There’s no way anyone could have predicted that 15 years ago. Heck, even Bezos didn’t know what it was going to be. If Amazon had stayed exclusively focused on retail it would not be the $1700 stock it is today, no matter what its PEG or Price/Sales ratios were back then.

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Q1) Who asks questions during earnings calls?

A) Analysts who work for the big brokerage houses and banks

true, but you can call IR for a lot of companies and they will talk with you

Q2) Who subscribes to Wall Street research?

A) Mutual funds, hedge funds, very large private investors

IMO, most sell side research is centered on above/beyond consensus and the next six months, often with no credit given for BS moves or competitive threats if the analyst doesn’t cover those competitors; plus, a lot of sell side is just rehash of the earnings calls, and anybody can listen to those; finally, other than a house like Morningstar, most analysts follow their own tunes and their own styles, with nothing uniform that can be measured.

By the time any ‘secret’ corporate news gets to these boards; you can be sure that is already in the price. Information first goes to the connected/big players; then it trickles down to us mere mortals.

if it matters, I haven’t seen ‘secret’ information here or anywhere else (and yet a lot of the picks have been successful), and I’d be hard pressed to come up with an example in my own career where secret this or that had any role; this isn’t to say that there isn’t an edge to be had from digging, but there are many people, large and small, who try that game. Even specializing in an area can bring one an edge.

My personal belief if that the market is very efficient, but it can’t foretell the future, and it has clear behavioral neurosis. From what I’ve seen Saul and others have been successful in recent years because he has a clear courage of convictions, and he is very nuanced and controlled in how he reacts to varying data points. You can quibble with that style of investing all you want (scares me, but so what), but it is ludicrous to imply ala the above that there isn’t a clear method behind it and that the lack of ‘secret information sources’ somehow presents itself as a threat. Rather, it is interpretation of KNOWN data that makes the difference, and that is where - IMO - Saul excels. He knows what he knows…

Course, that a 2c evaluation from me, but…

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“price doesn’t matter” Yes it matters but the only time you are likely to get any of these super growth stocks cheap is when few others want them. Near the very bottom of the next bear market. Assuming you have the guts ,cash, and near prescient foresight to buy the best of them and hold. Good luck with that.
Otherwise they will be expensive. For years during the following bull they will get progressively more expensive, that’s why it is a bull market.

And yes ,holders of most of these stocks will be burned badly eventually. It takes more nerve than some have to see your retirement change from age 55 to age 75 and not panic. Saul has done this successfully, but some of his “followers” may find it psychologically difficult.
Especially if they have no cash reserve and lack the tools or ability to do any kind of timing, recognizing the bear when it is on us and reacting to the new environment.

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Mauser this is the one point that never seems to be clear to me when this subject comes up. And, obviously it does a lot. In simple country boy terms, if the market takes two steps forward and one step back when the correction comes, and I take 10 steps forward and 7 steps back when the correction comes I am still two steps ahead of the market. This is why I can’t understand the talk of seeing your retirement drop through the floor etc. Are you speaking of people that are just starting to follow this board and buy some of these stocks? Because I suspect Saul would not be happy with a 50 percent drop, but I doubt it would ruin his life. I have finally reached a point, not in small measure because of this board, that I could take a 50 percent hair cut and not feel it in my every day life. It would hurt if the market failed to bounce off that 50 percent loss within two years or so, but other wise I would just truck on. I live off the income from my investments and when you are up 60 percent in 18 months and you have your life planned around 7 percent per year, well you can see how that works out. I would hate to take a 50 percent haircut and I have a much more conservative portfolio than Saul for that reason but isn’t it relative, He gains 200 percent and takes a 50 percent loss I play it safe and gain 30 percent and take a 10 percent loss which would be worse?
Just trying to understand.
mike

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I have finally reached a point, not in small measure because of this board, that I could take a 50 percent hair cut and not feel it in my every day life.

good for you, but I doubt if that applies to all on this board. And that “up 60% in 18 months” only applies to those investing everything 18 months ago. But this is now, not 18 months ago and nobody knows if we will be up 60% more in 18 months. My WAG is we won’t but my default is invested since the market goes up more than down.

It would hurt if the market failed to bounce off that 50 percent loss within two years or so, it has happened before. It will happen again (sometime who knows when) Especially if you are invested in high price Nasdaq stocks.

http://www.macrotrends.net/1320/nasdaq-historical-chart
and this only goes back 45 years. Can you imagine what it would look like with similar stocks in the 1930’s?

I am not worried about old timers who have been around since the start of this bull (in my case much longer) but newcomers who think it will always be like this.

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reacting to the new environment. something Saul has done well at in the past.

Mauser you said retirement going from 50 to 75. You forgot all of the years of compounding and outperformance that brought retirement from 70 to… 40, 45, or 50 depending on how old we are.

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