We’ve all read one or other version of the “worst” list as regards investing in 2022: "This has been the worst year of investing since [insert date long, long ago] for [insert any type of investing and most any asset class]. It’s been truly a terrible year for investors of all stripes. If one was unfortunate enough to have cashed out of something like an inheritance and decided to try one’s hand at high-growth tech investing a year ago, well…
So how to write an end-of-year portfolio summary with that as the backdrop?
For those needing a reminder of the board rules: we discuss individual companies here and do not focus on macro discussions, Fed decisions, etc. Important note: it does NOT mean that one should not, or is somehow discouraged from, having a view on those matters (some people seem to imply that)!! It’s just not the main topic of discussion for this board!!
But in our month-end portfolio overviews we also discuss why we invest in certain companies and not in others, and due to that, and this being my year-end review, I need to spend a little time on the interplay of these forces with my portfolio companies and choices.
Because companies do not exist in a vacuum. They exist within a wider macro context of social, technological, political, environmental, legal and economic forces. In short macro forces influence individual companies. And sometimes those macro forces are so powerful that it is not complete to assess an individual company’s performance without reference to the particular macro force. Any investor in China would not have been able to ignore the policies of the communist party this last two or three years (hence Saul’s rule of not investing in any Chinese companies - this is a macro call). An investor in an individual company operating in Ukraine or Russia would not have been able to stay out of assessing the impact of politics.
THREE YEAR REVIEW
For us on this board, the force which no-one could ignore three years ago was the pandemic: a major, massive tsunami of a social macro force. We accordingly made money on e-health, e-commerce, e-signature, e-communications. We collectively (perhaps implicitly) took an accurate view on, and benefited from, the impact of the macro force, as translated into the super-charged performance of our individual companies. This was further boosted by the political responses to the pandemic (lockdowns, QE, interest rates, stimulus).
In 2022 the tsunami was rising global interest rates and a reversal of QE. And, though off topic for this board, I did indeed have a particular view on this. It just turned out to be wrong (I never though rates would rise by as much as it did; there were some who got it right though)…It is not very rewarding to invest when one is wrong about a tsunami macro force with a direct impact on how your investment is priced.
In most normal years the macro force of the year can be a big distraction; not so much in years like 2022. Had I taken a more accurate view on interest rates (if it were even possible), I would have had a higher cash allocation and a higher allocation to already CF positive companies. I would not have been spared though - I would just not have lost as much money. But ja. Coulda, shoulda…blah. Useless. No use looking back - the market looks forward.
But before getting there, first a quick review of my performance for all years since running a concentrated high-growth portfolio (I started in Jan 2020) benchmarked vs the S&P and BRK.B.
| Year | Return | S&P | BRK.B |
|---|---|---|---|
| 2020 | 220.5% | 18.4% | 2.4% |
| 2021 | 52.5% | 28.7% | 29.0% |
| 2022 | -67.9% | -19.4% | 3.3% |
| Cumulative | 57.1% | 22.8% | 36.5% |
| CAGR | 16.2% | 7.1% | 10.9% |
So 2022 was a disaster. Still, the benchmark above is important to me, as it shows that I’ve been better off investing the way that I have been for the last 3 years, vs buying an ETF (the S&P) or buying Berkshire.
Back to looking forward. Remember buy low, sell high? I think we are now at a very, very low place for high-growth tech stocks. You only need to look at Jamin Ball’s historical graph and you can clearly see that SaaS is now much less expensive than it was a year ago. Now, without doing higher-grade math, and considering that we are investors with longer-term horizons here (and not day-traders), surely the same great company at less than half the price vs a year ago is a good deal, no?
Source: Jamin Ball, Clouded Judgement, with own annotations
Note that this graph shows the current price relative to expected next twelve months revenue - and this expected revenue was elevated in the red part of the graph and has recently been significantly reduced (it may be reduced further in the coming months) so the difference between the high and low part is arguably even bigger. I.e. stocks are even more undervalued now, relatively speaking. Just my opinion though.
For the coming year I have taken a view on the tsunami force of 2022: I believe that we are now close to the peak of the interest rate cycle in the US. A discussion of why I reached that conclusion, is OT, but stating the fact is important to understand my stock choices.
So, what are the implications for me? It means that I’m not in cash. It means that I’m bullish on high-growth SaaS and that I will be sticking with younger companies with longer time to positive cash flows, or with currently still low cash flows. Like SentinelOne and Cloudflare and BILL. Why is that relevant? Because companies like them with expected cash-flows further in the future have been punished much more than those with proven cash flows in the past year. And, should the tsunami abate - as it always does - those same companies, ceteris paribus, should benefit disproportionally.
And imo things won’t be the same - there could be some icing on the cake. I believe that my portfolio companies will slow, yes - this is well understood by now, but they could also show much improved margins in the coming year. That is one of the beautiful characteristics of SaaS companies: the ability to increase/decrease margins, and I think we will see that on full display in 2023.
CURRENT PORTFOLIO
| Company | Ticker | % of port |
|---|---|---|
| Snowflake | SNOW | 17.1% |
| Bill | BILL | 16.4% |
| SentinelOne | S | 17.7% |
| Cloudflare | NET | 15.8% |
| Datadog | DDOG | 15.2% |
| Trade Desk | TTD | 8.8% |
| Transmedics | TMDX | 8.2% |
| Gitlab | GTLB | 0.6% |
| Crowdstrike | CRWD | 0.2% |
| Cash | 0.0% |
I had to chuckle when I saw @silviocast calc of my return for the year, had I done nothing since Nov 2021. I would have lost less money! Really, it made me smile - or rather smirk. Now without getting into the debate (the thread has enough of that) my takeaway from this is that this last year - the market cared less about the quality of the individual company and just punished everything almost formulaically. SaaS: slash! High-growth: slash, slash!! Not yet CF positive: slash, slash slash!!!
I believe that individual company performance will matter more in the coming year than it did in 2022.
I discussed all of my portfolio companies in last month’s review except for SentinelOne, so will only delve into some of the numbers on that one. In December, I exited Crowdstrike and redeployed the cash into my other companies, as I indicated I would do last month.
SNOWFLAKE
Snowflake is a juggernaught. The only company which will have enormous individual customers - $100m and more - of all of my portfolio companies.
I’ve written and thought a lot about this company in the past years, and have a lot of confidence in where they are going and the durability of their growth. What stood out for me in the last quarterly report was that the GTM machine is improving even in this tough macro-economic environment with them adding a massive 28 G2000 customers in the quarter, second only to the 29 added in Q2 of FY2022.
They indicated that they will be moderating headcount growth and will be at a 23% FCF margin next year, from 21% this year.
I believe that we will see the power of our companies to manage their FCF and op margins by moderating spend in the coming year and SNOW will be a case study on how this is done.
SENTINELONE
A lot has been written on this company, with some opining quite negatively on their performance. But I really can’t fault:
- 106% yoy revenue growth, with a 91% revenue growth guide for next quarter (their ARR guide implies 96%)
- 134% NRR and magic number of 1.2x
- gross margins up 4%pts yoy to 71%
- op margins up 26%pts!! yoy (still negative, yes, yes) and a further 4%pts improvement in the guide for Q4
- 650 customers added vs 600 a year earlier and
- 72 >$100k customers added vs 71 a year earlier
- a prelim guide of around 50% revenue growth for next year (the guide was for 50% ARR growth but it should be close to revenue growth).
- a pledge to focus on improving margins next year and to
- reach cash flow positive territory in Q4 next year, with
- $1.2 billion in cash on the balance sheet
Their FCF has been less inspiring, but it fluctuates from quarter to quarter which is why I focus on operating margins. But last year Q4 was their best FCF for the year, so it may be the same this year. They are moderating headcount growth, so it sounds like a fairly good bet to me.
They’ve been taking market share in the endpoint/XDR market including large customers, and have expanded their product portfolio into cloud protection with Singularity Cloud, which is growing much faster than the overall business. They also expanded into identity so now cover endpoint, cloud and identity with an automated response philosophy.
The main gripe from others about the quarter’s performance has hinged on just one (important - yes) metric: ARR. For Q3 it came in soft ($49m added vs >$50m expected). Their ARR guide for Q4 of 20% sequential growth implies a slightly higher revenue for Q4 than the revenue that they guided to ($129m implied vs $125m guided) - and this is seen as an irresponsible/unnecessary guide (why guide to revenue which is lower than what your ARR guide implies?). And lastly their 50% ARR growth guide for next year. Some believe this may again be irresponsible as they may be forced to lower it when they report next and issue “real” guidance.
Now these are all real, valid concerns. But I take heart from the direction of RPO, which was up 16.3% sequentially (vs 12.5% for revenue and 11.1% for the much-maligned ARR) - so RPO growth outpaced both. And RPO is the leading indicator here…
I’m also choosing to trust management on this one; same as with my other companies (if I didn’t, I really should sell, right?).
CLOUDFLARE
Like all of my portfolio, revenue growth slowed. However I believe that we may be underestimating the impact that their 25% price increase coming up on 15 January will have on cash flows and revenues. If this goes as planned, then they should get a big FCF boost as well as a revenue boost.
They have not raised prices in twelve years! So this is a big deal.
I also think that, on top of their amazing general innovation cadence, their Zero Trust offering specifically is maturing and will give them a durable boost in future quarters as these are larger deals with longer sales-cycles.
Lastly, they seem to be more cautious with hiring and can curtail this to improve margins, should they choose to.
BILL
The standout metric here was of course how many new customers they added last quarter: 14,200 of them - a record by a long shot, coupled with continued strong growth without much in the form of headwinds showing up. And that they clocked in at a 1% FCF margin - a first for a Q1 for them.
They are in a great position in that higher interest rates boost their revenues and the record number of new customers they just landed should ramp up in the coming quarters, benefitting from that high NRR of theirs (131% when last reported in Q4).
That gives them a solid footing for maintaining relatively aggressive hiring but also a lot of scope to curtail spending if the need arises - something which they did not talk about at all in the earnings call, contrary to others. Still, I think they’ll have their fingers on the throttle button.
DATADOG
Last month I was still on the fence on this one. In their last quarter, revenue dipped more than most, customer growth was not great, margins dipped - gross margins by 1%pt and operating margin by 4%pts sequentially and FCF margin was flat.
But the thing that excites me and kept this one as one of my top 5 is the potential they have to bounce back given their usage-based model, coupled with their leading market position, strong cash generation and great NRR.
I thought this prezzo, published during December was a great overview of their drivers and strategy. Especially this slide is applicable to all of my portfolio companies as it shows the macro tailwind of cloud adoption nicely:
Source: Datadog Nov 2022 Investor Deck
TRANSMEDICS AND THE TRADE DESK
Both of these companies are smaller, non-SaaS investments which I may boost depending on performance. I expect big quarters from both of them when they report next.
CLOSING
This has been a brutal year for me and I guess for anyone invested in anything, really. I really hope that you did better.
Here’s to 2023!
-WSM
PREVIOUS REVIEWS
November 2022
October 2022
September 2022
August 2022
June 2022
May 2022
Apr 2022
Mar 2022
Jan 2022