Valuing Growth

[junomean2]

All,

As most others on this board have expressed, I have greatly benefitted from all of the wisdom and insight shared here. I know valuation isn’t a topic of interest for some but it is for others; I believe it has its limitation but also has its usefulness. I wholeheartedly agree with Saul on the irrelevance of P/S but do like utilizing some sort of valuation metric in order to make more informed buying decisions, using it only as one of many tools in my toolbox. I have come up with a metric which I call Growth Value (GV). This may not be original but I personally have not seen it elsewhere. I have posted about this before on the board but it was buried within a different topic so I figured I would add some more details and repost it on its own.

GV = EV/GP/%_Rev_Growth.
EV: Enterprise value
GP: Gross margin * annualized quarterly revenue from most recent quarter
%_Rev_Growth: YoY growth in quarterly revenue expressed as a percentage (20%, not 0.20).

My current threshold is 1; >1 is high and <1 is reasonable. I am not naïve enough to think that a stock at 1.01 is overvalued and one at 0.99 is undervalued, this is just a guideline. I like this metric because it accounts for a lot of which I think is important: cash position, debt position, gross margin, and revenue growth. This also does a good job leveling the playing field between companies because one company with a low price P/S and low revenue growth can be directly compared to one with a high P/S and high revenue growth.

Some examples from this board’s darlings are shown below. All data is annualized quarterly revenue, from each company’s most recent earnings release (CRWD hasn’t reported as of this post), and prices are as of closing 3/3/2021.

	**EV/GP**	**% Rev**	**GV**	**P/S**
**CRWD**	66.6	85.8%	0.78	50.1
**PINS**	19.5	76.4%	0.26	16.6
**NET**	54.8	50.0%	1.09	43.4
**FVRR**	46.9	89.2%	0.53	39.0
**DDOG**	48.7	56.2%	0.87	38.8
**PLTR**	40.9	40.4%	1.01	33.4
**SNOW**	153.5	117.2%	1.31	91.8
**ROKU**	38.0	58.0%	0.66	18.3
**FSLY**	38.9	40.2%	0.97	23.6

Some takeaways:

• PINS is WILDLY undervalued given its growth rate. I am honestly shocked at how undervalued and underappreciated this company currently is. The argument could be made that this growth is directly tied to COVID but those making that argument haven’t done much research into what the company has been up to. They will have great compares Q1 & Q2 followed by tough compares Q3 & Q4 but this company is doing a lot to increase its revenue and profitability regardless of the comparable quarter; I personally own a sizable position in PINS. Alas, this is not a post about Pinterest.
• FSLY has finally come back to earth (sort of). Despite the P/S difference between FSLY and NET, I think they are both actually close to a reasonable value now.
• I believe CRWD is and has been well priced and will most likely have a blowout earnings report 2 weeks from now.
• I believe SNOW is still richly valued, which isn’t really a surprise to anyone. Even after its stellar earnings report today this stock is still quite high.
• PLTR is still fairly rich even after its most recent drop. People think it has a long runway because the price is so low but they are ignoring how many shares are currently outstanding.
• DDOG looks good currently and even better when you plug in the ASSUMED 65% growth rate which will show up in Q3 (https://discussion.fool.com/ddog-realignment-34751066.aspx).

Hope this is helpful to some and contributes to each persons toolbox. I find valuation to be most helpful when deciding which position to fill out next with my available capital, not necessarily whether I am deciding to open a position. Use as you see best for yourself.

-Junomean2

[rmtzp]

Junomean2,

Thanks for introducing this model to the board. Any "new” way to think about our companies is a positive externality for this community – whether that is insights about their technology, assessments about its financial performance; or even valuation. I think most of us here can agree upon traditional valuation methods being suboptimal to evaluate "our companies,” so I do believe that fresh ways of thinking about this is valuable.

PINS is WILDLY undervalued given its growth rate. I am honestly shocked at how undervalued and underappreciated this company currently is.

I am of the belief that the market is usually smarter than me. So when I see an outlier (like Pintrest in your example), I wonder why is this the case. Is it that the sum of market participants haven’t picked up on the mispricing of a company? Or rather that there are inherent differences between the others you presented in your example?

I believe the latter is more probable for a few reasons. The main one being that some of the companies in your chart are sort of the central nervous systems of businesses. The pandemic demonstrated how companies were forced to induce layoffs, delay their rent/utilities, and even delay debt payments. But they could not get away from paying for their key subscription services. They proved to be imperative to their day-to-day.

The second (somewhat related) point is Pintrest’s lack of subscription services for its core business. In post 76165, Saul indicated how he altered rdutt’s “Oomph model” to bump up the metric based on percentage of recurring revenue from each business. This makes sense for all of the reasons of why we choose to invest in subscription-based businesses in the first place.

Now, that’s not to say that Pintrest isn’t undervalued. It certainly ticks a lot of boxes as a candidate for share price appreciation. But for these reasons, it doesn’t surprise me to see consumer-focused businesses with a lower GV. Back of the napkin calculations for others consumer businesses yield a similar relative undervalue (e.g. Etsy 0.12, Peloton 0.16).

To your point, this should be “one of the many tools in our toolbox,” so I simply wanted to share my thoughts on the tool you kindly introduced us to. I hope this interpretation is useful to you and others.

-RMTZP
Protect the identity of this board and maximize your learning by reading https://discussion.fool.com/for-board-newcomers-all-others-34765… before participating

[HTXfool2020]

Just thinking about the differences between some of the consumer businesses which RMTZP mentioned such as PINS/ETSY/PELETON what I am seeing in my mind is the metric should also have a consideration for TAM. Alot of the SaaS businesses have growing TAMs as well which somehow needs to be accounted for.

My 2 Cents
HTX

[Griffin100]

Back in the day, Jim Slater (I think?) popularized the PEG ratio, being Price to Earnings, divided by growth. Many growth shares have no earnings. In this suggested formula, Earnings is replaced by gross profit. Price (Mkt Cap) is replaced by EV.

So the formulae have a lot in common. The numerator relates to the value of the company, and the denominator is something related to trading performance (revenue, gross profit, earnings, cash flow). Then divide by a growth rate (same list …).

I think that Slater was consistent with dividing by earnings and earnings growth rate. This suggested formula divides by gross profit and revenue growth rate.

[MAS4R]

Many thanks for this post.

I have been experimenting with a very simple measurement:

Market Cap (usually EV is too close to matter for these companies)/TTM gross profit=multiple
Then QoQ gross profit growth/multiple = ratio
I have toyed with 1 as a separator value, but it is too arbitrary.

Instead, I went back to Q2 2018 and took the ratio at the end of each calendar quarter and then the average of the 7 pre-covid quarters to get a “normal” ratio for each company.

Thus, like you, I end up with a way of valuing companies directly against each other, accounting for growth as well as with a way of valuing each company against its pre-covid self.

My results are very similar to yours:

BASED ON FEB 25 closing prices:

ETSY: 8.5 ratio (the bigger, the cheaper) vs 4.2 before covid = super cheap relative to SaaS, twice cheaper relative to its pre-covid self. Similar situation to PINS. I think that those who believe ETSY is done after Covid have zero understanding of what ETSY does for small fabrication businesses and individual artists, which was my case until summer 2020 as well. The potential and the staying power are insane: I was not surprised at all that Germany and UK did great for them; Italy, France, Spain can be huge markets for ETSY as well.

SHOP: 0.97 ratio vs 1.12 pre-covid, “standard price”
DDOG: 0.94, pre-covid n/a
TDOC with Livongo: 3.5 vs 3.4 pre-covid for TDOC alone, bargain, no wonder Cathy Wood bought a ton at this same level in October/Nov and is buying more now.
BAND: 3.16 vs its pre-covid self of 1.44, so I bought over the last two weeks, of course 20% down now (there has been no correlation between company valuation and pullbacks over the last year or so).
NET: 0.7 vs 1.44 pre-covid, so twice as expensive
TTD: 1.12 vs 2.47, also roughly twice as expensive

Relative to each other, NET is extremely expensive, chasing SNOW basically. Another one at stratospheric valuation is APPN. FSLY is now much cheaper than NET, I think it was just under 1.

Separately, I also like to sum up three metrics: QoQ revenue growth, gross margin, and profit margin as an indicator of strength. Among mine (before SNOW, DOCU, CRWD, NARI have reported), first is ETSY at 229 followed by SQ at 207 (though BTC “revenue” is the reason), MELI at 182, etc. I used this to exit NVTA which I had bought in spring 2020 before reading through this board. I switched half to BAND for similar growth expectations but without setting cash on fire and the other half to NARI for much higher growth with much better finances (btw, as a customer, I liked NVTA, the testing process was fine and I do like to know things!).

Finally, I like two types of companies, 1/ mostly consumer facing future (hoped for) behemoths on a very long leash (SHOP, MELI, RDFN, IIPR, etc) and 2/ companies that push the boundaries of technology like SNOW, AI, DDOG, CRWD, etc. I tend to regard the latter as much more fleeting than the former and the idea is to apply Saul principles to them while holding group 1 on TMF principles.

[mostlylong]

I was playing with your [ratio] formula and it looks like it is the same as

100 x [Dollar Change in Gross Profit QoQ] / [Current Market Cap]

so it’s like a QoQ change in [Gross Profit Yield] using current market cap, and [Gross Profit Yield] is like earnings yield except using gross profit instead of net income