Wow the macro craziness certainly continued this month - still a helluva lot of uncertainty in the air. Especially from where I’m sitting in Northern Europe. This morning I saw another “UA” number plate at my local grocer, and I live in a small town more than 2000km from Ukraine.
A couple weeks ago I went for my umteenth COVID shot from a big temporary location outside the city and I saw queues of people - all getting out of “UA” cars at 9am in the morning. The big work-stream for local government was Ukraine refugees, not COVID anymore, and this was before the annexations of the last couple of days. And then we have an Etonian, son of Ghanaian immigrants to the UK, who studied history at Cambridge and Harvard, and managed to sink the pound and get the IMF to criticise his plans within weeks of becoming the Chancellor of the Exchequer, possibly dooming the brand-spanking new government in Downing street. Not to mention the new far-right and potentially fiscally irresponsible government in Italy. Oh and the US Fed raised rates by another 0.75%pts - the fastest pace of rate increases on record. It forced the Bank of Japan to step in to support the Yen for the first time since 1998 after the Yen lost more than 20% of its value against the dollar just this year. Globally the number of central banks raising interest rates in a month has not been this high in the last 50 years.
And that was just September…
A thought about cash as a portfolio position
Had I decided, back in May last year to play it “safe” and keep my money in cash, and for me cash means Euros, I would have lost just over 24% of my money in $ terms, before inflation. And inflation is a beast in Europe. In the Netherlands inflation was 7.6% in January of this year and is projected to hit 17.1% in September by Eurostat. That’s a lot of value lost. And I could have lived in Japan…or the UK. As it turned out I did not play it safe and I lost 32% in $ terms over that same period invested in high-growth “risky” stocks. And to be fair the massive losses of this year still hurt. But only because I keep anchoring on the ATH, which is folly, but I still do it.
Anyhow, enough of that. I just wanted to make the point that macro forces are impossible to predict imho and they hit every asset class - nothing is “risk free”. “Risk-free” government bonds lost a ton of value in many countries recently…
2022 YTD RESULTS PER MONTH
Jan -27.1%
Feb -23.9%
Mar -33.8%
Apr -43.4%
May -59.0%
Jun -59.6%
Jul -58.4%
Aug -54.2%
Sep -59.7%
Position sizes and why
Below are my current portfolio weightings, as well as what they were last month in brackets:
Cloudflare (NET) 18.0% (19.5%)
SentinelOne (S) 17.6% (15.0%)
Snowflake (SNOW) 13.8% (12.3%)
Bill.com (BILL) 13.2% (14.8%)
Datadog (DDOG) 12.6% (15.2%)
Gitlab (GTLB) 9.6% (6.4%)
Crowdstrike (CRWD) 9.8% (16.3%)
Twilio (TWLO) 0.9%
Cash 5.0% (0.5%)
This month I will try to explain (also to myself 
) why I take the relative position sizes that I do within my universe of companies. It is not only a matter of confidence for me. I have confidence in all of the companies in my portfolio. But in my life I’ve made a lot of good and bad investments, both on the stock market and in private companies. And in all of the cases where I’ve done really, really well, I was able to get in relatively early on in the lifecycle of the company. I therefore tend to have larger positions in the smaller companies out there in terms of both revenue and market cap. That has of course been a disaster in the last many months, as the fastest-growing, smaller companies who were not yet cash flow positive (MNDY, S, NET) got crushed. The more mature and already CF positive companies that we follow also got crushed by any objective interpretation of that term, but by a lot less than the others (DDOG, CRWD, SNOW). Then we have the ones that stumbled - and got murdered (TWLO, OKTA) and the ones that stumbled and then fell (UPST, PTON) - who just got obliterated.
While I have no interest in that last bucket (the ones who fell), I feel all of the others are fair game, and I think that the tide will eventually turn. And right now the smaller, faster growing, not-yet CF positive companies are really on sale. So in stead of playing it safe (relatively, of course) and overweighting DDOG, CRWD, I’m overweighting - relatively speaking the likes of S, NET, BILL.
What I did in September
Not much, to be honest. Except a lot of hand wringing. I tried some trading but have now come to the conclusion that I am not, and will probably never be, a trader. My companies all reported in August and early September and the reports were roughly as I expected, except for MongoDB, which was worse and I sold after results and SNOW which was better and I increased my allocation. ZScaler was much better than I predicted, and I didn’t own it going into results. Still, I was not tempted enough by the big billings number to get back in. I keep on asking myself whether I would rather own NET, ZS or both. And my answer on that one keeps on being NET. So I mostly rebalanced to what I have now, and not much else.
SOME THOUGHTS ABOUT MY PORTFOLIO COMPANIES
In a recent podcast about Crowdstrike (Business Breakdowns: CrowdStrike: Cyber SaaS op Apple Podcasts) the analyst pointed out that CRWD was one of only two SaaS companies in history to have hit $2bn in run-rate ARR and still be growing north of 50% yoy - the other being Snowflake (and I believe the third will be Datadog). That took a while for me to digest. Were these three companies really that unique? I then looked for any company that hit $2bn in revenue except for Crowdstrike and Snowflake and was still growing >50%. I could find only a couple: Microsoft, Google, Facebook - and the first two are currently $1trn+ market cap monsters and the third until recently was (challenge to the rest of you guru’s: are there others?). That put these three companies of ours in a very, very select group and qualified them as the gold standard for my purposes.
Based on that, I set out to evaluate my other holdings against these three to see if I just maybe had a baby SNOW somewhere. Here’s what I did. I plotted these three’s revenues and operating margins from the quarter in which they had ±$45m in revenue (their last <$50m revenue quarter) up to the point where all three of them were operating margin positive, to see what that looked like. Here it is:
Now this progression of 11 quarters is telling in its own right: there is a very clear inverse relationship between operating margin and revenue growth. SNOW chose to spend much more than the other two earlier on, and grew much faster as a result. Now obviously there were other factors at play too, but these three are the gold standard; all 3 had fantastic product market fit, and crucially all had very high gross margins so I’m willing to ascribe most of the growth delta to their choice of burn rate. Happy to hear other arguments, but big picture, this is what I keep on getting back to (my own company is a case in point: we are profitable, nicely cash-generative, and grow at around 20-30% pa. Could we have grown faster? Hell yeah - if we had hired more people.) Even though DDOG had a positive operating margin when it had revenues of ±$45m and SNOW had an operating margin of -174% (gasp!!!) at the same time, 11 quarters later SNOW was sitting on a 3% operating margin and DDOG on 10%. Not such a big difference. But SNOW’s revenue was almost twice as large as DDOGs by that time, at $334m vs DDOG’s $178m.
Why all the ancient history? I think all 3 companies are exceptional. Truly exceptional - and I would have loved to have bought shares in all three when they had <$50m in revenues.
So knowing what their path looked like when they were smaller could perhaps help me evaluate whether I had the next DDOG, SNOW or CRWD in my portfolio.
So here goes.
SentinelOne
I’ve given a detailed write-up on the adjusted numbers (here: https://discussion.fool.com/wsm8217s-portfolio-1-july-2022-35139370.aspx) and the most recent quarter (here: https://discussion.fool.com/wsm8217s-portfolio-30-aug-2022-35160798.aspx). I can also really recommend @SlowAndFast overview of the numbers, and @stocknovice’s overview of the operational progress (also of all of the other companies in my portfolio for that matter). In addition to that, this is how S compared with the three greats above:
See it sneaking in just above Crowdstrike and just below Snowflake on that revenue graph, and just above (i.e. better than) Snowflake on the op margin one? It’s tracking well to be another great company, if the incredible pace of revenue growth continues and operating margin continues to kick in. And management has told us that they aim to improve operating margins by 30%pts per year going forward, and improved it by 42%pts vs a year ago this last quarter. If they delivered on the 30%pts promise, they will be at operating margin positive territory in a quarter or two more time than Snowflake took to achieve the same feat. So yes, not quite as efficient a machine as Crowdstrike or Snowflake was when they grew up, but right up there with the best of them if they can continue to pull it off.
I think SentinelOne could just be the new SNOW, DDOG or CRWD in the making. And while S is now a $7.5bn market cap company, SNOW is $54bn, CRWD is $38bn and DDOG is $28bn. That’s roughly between 4x and 7x upside in a couple of years if they can continue on their path. And that is at current market prices, which I think are very depressed so there may be even more there if the macro gods decided to smile on us again.
Cloudflare
Cloudflare had a fantastic quarter followed by a jaw-dropping GA and birthday week. It has a market cap of approx $18bn.
For a great expert overview over the incredible innovation cadence, read Peter’s piece here: https://softwarestackinvesting.com/cloudflare-ga-week-recap/#more-6406
For Cloudflare the comparison I referenced above is a little less relevant as they had a number of quarters after the equivalent period.
We know NET is no SNOW in terms of the explosiveness of the growth. So what makes it such a great company? Its ability to continue to do more of the same quarter after quarter. There is a deceleration of growth visible for most of the companies in my portfolio, and Bessemer Ventures has calculated a growth decay of about 20% of the growth rate each year for their SaaS universe. But there has to date been no slowdown in Cloudflare’s revenue growth.
This is amazing, and is the story of their uniqueness. They innovate their way to maintaining hypergrowth.
In addition the CEO has said multiple times that they will be cash-flow positive in the back half of this year. And Prince is someone whom I believe when he says something like that.
I was a relative latecomer to the Bill.com party but have since made it a core holding. It has a market cap of ±$14bn and has been growing like weeds. There has been no metric that I can find fault with, and they seem to have integrated their acquisitions to perfection, resulting in a stratospheric growth rate. They have done all of that while keeping their operating margin hovering close to zero. Importantly they indicated that they plan to become non-GAAP profitable in 2023 - next fiscal year. Not operating margin profitable, no - bottom line profitable, excluding SBC.
Snowflake
Snowflake just came along and blew my socks off with their latest results. They grew at 83% yoy at a $2bn+ ARR run-rate, and they’ve been operating margin positive for the last 4 quarters and FCF positive for the last 7. It is clearly the #1 of the three “gold-standard” companies I highlighted above, and for being such a special company, I’m willing to have it as one of my largest allocations despite it having the largest market cap of the lot. The exception to my general story above of owning the smaller companies in larger proportion to the bigger ones.
Datadog
I don’t really understand why the dog is currently the closest to its 52 week low of all of my positions: only 9% above it’s low of 16 June. I thought the results were good but the leading indicators weren’t and pointed to a slowdown in the second half of the year. But I definitely didn’t think that it was that bad. Be that as it may, I like the current price and think that the team at the helm of DDOG is one of the best around. And although they certainly were cautious in their guide, the CEO commentary about new logo wins, attach rates and pipeline were all exceptionally positive. I wonder therefore, if we aren’t seeing something similar to what we saw with the onset of COVID, and that the run-rate will revert to historic levels after a quarter or so of slowdown. Regardless of which way it goes, I’m willing to sit on a slightly lower % allocation as we wait it out.
Gitlab
I’ve been thinking about my Gitlab position in the light of the various relatively negative commentaries by technical folks like @Smorgasbord1 and @FlixFool about the category, and their financial performance vs my other portfolio companies.
Gitlab has been a slower grower at this scale than DDOG, CRWD and SNOW was, but I think what got me excited is the recent acceleration in revenue growth coupled with the extreme bullishness on the conf call. It’s also a relatively smaller company at a $8bn market cap. They were a 50-60% grower last year and a 70%+ grower this year to date. And no other management that I listened to commented so strongly in this last quarterly results season that they have not seen any impact from macro in their business.
However the comments about the category and competitive dynamics do ring true, and additionally I’ve been pondering another nagging metric that I believe I may have too quickly rationalised away in my enthusiasm - $100k adds:
>$100k Q1 Q2 Q3 Q4
2021 23 28 36
2022 41 59 44 65
2023 53 48
They added 48 customers spending $100k or more in ARR this last Q, vs 59 a year ago and 53 last Q. That’s a slow-down however you want to cut it. Management did not address this, and no-one asked about it in the call. Also my initial rationalisation doesn’t sound all too convincing to me, the longer I thought about it. Basically, because they have such a high NRR and they target really large companies (T-Mobile size), I argued that a more interesting metric to look at is $1m ARR customers. And to be fair that did grow nicely: they had 39 of those end Jan 2022 vs 20 end Jan 2021 (+95%). But we don’t know what that metric did this q so no use postulating a large increase there.
So maybe that $100k customer adds is seasonal? What does $100 customer growth look like QoQ?
>QoQ% Q1 Q2 Q3 Q4
2021 12% 13% 15%
2022 14% 18% 11% 15%
2023 11% 9%
Nope, not a seasonal thing and also a slowdown - first time it dipped below 10%…So now I’m hanging my hope for a continuation of their recent >70% growth on to management’s commentary alone, and not on the numbers supporting same.
Wary of Saul’s commentary that sometimes we don’t see the forest for the trees, I’m still willing to give this one a go despite those concerns. But the commentary about their competitive position and the market for dev tools in general, coupled with this metric and the fact that their operating leverage, while present, is a much slower march to profitability than some others, led me to conclude that I was perhaps a bit too enthusiastic in my allocation and intend trimming this one down a bit.
Crowdstrike
Top dog in an industry with huge tailwinds. But after my initial write-up last month I started seeing more cracks in their results than for some of the others. Their revenue growth rate dipped below 10% qoq for the first time ever. If that sequential growth would persist they would be a sub-50% grower very soon.
And then there are the leading indicators. Even though they added a record net new ARR of $218m in the quarter, their RPO growth dropped to 49% yoy (vs 60% in the prior Q and 81% in the same q last year). cRPO was worse - it grew just 37% yoy last Q and current deferred revenue by 54%. And although this only reflects commitments, I like them apples more if they are committed than not.
Similar to DDOG, I feel more comfortable with a slightly lower position here until they show me that those customers who decided not to commit to longer contracts, did in fact end up spending the money.
Twilio
Twilio is a bottom-fishing experiment and a tiny position. I’ve never owned the company before but I’ve followed them closely as they are active in the field that I work. They are dominant in their field. Their stock has been beaten into the ground because of a spending habit which the CEO said he is now going to rehab for (but he just had to take a last swig of the spending bottle with the announcement of a “sabbatical program” for tenured employees this last Q). Let’s see if he sticks to the 12 steps in the next quarters. For those who don’t know the details: management said they will become profitable next year (they’ve never been), and took a first step by announcing the axing of 11% of the workforce. But it’s not yet clear that the market believes they will actually do what is necessary to get there. If they actually do produce the goods on that front, the stock could rerate nicely.
CLOSING
And that’s it, folks. This year is quite a slog…
Good luck to all!
-WSM
Previous reviews:
August 2022: https://discussion.fool.com/wsm8217s-portfolio-30-aug-2022-35160798.aspx
June 2022: https://discussion.fool.com/wsm8217s-portfolio-1-july-2022-35139370.aspx
May 2022: https://discussion.fool.com/wsm8217s-portfolio-30-may-2022-35121245.aspx
Apr 2022: https://discussion.fool.com/wsm39s-portfolio-review-april-2022-35102080.aspx
Mar 2022: https://discussion.fool.com/wsm8217s-portfolio-review-end-march-2022-35085614.aspx
Jan 2022:https://discussion.fool.com/wsm8217s-portfolio-31-jan-2022-35041176.aspx
Dec 2021 full-year: https://discussion.fool.com/wsm8217s-year-end-portfolio-dec-2022-35015067.aspx
Dec 2020 full-year: https://discussion.fool.com/Message.asp?mid=34710356
]. So, if our tech seems like something from the future, good — that’s exactly what it is.’