Here’s an example about Zoom which should be very clear.
I bought Shopify a few years ago at roughly $27 which was (roughly again) the day-after IPO price, give or take. Shopify was growing about 100% too, or close to it. I sold Shopify a couple of years later at $145, which meant that I had a profit of 437%… (It was at 537% of the price I paid, a quintuple and more).
At that $27 it had an EV/S of about 10 or 11 as the charts show it. Zoom has a EV/S of 41 or 42 or more.
If Shopify had opened at an EV/S of 40 and I had bought it there, it would have been at $108 (4 x $27). When I sold it at $145, instead of making a profit of 437%, I would have made a profit of 34%. That’s 34% compared to 437%.
Zoom already has the first 400% built into it’s current price.
Doesn’t your view in this instance point to the fact that valuation is at least somewhat important?
You have written in the past that it isn’t something you generally consider, but this case at least seems to stretch that idea to its tipping point. There really is a point in time when valuation matters and Zoom is the case in point.
Not trying to nit pick here, but I think this is a great example for all of us to consider.
Doesn’t your view in this instance point to the fact that valuation is at least somewhat important? You have written in the past that it isn’t something you generally consider…
AJ, I thought this was a good question so I didn’t want it to go unresponded to. I’m not Saul, but when I read his thoughts on valuation [not mattering], my take was that he meant that absolute valuation is impossible. In other words, you can’t just say you won’t buy anything over a P/S ratio of X. You can buy one company at a PS of 3 and it’s terrible and another at a PS of 15 and it’s a bargain.
To take that even one step further, there might even be a situation where a company with Zoom’s (PS~50?) valuation would be attractive. Imagine a company we felt as strongly about as TWLO but growing at 150% and accelerating each quarter for the last 4 years. Yeah, that doesn’t exist…but that the point. It would have to be something as crazy as the Zoom valuation.
Anyway, I’d be interested to know if Saul agrees, but I think it’s interesting. I seem to recall him saying something about over-valuation like, “when I see it I’ll know.” Seems like Zoom was it.
… I’m not Saul, but when I read his thoughts on valuation [not mattering], my take was that he meant that absolute valuation is impossible. In other words, you can’t just say you won’t buy anything over a P/S ratio of X. You can buy one company at a PS of 3 and it’s terrible and another at a PS of 15 and it’s a bargain.
You are spot on Bear! We all know what intrinsic value is but I have yet to find a formula for calculating it accurately. I’ve scoured Graham and Dodd’s bible, Security Analysis and it’s not there. In fact as newer editions appeared they changed their minds about valuation. Of course Discounted Cash Flow is, in theory, perfect but the trouble is that most of the inputs are pure guesswork. Back in the early Graham and Dodd days growth was much slower than it is today with “Saul” stocks so growth today has a much higher impact on valuation that it did back then. The only mention of a calculation to take growth into account that I know of (and don’t remember the details) is by Peter Lynch who justified higher P/E ratios for higher growth.
The market is usually pretty good at estimating valuation (The Wisdom of Crowds) and we can make use of it by comparing like with like. You want to assets a medical robot? Compare valuation with Intuitive Surgical (ISRG). When I was interested in retail, where there are many candidates, it was interesting to see how P/E ratios formed groups, darlings at around 35 and down from there to the doghouse.
I don’t recall anyone ever saying “valuation doesn’t matter” other than people critiquing others willing to buy at some high metric. Some may not care about the EV/S but that is just one simplified, incomplete way to measure valuation. Why people can’t seem to get this distinction is beyond me.
A company growing at 1000% could be worth 100 times sales. Its valuation isn’t necessarily higher than a company with declining sales at a PE of 2. I would suggest that Zoom’s “too high” valuation isn’t based on any metric (though it may be reflected in those metrics) but rather a wholistic view of what the company is worth. If Zoom was growing at 500% and expected to continue in that range I would buy in at its current EV/S. Or maybe if it clearly had no competitors and a huge technological moat.
Saul is invested in GH so he clearly doesn’t have a problem investing at an EV/S at the level of ZM.
