No. of Recommendations: 5
High P/S last as long as the fundamentals entail they do. Markets will move up and down and things will adjust up and down, but they never adjust really down until there is a change in fundamentals. They always stay expensive unless the business model breaks.

I hear these examples that Netflix once had a price to sale of 1.8, NVDA something similar, etc. Fine, go buy the universe of low price to sale stocks and hope a few grow their multiples. You simply cannot systematically do this.

Thus, how do you find SHOP, ANET, NVDA, et al.? (1) extremely high relative strength (sorry, you won't find it at the bottom), (2) it is considered "expensive". Thereafter you can read into the narrative etc.

There are points in the life cycle of almost all these stocks when FUD, serious FUD hits, or if not FUD the market just crashes and everything crashes with it to abnormally low levels and everyone panics, says we had a party, etc.

Nutanix, when was the big money made on Nutanix? Buying at the IPO, buying when it dropped below IPO, and perhaps buying in the recent October crash.

Big money made on Netflix, hey, you guys already discussed them.

But there is something about companies that have market caps that are extremely small relative to their TAM. Those stocks can appreciate for extreme returns even when "expensive" because they really are not.

The market is a discounting method for risk/reward. Therefore a company like Zscaler cannot be valued at 1.8x sales. Why? That means, just to maintain the same multiple ever year the stock will grow by 50% or more every year. There is no discount for risk. And thus, since everyone knows this, greed being the rule of the game, investors will bid for Zscaler at 1.8x to get these near risk-free extraordinary returns and in their desire to own Zscaler they will big the price to sales multiple up. So be it.

However, since there is great uncertainty as to what the opportunity really is there will be large price swings. Sometimes enthusiasm will grow to high, sometimes pessimism too low, but given the large price swings, there is also a larger annual increase in share price from bottom to top. And further, given the growth rate and often growing CAP, the price must go up to maintain the same discount rate.

This discount rate can be problematic for the market. The market is use to returning to the mean. As profits grow competitors jump into the market and drive profits back down. Thus why CAP is so important. Rapid growth is great but it will attract competition and without CAP there will be no exceptional returns as competition eats up the profits even as the market grows.

Given this presumption of return to the mean the market always misses on the discount rate and undervalues the stock, except in times of extreme enthusiasms and clearly in bubbles.

With Zscaler there is a common sense recent evaluation from a well educated CPA/Financial MBA sort of guy who is credentialed. He starts by stating that (1) sequential growth is slowing (he used conventional analysis that was wrong and contradicts himself) and he ends with (2) "Although big players have not YET transitioned towards the cloud-based deployments of security solutions the prospective growth in the industry will certainty {attract them}." I emphasized "yet".

Why have not big players done so? Because it is disruptive to their business models. They are moving to the cloud, they are bragging about it, but they are not doing so in a manner that disrupts their business models. Meaning supplementary hybrid cloud virtual machines that work with the appliances to provide "cloud" based security.

Thus the market conventional wisdom as exampled by this person's analysis assumes return to the mean - even when there is no competition that can be named that presently exists.

That is the theoretical reason why "expensive" is really not so even though it may seem so - except in times of extreme enthusiasms and for sure in bubbles.

Trust me, I'm out in a bubble. And yes there will (inevitably in such investments) be extreme volatility (it is built in), and yes there is risk (every investment has risk) but the risk is not so much valuation except in extreme circumstances but in continuing business fundamentals.

With Zscaler multiple sources (including the above) and including Zscaler themselves indicate that there is nothing else like them. Is what they have what the market wants or will the larger player strategies of not cannibalizing their businesses and providing hybrid virtual machine spin-offs for cloud deployments be what the market wants? Will this latter model be able to morph to provide more and more value and not cannibalize their businesses at the same time, relative to Zscaler.

Who knows. Sometimes the hybrid works, sometimes it does not. And perhaps Zscaler will continue to add more and more functionality and value to its solution and add to the ZIA and ZPA portfolio to provide a more complete solution to not only service the greenfield internet breakout opportunities (which is quite large) but also to go straight after the appliances themselves (something Zscaler only does incidentally at present).

Or perhaps Amazon will just build something and go boo! I don't know.

But that is the theoretical framework that explains the contradiction between the risk of low valued stocks vs. high valued.

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