*** Why I Invest the way I do! ***
I thought that with the disruption we had this weekend I owed it to you to review why I invest the way I do, anyhow well it works long term. Here we go!
First of all, please don’t attempt to follow my picks, or to invest in companies just because I have. I’m not a financial advisor. And you may have a completely different personal financial situation than I have, with different amounts of assets, different amounts of debts, different family responsibilities, the whole works, and a different temperment for investing as well. And also, I make mistakes all the time! And I may change any pick the next day and not announce it until the end of the month, and if I should be ill or whatever, I may not get around to doing an end of the month summary then. You MUST make your OWN decisions based on your OWN evaluation of the companies!
Second, let me emphasize that this method of investing isn’t for everyone. If you aren’t comfortable with it you probably shouldn’t do it. Some people are more conservative and prefer value investing. There are boards for that. Others are more adventurous and risk taking and like market-timing and jumping in and out of the market. There are market-timing boards too, as well as boards for almost anything you may like (options, turn-arounds, dividends and income, leverage, whatever). What I try to do, and what this board is for, is to pick the best high growth companies we can find with the best opportunities for future growth, to crowd source information about them, and evaluations of them, and then stick with those companies as long as the story stays intact. Simple as that.
Let me now give you an idea how that has worked. Here’s a 5 year summary of my portfolio results from the beginning of 2017 until the end of 2021. Others on the board have had similar results, some a little better, some a little worse.
2017 + 84.2%
2018 + 71.4%
2019 + 28.4%
2021 + 39.6%
That compounds to 1,886% of what my portfolio had started with in five years!!! It’s not up 88%, or up 188%. Its 1,886% of where the portfolio started The power of compounding! It’s 19 times what I started with in just five years. A 19-bagger on my entire portfolio! Not a 19-bagger on one stock in a 50 stock portfolio. A 19-bagger on the whole thing! In five years! Those are really crazy numbers, and I might not believe them either if I hadn’t seen them happen!!!
During those five years the S&P was up 112%, even with 2021’s large gain (large for the S&P). That’s up 112% compared to up 1786%!!! You can add a few percent by adding in dividends, but that doesn’t change the comparison at all.
And since we had someone recently screaming about how we should be in Value Stocks, here is how the IJS did in those five years. The IJS is an ETF that tracks the S&P 600 of Small Cap Value stocks. I’ve been following it, it feels like almost forever, to give me some comparison to value stocks. It started 2017 at 140.0 and ended 2021 at 104.5. It LOST 25% of its value over those five incredible years when my portfolio was up 1,786%. So tell me, does Value Investing still look really risk free and tempting to you?
Now, let’s go into 2022. At today’s close, when I was down 39.1% this year, I was still at 1,149% of where I started 2017. An 11 bagger and a half! I’ll take it. I always expect that after rising there will be some valleys, and indeed there have been every year. (This is a big one though).
As of today’s close the S&P was only up 92% in the same five years plus (up 92% compared with up 1,049%).
And the IJS Value ETF was DOWN 29% in those five years plus (down 29% compared with up 1,049%)
Please remember back (or if you weren’t here, look back) to the October 2019 bottom, two and a half years ago, when all those trolls showed up on our board and were telling us that our “overpriced” stocks would “NEVER see the ridiculous highs of 2019 again”, and asking why didn’t we get smart and sell out and invest in S&P ETF’s. It was pretty scary back then, and even some of our regulars were thinking we might have to wait two years before our stocks would regain their highs. It seems pretty funny now, considering many of our portfolios were up by over 200% in 2020! It’s worth keeping that in mind when trolls show up trying to get you to sell out. Because there always WILL be corrections, and our companies WILL fall temporarily, and the trolls WILL show up, usually at the botttoms. Remember to pay attention to your companies, and how their businesses are doing, and what their prospects are, rather than the stock price when they are all falling in a “market rotation” or “correction.” Our companies will come back.
Now a new subject! Why don’t I get all excited about the valuation of my companies’ stocks? Well, I’ve posted this in the past, but I’ll post it again as it seems needed. It has to do with the fact that we invest in SaaS companies which have a different and extraordinary business model, and thus traditional measures of valuation simply don’t fit for them
Some who are new to the board seem almost personally offended that I don’t calculate EV/S on any of my stocks, and that I don’t pay much attention to it, or to the fact that all our stocks usually have EV/S ratios which are very high by traditional EV/S standards.
I don’t have the answer to what is “overvalued,” but I know that traditional EV/S ratios have almost NOTHING TO DO with our companies! Our companies are profoundly different than the companies that EV/S was traditionally used for. Why? Here are some reasons:
First of all, a company with 70% to 90% gross margins is worth a much higher EV/S ratio than a company with 30% or 40% gross margins because each million dollars of sales is worth so much more to the company in take home dollars.
Just think about this for a minute. If you have 85% gross margins, a million dollars in sales is worth $850,000 to you. If you have 42% gross margins (still quite acceptable), the same million dollars in sales only brings you $420,000. Now really think about that. How can you put the same million dollars in the denominator of EV/S and expect to get a sensible comparison? Our company with an 85% gross margin is naturally worth twice the EV/S of a normal company with a 42% gross margin, other things being equal.
And a company with a 28% gross margin (believe me, there are plenty of those too, in the real world) only keeps $280,000 out of that million in revenue. How can you put the same million dollars in revenue in the denominator of EV/S for all three of those companies??? Our company with 85% gross margin is naturally worth three times the EV/S sported by the 28% gross margin company, other things being equal… But… other things aren’t equal!!!
Second. For a company that is leasing software that becomes integrated into the core of the customer’s business and has a subscription model that brings in recurring revenue, each million dollars of sales today is not just for this year. It’s for next year too, and the year after, and the year after that, and…. pretty much forever. No one, simply no one, is going to tear out a system that is core and essential to the smooth running of their business, and that would disrupt their entire business to pull out, to save a few dollars. It ain’t gonna happen folks.
Okay now, you have a million dollars of sales this year that will, for all practical purposes, be there next year, and the year after too and new sales next year will be an extra bonus added on. When you put that million dollars into the denominator of the EV/S equation, what do you have to multiply that million dollars by to take into account all those future years of recurring revenue? By three? By four? By five? That sure brings down the real EV/S for our SaaS companies, doesn’t it?
Compare it to a clothing manufacturer (just for instance). It sells 100,000 coats this year, but it starts from scratch next year. It has no idea if it will sell 100,000 coats next year, or even 50,000 (maybe another brand will be in fashion). On the other hand, our companies start with last year’s revenue locked in, and this year they add revenue from there, while that traditional company has to start all over again from zero this year. Recurring revenue on a subscription sure beats the heck out of that, doesn’t it?
Really think about that! The clothing company’s million dollars in revenue comes in just once just once. Our company’s million dollars in revenue is really at least a billion as it will probably be coming in each year for at least ten years!
At first glance that clothing company example may seem irrelevant. But no, the EV/S of maybe 3 or 4 that it carries, has helped to shape the idea in your head of what a EV/S normally is. But if the clothing company’s EV/S is 3, if one of our companies has the same revenue this year (the same S in the denominator), what should its EV/S be? Four times that? Six times that? Ten times that?
Third. But wait! Our companies also have a dollar-based net retention rate maybe averaging 125% or so. That means that this year’s sale revenue isn’t just going to recur next year, but it will be 25% bigger next year, and bigger the year after that. Well of course a company with a 125% dollar-based net retention rate of recurring and growing revenue will have a higher EV/S ratio, than a normal company with the same revenue, the same S value, down there in the denominator, which may not even be there at all next year … (duh!)
Fourth. And then there is growth rate! The average growth rate of the companies in my portfolio is probably about 80%. Well, of course a company that is consistently growing revenue at 80% is going to have very high EV/S ratios, because in just three years a consistent 80% growth rate means they will have almost six times as much revenue as they have now. That’s in just three years! Now I know that they won’t keep that 80% rate for five years, but just to illustrate the effect of compounding, in 5 years they would have about 19 times as much revenue as they have now. Clearly that S in the denominator is going to grow very rapidly even if the growth slows some.
Fifth, think about capex. A traditional company that makes things, if it doubles sales it has to build new factories, buy new machinery, hire additional workers, line up new sources of supply, etc. Our companies do it almost all over the Cloud. No factories! Almost no Capex expense except offices.
Sixth, our companies almost all have no debt. They just have cash or equivalents on hand.
Seventh, and finally, of course a company that is leasing a software solution that every enterprise on the planet needs, and that the vast majority don’t have yet, and that all those companies will keep indefinitely once they install it, will have a higher EV/S ratio than a company selling a product that anyone can put off getting a new model of, or stop buying for the duration of a recession, etc.
Here’s the key to this!!! You can live another year with your old cell phone, or computer, or car, or raincoat, or refrigerator, or kindle, or ski jacket, or your old factory, or whatever, without buying a new one next year, but once you lease this software, you keep leasing it indefinitely, no stopping for a year. If you think about that and understand it, you’ve gotten the message!
And of course, of course, of course, companies that have ALL these features are just going to have very high EV/S rates. That’s just the way it is.
And I don’t know what is high, but I will NEVER sell out just because the price has gone up, and because some people think the EV/S is too high (although I may trim if a company has become too large a part of my total portfolio). I just don’t know where these companies will ultimately end up.
Thus my decision about my confidence in a company is based on gross margin, recurring revenue, growth rates, dollar-based net retention rates, necessity to their customers, dominance in their field, my confidence in management, and how all that looks to me for the future. Traditional EV/S simply doesn’t enter the equation.
It’s not that I don’t look at price. It’s that I don’t know when they will stop rising, and I’m not a guesser.
Here’s a powerful example: On March 16, 2020, with the onset of Covid, my portfolio fell to down 16% on the year, or 84% of what I started with. One month later, on April 17th, it was up 54% from that bottom at plus 29% year to date (129/84 = 1.54)
Up 54% in a month, in stocks that were already considered “overvalued” even when they were at that Mar 16 bottom! Should I sell out and take profits? That’s what the market timers would do.
Or another month later, on May 16, when they were at up 61%, up 92% from the bottom in just two months!!! Clearly time to lock in profits and sell out!
But amazingly, if I had sold out then, and locked in a 61% ytd profit, I would have missed the next 172 points of the 233% profit I finally made in 2020. My portfolio finished up almost four times that 61% ytd profit.
No, I don’t play those games. I pick winners and stay with them.
I hope that this helps,