Saul showed us many principles, but I think the ability to change (our minds, our companies, etc) is probably the rarest, most important, and most profitable. In one of his greatest posts, he wrote (back in 2018) about why he had changed when SaaS companies came on the scene. Here’s my favorite snippet:
We may be prone to misremember how conservative this statement was at the time. Not only were there many SaaS companies growing in the 40-60% range, but there were many growing at faster like Twilio and Square…and soon would come Datadog, Crowdstrike, Snowflake and others — some growing 100% YoY or more, and with recurring revenue!
We still have SaaS companies today, but ZERO growing at 60%+, and I might be forgetting something, but I can’t think of any expected to grow even 40%+. We forget how much things have changed.
Here are some current revenue growth rates as of the last reported quarter:
Crowdstrike: 22%
Cloudflare: 34%
Snowflake: 29%
Datadog: 29%
Monday: 25%
(Sure we have DUOL at 41% and even RBRK at 48%, but those will be dropping fast.)
So if we can’t find subscription/recurring revenue companies growing fast enough, we need to change.
We certainly see companies growing fast enough:
AppLovin: 66%
Reddit: 70%
Palantir: 70%
Credo: 272%
Astera Labs: 92%
Sandisk: 61%
…but without the backstop that is recurring revenue, we need some new tools. Even SaaS companies couldn’t maintain these growth rates for long, and these companies won’t either. This time around, I think we need to figure out what a reasonable price looks like.
But if we want to see the kind of returns that make stock picking worthwhile, we can’t just buy the dip on SaaS and hope for the best. Saul pointed out back in 2018 that it was early innings…it’s not anymore. Some of these companies will probably have long lives and do fine. Maybe they’ll beat the market by 5% or something. But the bottom line is: we need more than 20-25% revenue growth! We might be tempted to stump for the one or two that might grow at 30%+ going forward (mine is RBRK), but I think we’d do better to realize, that’s still nothing like 2018. The glory days are not coming back.
As WPR just said on another thread:
I think Saul would agree. Let’s try to expand past SaaS.
What hasn’t changed? The thing to look for is Revenue Growth that can surprise the market and outperform expectations. As impressive as the growth rates are for AppLovin and the others I listed above, can we find some new companies that the market hasn’t caught onto yet, that haven’t already rerated due to their 60%+ or 100%+ growth? I think we can! This was a good recent example: Introducing Lumentum (LITE)
I just want to expand my horizons as much as possible. Clinging to what worked in the past is something Saul managed to (adeptly) avoid. I’d like to as well.
I would venture that if it hadn’t been for the incredible forward pull of demand due to COVID, none of these companies would have seen 50%+ sustained growth for the time they did. They would have probably grown closer to 30% all along. Now if that IS true, looking for companies that grow 60% durably(!) is throwing the wrong anchor in my mind - a mirage. I am not saying we shouldn’t invest in 60% revenue growers, in fact, I am investing in some that do currently grow at this clip or even higher; what I am saying is that we shouldn’t have the expectation that they’ll continue to grow durably at this pace (as Bear rightly pointed out).
This brings me back to the second part of this discussion and whether our investing criteria have, or should change. I have two thoughts here:
First, what is the goal? Triple our portfolios in the next 12 months? Or outperform the S&P500 by 10% per year? Or outperform the S&P500 by 2% per year? Note, a consistent 2% annual outperformance over 20 years will roughly double your money compared to an underperforming investment. The spectrum of goals can be continuous where you try to outperform the S&P500 at the maximum rate that’s possible for a given amount of risk (and a given amount of time you have to tend to investing). Anyways, I think one’s individual goal will strongly affect the types and mix of companies to invest in AND the style/methodology of investing in those companies.
Second, and coming back to the growth rate question and what companies to invest in, and whether our investing criteria should change, let’s start with what I think is an universal truth:
The reason we invest in revenue growth is because we believe that this will eventually turn into profits and not only that, but that it will maximize the profits from now until “then”, compared to slower growing companies. Again, the spectrum of potential growth trajectories can be large. What is better, a company that grows 1000% YoY for a few months and then falls of a cliff or a company that grows at 30% for many years, or a company that grows at 15-20% for decades? Maybe one that starts higher at some point and very slowly decelerates? (and I am not talking about timing here; instead I am talking about the long term, meaning many many years and to decades, where I assume that taking our portfolio as a whole, we can be constantly investing in an “average” company that grows in such a way, even though individual companies can come and go in an out of the portfolio).
I don’t think there is a generally true answer as to which revenue growth rate trajectory of the scenarios layed out above will make more profits from now until “then”. It depends on each individual case (i.e. individual company) and our goal should be to pick the most successful ones. Or stack those 70-30 bets in our favor, as @Stocknovice likes to say.
Maybe there is a bit of universal truth in the idea that, at a constant valuation (P/S), a company growing revenues durably at x% YoY should give you a return of x% per year. And if the S&P500 returns 25% in a year, you should aim for x=30%. If the S&P500 returns 10% or 15%, maybe x=15% or x=20% is enough. And if revenue growth is not durable, but eventually decelerating (even if accelerating for a few quarters initially) maybe YoY revenue growth needs to be initially much much higher than 30% to continuously outperform the S&P. I just think predicting outperformance gets much harder if revenue growth isn’t somewhat durable or unpredictable.
So where does that leave us? I am not saying we shouldn’t look for new companies to invest in. In fact, I echo what @wpr101 said on the other thread,
I also think keeping an open mind goes both ways. How do we know that the top durably growing software companies are not (on average and whether they are new or not) going to outperform the S&P500 by a mile from now on? What I am saying in response to the question if our investing criteria should change, is that, at the most basic level, Saul’s investing style of looking for, and investing in companies (old or new), that will maximize future profits, shouldn’t change. And I think the 20-25% revenue growth, that @PaulWBryant thinks is not enough, is probably at the lower end of the range where, especially at 20%, durability over decades is needed to outperform the S&P500. Maybe those are all just opinions which can’t be proven one way or another, or only in hindsight, and everyone should make up their own mind… By the way, we had a similar discussion about what growth rates to look for, a little less than two years ago, here.
There is an additional nuance I want to bring for consideration. High revenue growth cannot be the only criterion, because it doesn’t guarantee those maximum future profits. And this is where software shines over (especially Capex heavy) hardware, because we have established tools and evaluation strategies that I think still work in the age of AI and will continue to do so. Looking for high gross margins and a clear trend towards improving profitability, we can make sure that those future profits will come. Can we even assess this with companies like Coreweave, Iren or Nebius? Or are all those mega deals they make with the Hyperscalers too obscure (financially) to properly evaluate with the information we have? How do we know that the Coreweave’s of the world don’t screw themselves long term with some deals that might look great on paper now, but are really unfavorable in the future? At which point are we just gambling when we invest in those companies (or stories)?
Lastly, @PaulWBryant brought up “the right price”:
I think this is a really really tough one. I am not saying that price doesn’t matter. But I think it is much harder to actually know what the right price for any company is. Yes, there are established valuation techniques, but how good are they really - especially in growth investment - where little changes of the input conditions to a discounted cash flow analysis can create enormous changes in the projected future cash flows? Take Cloudflare as an example of a company that has constantly been one of the top of the most expensive companies on Jamin Ball’s tracker. Clearly, two years ago, after revenue growth rates had dropped from previously 50% to 30% there was an argument that Cloudflare is totally overpriced and that argument even continued until a year ago when YoY revenue growth had continued to drop to 27%. And yet, Cloudflare stock has roughly doubled in the last two years (a ~40% CAGR) and at some points in the last two years it has even tripled (a ~70% CAGR). This just goes to show that I’d be at least very skeptical if someone tells me they think a growth company is overpriced at any given point. Even if that might be and definitely will be true in hindsight for some companies, how am I going to know this is true for sure right now?
If now, or sometime in the future, a shrinking number of companies with metrics meeting our minimums occurs, we a faced with lowering a standard – growth, ticker quality or the number of tickers in our portfolio.
I offer, the best approach is reducing minimum growth %’s a bit, is a better option while maintaining ticker quality standards and not adding risk by holding too few tickers in one’s portfolio.
Thanks to everyone for their actionable recommendations, Gray
It seems to me, the biggest change we need to make is to simply apply the same methodology to companies outside of software. Drop the need for a SaaS business model and everything else is applicable to any company.
After that, tempering expectations is a good idea, as Ben discusses eloquently (@SlowAndFast, thank you for your reply in this post … I was trying to figure out how to express exactly what you said). The one area I have often disagreed with this board is that I never understood turning down 25% annual growth in a high quality company, particularly if it is reliable or slowly accelerating.
Some flexibility in criteria is also needed. A perfect example is debt. SaaS companies were able to grow without taking on debt, but that is not typical. More importantly, ignoring companies with debt will eliminate potential amazing investments. While I dislike seeing debt on a corporate balance sheet, I am willing to accept it as necessary for growth. But if I do see debt, I start looking closely at projected growth and the path to profitability.
There is perhaps one addition worth considering: How adept is the company at evolving in response to new technologies, new competition, changing market conditions, etc.? “AI disruption” has been a big topic lately, but perhaps a more useful perspective is change caused by AI. Or change caused by any new technology. There is a huge difference in prospects between a company that will evolve with new opportunities and one that sticks with what it has done in the past. A company does not need to be new to take advantage of new opportunities!
I’m sensing confusion, because people are bringing up profitability, durability of growth, debt, competition, potential disruption, and other factors and risks. Of course that all matters and my post was not suggesting we ignore any of that. Let me try to restate what I was saying in other words:
Two of the major criteria Saul saw and valued back in 2018 were:
Recurring (subscription) revenue
Really high growth rates
For a brief time, we could have both of these. Now, we can’t, so my post was not just prescriptive, but descriptive. This is the way the world is now, and we must choose. Or as Saul put it:
For my part, I’m letting go of the recurring revenue requirement and holding onto the reallyhigh growth requirement.
Another way to say this is that I’m going with the big potential over the seemingly safe. In the last few years, I (to give just one example) watched APP go from $30 to $300 while I held Zscaler as it went nowhere (even with increasing revenue/profits). I ignored potential because I preferred predictable. I’m changing this.
If I can get both, amazing. But if this is a fork in the road (as my buddy Drowsy put it), and I have to pick one or the other, then I’m picking growth.
Yeah a lot of topics examined at once can make things confusing.
As stock pickers, we want to pick stocks that go up in price but stock prices fluctuate and so we do the fundamental analysis on various companies to try to pick the best businesses or more specifically those businesses which will do incredibly well going forward from today. And the businesses that do incredibly well will see their stock prices rise in the long-run. But buying just 1 business/stock is not a great practice because if you are really wrong just one time then you could be back to square one. So, I would say that a prudent investor needs at least 5 businesses/stocks in a portfolio.
The goal for my stock portfolio company is to maximize long-term capital appreciation (i.e. higher CAGR). Several years ago it was difficult to make money because the whole market was dropping and there were very few new IPOs of companies with great businesses and very high revenue growth rates. Times have changed again and the investing environment has returned to a more favorable state. SaaS was great from 2017-2021, but since then there was a slowdown and as well as other threats of disruption. Not all SaaS companies will be disrupted by AI but some (maybe many) will be negatively affected with reduced revenue growth rates. Stock pickers who pick well will do well but picking wrong in SW can be very costly.
For me, AI has largely replaced SaaS as the majority of my growth stock portfolio holdings. It’s been that way for a while, partially intentional (replacing SaaS with AI) but also because my process prioritizes fast revenue growth as the first stock selection criterion. Most SaaS companies fell off my interest list because the revenue growth rate has dropped too low. The one that remains is AXON (not purely SaaS but with a large and rapidly growing SaaS component); AXON still grows revenue faster than 30%, which, for me, is a cutoff. Even AXON has an AI component and should be a strong AI beneficiary. If one looks at my growth stock portfolio’s allocations, one doesn’t see any companies with top line growth below 30% (IREN might be an exception but I think it will soon see great growth). For me, revenue growth is the single most important criterion because companies that aren’t growing revenue fast will not be able to grow profit or cashflow fast (for the long-run).
For anyone who’s interested in my process and my other criteria for picking stocks, I’ve written a 7-part series on the topic on my blog:
I’ll also say that the other thing that I’ve done that’s been super helpful is separating my growth portfolio from my other assets (e.g. fixed-income portfolio, real estate, etc.). Being laser focused on the growth stock portfolio’s goal of maximizing long-term CAGR helps me make better decisions to further that goal without getting distracted by volatility and other financial goals that can be addressed in my other asset classes.
Thanks for calling out the portfolio allocation as part of the overall strategy. Although we push those discussions to other areas of Fool.com, it’s important to call it out.
Setting up a hypergrowth, hyper aggressive portfolio that invests in MoMo names in Saul style depends upon so many factors not discussed here.
I’ll stop here after stating that this is EXTREMELY important, BUT off topic.
Just a shout out! Long time lurker of your content. Just wanted to say thanks for all you do. These types of posts (GauchoRico's Financial Disaster - GauchoRico Stock Investing & Personal Finance ) are super helpful even though we don’t discuss them here. Keep up the good work for those of us that are always looking for mindset and portfolio strategies.
With a slowing growth company, we are often just hoping the growth will hold up enough to make the stock go up at some point. If profitability is increasing, this can certainly help…but there’s a ceiling of course…you can’t increase profit percentage forever (you can go from 5% of revenue to 20% …maybe even to 50% in some cases, but you can’t go to 100%+.).
And with a 30% or 25% or 20% revenue grower, we shouldn’t assume growth durability. We don’t do well predicting 5 years or 10 years out.
Is short-term hypergrowth any better? Let’s look at some math:
If you have $100m in sales and grow 1,000% YoY for 12 months, you then have $1b in sales.
If you have $100m in sales and grow at 30%, it will take you 9 years to get to $1b. (With 20% growth you need 13 years, and with 15% growth you need 17 years.)
If that sounds bad for the slower growers, durability concerns make matters worse. Will the 30% really stay at 30%? (For that matter, what happens after 12 months for the 1,000% grower? Will growth immediately go to 0%?) Unlikely…but that’s something to consider, as is price, profit, etc.
Take Datadog – will it grow at 25%+ or 20%+ for long enough to beat the market over the next 20 years, or will growth at some point slow to ~10% or even ~5% (maybe several years from now)? I can’t predict that far out.
To be fair: You can absolutely overpay for 100% or even 1,000% growth. Snowflake-2021 and Upstart-2021 are examples of this, and both managed to get over their skis, price-wise. So we need to be early, and we need to be holistic. But nobody said exceptional returns would be easy to get.
Compounding at a “good” rate for decades is powerful, but I believe it’s more rare than we think. The power of compounding at an exceptional rate for a limited time – which many companies do (esp early on in their S curves) – is underrated.
And it’s not a software company - it’s hardware. Oh, and it pays a (small) dividend. Plus its forward PE is only just under 25.
Yeah, it’s Nvidia. Of course, being so large, the question isn’t whether Nvidia can beat the market because, well, it is the market. How are you going to beat that?
