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The stock prices of hypergrowth software companies have gotten ridiculously cheap, and I’m going to prove it.

I recognize it is hard to convince folks (including ourselves, sometimes) of this. Just because a stock’s price is half of what it once was, does not mean it is suddenly a bargain—perhaps it simply went from “ludicrous” to “unreasonable.” This is the pervasive cognitive dissonance we’re experiencing now, trying to reconcile selling out of companies we know to be exemplary.

Despite growing awareness of the positive differentiation that a SaaS business model provides, alarmist headlines around “ridiculous Price-to-Sales multiples” make for easy press, gives temporary validation to those who have underperformed us for years to say “I told you so,” and provides pundits and passers-by license to dismiss these high-quality businesses as nothing more than stratospherically-priced story and momentum stocks that have become disconnected from their fundamentals. Nothing could be further from the truth, of course, but without a way to demonstrate this point numerically, these negative assertions are sustained.

We see this now on the board with such off-handed comments like, “there’s literally no bottom” or “P/S of 20x-30x should actually be 5x-10x.” Such generalizations, usage of irrelevant ratios like price-to-sales, and apples/oranges comparisons to legacy valuation techniques rule the day in a discourse where seemingly the only person of prominence taking the other side of the argument is Cathie Wood. I’m going to challenge this FUD head-on, but first allow me to tell a story…

Jewels vs. Jokes – A Lesson in Price-to-Gross Profit

There are two stores in the town of Profitville: "Jewels" and "Jokes." Jewels sells lovely gemstones for $100 each. Unfortunately for Jewels, a gemstone must be mined, cut, and polished by experts. For Jewels, getting a gemstone from under the ground to on the shelf comes at a high cost--$99 to be exact, good for a 1% gross margin For each gemstone sold, Jewels makes just $1 of gross profit ($100 Revenue - $99 Cost of Revenue).

Jokes, on the other hand, sells jokes to those looking for a quick, cheap laugh. For just $1, a customer can hear a witty anecdote to brighten their day. Seeing as jokes can be conjured from thin air, the cost to produce a single joke is $0 (100% gross margin) meaning for each joke sold, Jokes nets all $1 revenue as gross profit. This is something that Jewels and Jokes have in common—a gemstone and a joke both yield the same gross profit to the company’s owner. Another thing these two companies have in common is their market cap—both are valued at exactly $100. Finally, business this year was terrible, Jewels only sold ONE GEMSTONE, and Jokes only sold ONE JOKE.

Which company is “cheaper?”

Well, looking at the Price/Sales ratio, it must be Jewels. I mean, Jewels P/S is 1x, while Jokes is trading as an astronomical P/S of 100x.

Of course, I’m being facetious, because “P/S” for these companies, and any other real-life company, is largely irrelevant. What matters far more is gross profit; gross profit is the money that actually flows into the business once costs to produce the revenue are paid. Gross profit is then used to pay for overhead (SG&A and S&M) and R&D. This extreme example shows why Price-to-Gross Profit (P/GP)—while still very imperfect—is a far better measure than Price-to-Sales for making valuation comparisons. If I’m a homebuilder, I can artificially drive revenue by increasing the cost of each home by $50k and just advertising that every house comes with a bitcoin in the front yard. Never mind that it doesn’t do anything for my gross profit, but my revenue sure did jump!

As I move into the next section, keep in mind that gross profit, based on industry and company, is extremely wide-ranging. From Ford and GM at or below 10%, to Monday, ZoomInfo, or Upstart above 85%. An understanding of gross profit is exceedingly important to understand; much more so than sales.

A Comparison of Price-to-Gross Profit

These past couple of months have seen a painful rotation out of high-multiple hypergrowth stocks and into blue chip industrials, megacap tech behemoths, financials, and other cyclicals. As Jim Cramer puts it, into “companies that make real things” (because software, of course, is imaginary). Regardless of the real reason for this rotation (cough, algorithmic momentum trading, cough), the common justification has been that inflation and the auspices of higher interest rates have caused a “great reset” of multiples. Okay, fine. So, perhaps now that hypergrowth has fallen anywhere from 25-75%, are we nearing a bottom, have we overshot the bottom, or is there no bottom at all and we’re going to slowly watch DataDog drift to zero whilst my marriage falls to pieces?

First, let’s see what all the fuss is about, here is a list TTM P/S multiples of favored hypergrowth companies (bounded by “**” for easy reference) compared to a subset of “blue chip” companies that are pushing all-time-highs amidst this carnage.

Ticker      	 Cap($B) 2021Rev($M) 	P/S (TTM)
**Snowflake** $89 $1,025 87.2
**SentinelOne** $12 $164 75.4
**Cloudflare** $34 $589 57.9
**DataDog** $45 $880 51.6
**Zscaler** $37 $761 48.3
**Monday** $10 $255 40.5
**Crowdstrike** $42 $1,286 32.7
**Amplitude** $5 $147 32.7
**Zoom Info** $22 $665 32.5
**Upstart** $10 $634 15.2
Middlesex Water $2 $144 14.4
McDonalds $200 $22,520 8.9
Apple $2,870 $365,810 7.8
Coca Cola $263 $37,800 6.9
Qualcomm $209 $33,570 6.2
Proctor & Gamble $397 $77,140 5.2
Deere $114 $44,000 2.6
Raytheon $134 $63,760 2.1
Aflac $40 $22,580 1.8
Ford $95 $134,610 0.7


If we stop here, there’s only one conclusion to draw from the data—hypergrowth is poised to fall much further and I need to put my 401(k) into Ford. But, of course, it would be illogical to stop here, because TTM P/S is an overly simplistic ratio, and is not informing the true profitability of the company.

For the next table, I’m applying the TTM Gross Margin (GM%) of each of these companies, to arrive at a TTM P/GP. P/GP gives me a much better sense of the money coming into the business less the direct costs to produce the revenue.

Ticker	         Cap($B) Rev($M,TTM) 	P/S(TTM) GM%    P/GP (TTM)
**Snowflake** $89 $1,025 87.2 60% 144.6
**SentinelOne** $12 $164 75.4 59% 128.6
**Cloudflare** $34 $589 57.9 81% 71.8
**DataDog** $45 $880 51.6 76% 67.5
**Zscaler** $37 $761 48.3 78% 62.1
**Amplitude** $5 $147 32.7 69% 47.1
**Monday** $10 $255 40.5 87% 46.6
**Crowdstrike** $42 $1,286 32.7 74% 44.4
**Zoom Info** $22 $665 32.5 86% 37.6
Middlesex Water $2 $144 14.4 56% 25.7
Apple $2,870 $365,810 7.8 42% 18.8
**Upstart** $10 $634 15.2 86% 17.7
McDonalds $200 $22,520 8.9 54% 16.5
Raytheon $134 $63,760 2.1 18% 11.8
Coca Cola $263 $37,800 6.9 61% 11.4
Qualcomm $209 $33,570 6.2 58% 10.8
Proctor & Gamble $397 $77,140 5.2 50% 10.2
Deere $114 $44,000 2.6 28% 9.4
Ford $95 $134,610 0.7 10% 7.0
Aflac $40 $22,580 1.8 41% 4.3


You’ll notice that every P/GP increased from the P/S, this is logical since the denominator “GP” is necessarily lower than the denominator “S” as “GP” backs out the cost of revenue. You’ll also notice that **hypergrowth** is still richly valued—albeit to a diminishing degree. While the dichotomy exists between hypergrowth and blue chips, the contrast is not as profound. There’s even some blurring of the lines, as Upstart now has lower TTM P/GP than Apple and an old-school water utility like Middlesex.

While the hypergrowth/blue chip contrast is diminished, hypergrowth on a TTM P/GP basis STILL looks overvalued, though. Bad news? Well, not really, because TTM P/GP is still imperfect because we’re looking into the past. Nobody buys a company for what they did, they buy it for what the company will do. So, the next step is to apply some growth expectations. Here’s where things get tricky, because now we’re making predictions about the future. A thorny exercise, for sure, but thankfully, when revenue is recurring, on a contracted subscription, and net retention rates are high, revenue is highly predictable. So, bear with me while I apply some reasonable top-line growth expectations for the next three years, to arrive at a P/GP for estimated 2024 Gross Profit:

Ticker	        P/GP    Gr(22)	Gr(23)	Gr (24)	P/GP (24)
Middlesex Water 25.7 4% 4% 4% 22.9
**Cloudflare** 71.8 51% 49% 47% 21.7
**Snowflake** 144.6 105% 90% 80% 20.6
**Zscaler** 62.1 60% 55% 50% 16.7
**SentinelOne** 128.6 120% 100% 80% 16.2
Apple 18.8 7% 6% 5% 15.8
**DataDog** 67.5 72% 67% 62% 14.5
McDonalds 16.5 6% 5% 4% 14.2
**Crowdstrike** 44.4 55% 45% 40% 14.1
**Zoom Info** 37.6 60% 50% 45% 10.8
**Amplitude** 47.1 70% 65% 60% 10.5
Coca Cola 11.4 6% 5% 4% 9.9
Raytheon 11.8 9% 8% 7% 9.3
Proctor & Gamble10.2 4% 4% 4% 9.1
Qualcomm 10.8 8% 7% 6% 8.8
**Monday** 46.6 85% 75% 65% 8.7
Deere 9.4 8% 6% 4% 7.9
Ford 7.0 9% 5% 4% 5.9
**Upstart** 17.7 120% 30% 25% 5.0
Aflac 4.3 -4% -4% -4% 4.9


Okay, now we’re cookin' with grease. Upstart is darn near the cheapest company out there, and the comingling between hypergrowth and blue chips is like a man named Brady meeting a lovely lady. Before you deride my growth estimates, take note of the universal deceleration among the bunch. I factored in not a single year of acceleration, despite the high likelihood that such a thing occurs.

While I do feel better about the valuation of the hypergrowth companies now, I’m still not super excited. But, I’m still missing something… Oh wait, I see it. I’ve assumed in the above that the earth dissolves into the sun in year 2025. Assuming this does not happen, let me go out a couple more years, to 2026 assuming an 80% growth durability in 2025 and 2026 (e.g 50% growth in 2024 becomes 40% in 2025 and 32% in 2025). And I’ll tell you what, I’ll leave the blue-chip company growth steady. Here’s where we land with that reasonable assumption:

Ticker	        P/GP(2024) P/GP (2026)
Middlesex Water 22.9 21.6
Apple 15.8 14.7
McDonalds 14.2 13.4
**Cloudflare** 21.7 12.1
Coca Cola 9.9 9.3
**Zscaler** 16.7 9.0
Proctor & Gamble9.1 8.6
**Crowdstrike** 14.1 8.5
Raytheon 9.3 8.5
**Snowflake** 20.6 8.3
Qualcomm 8.8 8.1
Deere 7.9 7.5
**DataDog** 14.5 6.9
**SentinelOne** 16.2 6.5
**Zoom Info** 10.8 6.2
Ford 5.9 5.6
Aflac 4.9 5.2
**Amplitude** 10.5 5.1
**Monday** 8.7 4.1
**Upstart** 5.0 3.6


Wow, am I cheating here? I mean, Monday.com would have to rise 3.5x from here to just get to the same P/GP multiple as McDonalds! DataDog would have to triple to get to Middlesex Water—what the hell are they putting in that water?!

And oh, I can do you one better. Gross Margins are not static. In fact, these are little companies still that are (hopefully) becoming big companies. What happens when companies scale? Margins improve. So now I’m going to include some very meager margin expansion.

Ticker	        GM %(TTM)  P/GP (2026)	GM%(Est)P/GP (2026) w/ Est. GM%
Middlesex Water 56% 21.6 56% 21.6
Apple 42% 14.7 42% 14.7
McDonalds 54% 13.4 54% 13.4
**Cloudflare** 81% 12.1 85% 11.5
Coca Cola 61% 9.3 61% 9.3
Proctor & Gamble50% 8.6 50% 8.6
**Zscaler** 78% 9.0 82% 8.6
Raytheon 18% 8.5 18% 8.5
**Crowdstrike** 74% 8.5 75% 8.4
Qualcomm 58% 8.1 58% 8.1
Deere 28% 7.5 28% 7.5
**Snowflake** 60% 8.3 75% 6.7
**DataDog** 76% 6.9 80% 6.6
**Zoom Info** 86% 6.2 88% 6.1
Ford 10% 5.6 10% 5.6
**SentinelOne** 59% 6.5 73% 5.3
Aflac 41% 5.2 41% 5.2
**Amplitude** 69% 5.1 73% 4.9
**Monday** 87% 4.1 88% 4.0
**Upstart** 86% 3.6 88% 3.5


I’ll stop here, but I could (and rightfully should) go on. Oh heck, why not! Remember that 80% growth durability I used for 2025 and 2026? Let’s make that 60% growth durability, and go out another three years (e.g. 50% growth in 2026 becomes 30% growth in 2027, 18% growth in 2028, and 11% growth in 2029). Again, I’ll leave blue chip growth steady:

Ticker	        P/GP (2026) P/GP (2029)
Middlesex Water 21.6 20.0
Apple 14.7 13.3
McDonalds 13.4 12.4
Coca Cola 9.3 8.6
**Cloudflare** 11.5 8.3
Proctor & Gamble8.6 7.9
Raytheon 8.5 7.4
Qualcomm 8.1 7.2
Deere 7.5 6.9
**Crowdstrike** 8.4 6.3
**Zscaler** 8.6 6.0
Aflac 5.2 5.6
Ford 5.6 5.1
**Zoom Info** 6.1 4.4
**DataDog** 6.6 4.3
**Snowflake** 6.7 3.9
**Amplitude** 4.9 3.2
**SentinelOne** 5.3 3.1
**Upstart** 3.5 2.9
**Monday** 4.0 2.6


Price-to-Gross Profit Black Magic – Still Imperfect, but Actually to the Detriment of Software

To head off naysayers, I realize I’m using a gross profit multiple, which is different than “Operating Profit” or “Net Profit.” So maybe, you might be thinking, I am deliberately using “Gross Profit” instead of “Operating Profit” or “Net Profit” to skew my results and support my narrative? Negative—I’ll leave that bush league stuff to those that push P/S comparisons. In fact, using “Gross Profit” instead of “Net Profit” is to the detriment of software companies. Why? To understand, we must understand the difference between gross, operating, and net. Gross profit is reduced by Sales, General and Administrative (SG&A) expenses and Research and Development (R&D) expenses to arrive at Operating Profit (aka “EBIT”). “Operating Profit” is then subsequently reduced by interest and taxes to arrive at “Net Profit.”

So, let me ask you this—if Ford, Deere or Coke fired their marketing and sales staff—would revenues be impacted? Answer: omg yes, and drastically so. Conversely, if ZScaler or Snowflake stopped marketing, would their revenue be impacted? Answer: Yes, but to a much much lower degree. SaaS revenues are contracted under subscription, firing marketing staff would hit upsells, cross-sells, and renewals, but it’s likely that business would hum along for some time unaffected.

What’s more, which sort of company do you think has higher overhead (General and Administrative) costs? Deere, Ford and Raytheon—with their mountainous back-office functions, warehouses, factories and supply chains, or super-lean software firms like ZoomInfo and ZScaler? I won’t answer that.

And finally, these companies are almost all debt-free (ZI an exception), interest expense is a non-event.

There’s a reason why mature tech/software/cloud companies like MSFT, ADBE, NVDA, FB, and others can maintain net margins that are higher than many of the blue chip’s gross margins--they’re completely different businesses that can’t be reasonably compared at a simple sales multiple.

In Summary

I hope my analysis and forecasting exercise gives some of you all comfort that, indeed, there is a bottom, and we’ve actually overshot it. That is not immediately apparent when looking at illogical multiples, but it evidentially obvious when looking more than an inch deep and projecting a few, predictable years into the future, and looking at gross profit instead of sales.

May these stock prices soon realize this gravy train has not stopped because the 10-year yield is suddenly higher.

Eric Przybylski, CPA
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Fantastic Post! Educational, witty, funny!

And best of all, I can take comfort in knowing that I'm not the only Saul Disciple who's marriage is intertwined with the stock price of Datadog!
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Eric,

I like your analysis, and thank you fro running all the numbers, but I do not see things in precisely the same way.

>> Price-to-Gross Profit Black Magic – Still Imperfect, but Actually to the Detriment of Software

To head off naysayers, I realize I’m using a gross profit multiple, which is different than “Operating Profit” or “Net Profit.” So maybe, you might be thinking, I am deliberately using “Gross Profit” instead of “Operating Profit” or “Net Profit” to skew my results and support my narrative? Negative—I’ll leave that bush league stuff to those that push P/S comparisons. In fact, using “Gross Profit” instead of “Net Profit” is to the detriment of software companies. Why? To understand, we must understand the difference between gross, operating, and net. Gross profit is reduced by Sales, General and Administrative (SG&A) expenses and Research and Development (R&D) expenses to arrive at Operating Profit (aka “EBIT”). “Operating Profit” is then subsequently reduced by interest and taxes to arrive at “Net Profit.”

So, let me ask you this—if Ford, Deere or Coke fired their marketing and sales staff—would revenues be impacted? Answer: omg yes, and drastically so. Conversely, if ZScaler or Snowflake stopped marketing, would their revenue be impacted? Answer: Yes, but to a much much lower degree. SaaS revenues are contracted under subscription, firing marketing staff would hit upsells, cross-sells, and renewals, but it’s likely that business would hum along for some time unaffected.

What’s more, which sort of company do you think has higher overhead (General and Administrative) costs? Deere, Ford and Raytheon—with their mountainous back-office functions, warehouses, factories and supply chains, or super-lean software firms like ZoomInfo and ZScaler? I won’t answer that.<<

This gets down to some of the critical assumptions people use, and indeed I hear repeatedly that these companies with gross margins of 60% or 70% or 90% are just intrinsically more valuable than old economy companies.

I don't disagree with the sentiment, but believe this is a category error. I am less impressed by 70% gross margins than others, because I view this essentially as an accounting artifact, with costs moved from one cost center to another.

Gross margin was created back in the days of yore, and intended to identify the cost of goods sold. It makes a lot of sense for Ford and Maytag, with units that are basically giant hunks of expensive steel. For software, it makes not as much sense when your cost is just some cheap electricity and a bit of labor. Comparing COGS and gross margin for Ford and Cloudflare is comparing apples to Monkey's bananas.

I believe that net margins are much more important, and that the SG&A for SaaS companies is much more critical to their business than to an old-school hardware company. In particular, the R&D component is the lifeblood of these companies, the true cost of operations. The pace of innovation is relentless, far more so than for Ford, and if a competing company gets an edge, or the software company does not execute their developments properly (*cough* Alteryx), then the consequences are crippling. Ford can reduce R&D for a year or two without it destroying the company - it will tell eventually, but if the 2023 Ford models are pretty similar to the 2022, will that doom the company? Probably not. Can you imagine the impact if Crowdstrike suspended R&D for a year? These expenses are realy true operating expenses for SaaS companies, not discretionary development expenses.

Now, that being said, I recognize many of the SaaS companies are early in their lifecycle, still spending as much SG&A money as they can afford on land and expand sales, and net profit is still small or negative. I expect that to change as they scale, but even then, I do not expect as much net profit as others seem to be anticipating based on my perception of continuous need for high R&D expenses.

I think there is some evidence of this, as most of the SaaS companies seem to have SG&A that grows as an appreciable fraction of revenues, a higher fraction than old economy companies. I personally keep a close eye on SG&A and, particularly, R&D expenses, try to make sure that these expenses show reasonable scalability, and favor companies that have lower fractional increases of SG&A relative to revenues.

Regards,
Brian
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Ford can reduce R&D for a year or two without it destroying the company - it will tell eventually, but if the 2023 Ford models are pretty similar to the 2022, will that doom the company? Probably not. Can you imagine the impact if Crowdstrike suspended R&D for a year? These expenses are realy true operating expenses for SaaS companies, not discretionary development expenses.

Not sure that would be the case to be honest. Lot's of SaaS are so in intertwined in the daily operations of companies that you might as well just stop development for two years and you'll be just fine.
If you Look at how much legacy software still lingers around at many places it's hard to imagine that customers would switch away because no new features were released. Most often they can't even keep up with all the new features being released. This is ofcourse just anecdata based on my firsthand experience working at a SaaS company and not real hard data.

On the other hand I also think the coke brand(their moat) is so strong that it would survive two years without marketing.
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"Not sure that would be the case to be honest. Lot's of SaaS are so in intertwined in the daily operations of companies that you might as well just stop development for two years and you'll be just fine."

As someone who knows the IT landscape well I view this as very simplistic thinking for the following reasons.
- Not all saas are equally "sticky". For example the switching costs to move out of Microsoft, Salesforce.com, ServiceNow, and Amazon (depending on depth of usage) is immense. Much less so for companies less critical to central operations or companies with a lot more viable competition. (collaboration software, planning software, other one off best of breed only task tools)
- Example 1 - Think about how easy it is to move from Zoom to any other collaboration tool (teams, webex etc). Awesome tool but very little moat unless they become a real platform people develop on. All it takes is buy the new tool, train the staff on the new one and boom your off (people change management is the hardest part of this equation but still relatively easy).

- Example 2 - Switching cost for endpoint security products mainly comes due to pain of agent change and the knowledge/capabilities your team has around a tool. The more outsourced a security operation is the less sticky pt #2 becomes since many companies offer a managed security service these days.

I am a big fan of saas and invest in a lot of it but some posts make assumptions that it is common for a saas to end up like salesforce.com and use that as the model. That is by far the upside outlier and not a great comparison usually. The far more likely case is x solution will grow into something a lot less lucrative so your exit timing will be much more critical. For it not to be so it has to be a true platform, tie deep to the enterprise, have real differentiation or minimal viable competition.

For these reasons I am still evaluating Monday.com and Asana and have them on the watchlist but view them as price must be right entry point stocks vs. potential industry game changers like NET. DDOG and SNOW I view as middle tier in that stickiness matrix and perhaps SNOW has a chance to disrupt but I suspect Amazon and Microsoft will win that game in the end.

Note this is more meant to be a relevant strategic lay of the land long term post vs. encouraging any short term decisions. Now would be a bad time to sell most things tech IMO.
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Great opening post, thanks so much. I had only a micro version of this based on Bert's 3-year forward looking revenue estimates. His are as good as any, I guess, so if you have a Bert subscription you could use those plus your gross margin estimates to get the gross profit.

___


"- Example 1 - Think about how easy it is to move from Zoom to any other collaboration tool (teams, webex etc). Awesome tool but very little moat unless they become a real platform people develop on. All it takes is buy the new tool, train the staff on the new one and boom your off (people change management is the hardest part of this equation but still relatively easy)."

On the other hand, being well-versed in IT may be a weakness for you in this case :)

So here is a layman perspective from a big organization.

There is no moving out of ZM for us and many like us, at least not without potentially destructive earthquakes. That said, the fact that we live and die by ZM but went CSCO for phone (as well as security) is also significant, I think. I have no idea what our partners/competitors use for phone or security and it is true that nobody outside of IT would care. But ZM?

"people change management is the hardest part of this equation but still relatively easy"

It is absolutely not easy when you deal with large numbers. It is in fact deleterious to morale and operations. The fewer visible tweaks and changes, the better.

Some joke that IT folks update software all the time for no other reason but to justify their salaries. I don't know anybody who says "man, this is awesome, we got an update!" The reaction is always "not again, not now!" On the mild end :)

Here is what happened when we changed something trivial. We use SAP for travel management and the move from whatever we had prior to that to Concur was an absolute nightmare that lasted over a year. It was a major talk point at all level meetings just how annoying Concur is and how unbearable the change. It is still disliked several years later, but then again I have not traveled on business in 2 years. My days as a frequent flyer were gone (by choice) prior to Covid but it now feels like memories from a different era altogether.

I agree on tools like MNDY, ASAN, SMAR but even so, once they become entrenched among non-IT savvy staff, you will be very hard pressed to make the change. As is, the biggest challenge is education, getting people to learn about the product and its usefulness. And getting those in charge to pay for it.

Generally, change in systems used by non-IT folks is a challenge, it is dreaded, and unless the benefits are obvious, it is certainly opposed.

On the other hand, nobody gives half a penny whether we buy Chevy or Ford or whatever, in fact, I guess we are going to only buy electric soon if we don't already. I don't even know! As for soda, we would probably like to ban it all anyway :) Nobody cares who makes the vending machines, what appliances we buy, etc.

When it comes to airlines, there used to be an option to choose A vs B if frequent flyer and price difference was minor but on the whole, the choice of airlines used to be, and I am sure it is even more so now, in terms of cost alone. Hotels, totally a matter of whether it fits within allowance, or whether it is THE venue. Completely interchangeable.

And we can definitely exist very well with a fraction of the air travel, hotel expenses, and vehicle fleet. We already do and have not missed a beat. There is something to be said about in-person networking so certain travels remain important but in most cases you realize that you wasted 3 days for the sake of a couple hours worth of something.

Our need for buildings has alleviated. Now, that is a colossal expense.

Indeed, I cannot think of one single traditional product on top of my head that, if changed, anyone would care. But MSFT, AAPL, CRM, ZM, NOW, WDAY, ADBE, DOCU, I mean...this is what we run on. Contrary to what I have heard from some (that security gets cut first), there is absolutely no way we cut on cybersecurity. Much more likely we cut on physical security!

To bring everyone's favorite comparison home, in 2010 we were much more like in 1999 than in 2021.

The world has changed but as always there will be a very large group of people that will not adapt but rather will be left behind. Some of our retirements are due to unwillingness to "go digital."

So this is why I have come to like software updates: gotta learn to thrive with constant changes even the most annoying! :)
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Is Salesforce really the best example?

I mean you cannot compare a company in its prime growth phase (organically!, like most of our stocks right now) with a company that has only grown through takeovers for years?
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As someone who knows the IT landscape well I view this as very simplistic thinking for the following reasons.
- Not all saas are equally "sticky". For example the switching costs to move out of Microsoft, Salesforce.com, ServiceNow, and Amazon (depending on depth of usage) is immense. Much less so for companies less critical to central operations or companies with a lot more viable competition. (collaboration software, planning software, other one off best of breed only task tools)
- Example 1 - Think about how easy it is to move from Zoom to any other collaboration tool (teams, webex etc). Awesome tool but very little moat unless they become a real platform people develop on. All it takes is buy the new tool, train the staff on the new one and boom your off (people change management is the hardest part of this equation but still relatively easy).


Yes Zoom is definitely not one of those, that's why I said "lot's of SaaS is intertwined" and not "every SaaS". So I'm well aware that you have to evaluate the stickiness, moat and pricing power of every individual company.
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Eric, I found this very entertaining, thanks. For the record, I did a similar excercise, using my own forecasts of revenue and free cash flow (which is the primary input for DCF analysis), here:

https://boards.fool.com/the-valuation-of-my-portfolio-350066...

In that post I came to the same conclusion, namely that all of the companies in my portfolio were undervalued, and I listed them from most to least undervalued.

Below is a comparison of my calculations from most to least undervalued (I exclude Pubmatic from this list) compared to yours:


Cash flow (me) Gross Profit(you)
Upstart Monday
Monday Upstart
Amplitude SentinelOne
Snowflake Amplitude
SentinelOne Snowflake
ZoomInfo Datadog
ZScaler Zoominfo
Datadog Zscaler


The difference in the number 1 and 2 spot is probably due to me assuming a slightly higher revenue growth for Upstart than the very big drop-off in growth that you assumed above. The others are similarly driven by slightly differing assumptions. I did not list all of my assumptions in my post as they go out 15 years, but the gist of my assumptions are similar to yours, except that I also estimated free cash flow margins.

I wanted to just make the point that we got to a very similar ranked list and conclusion - namely that our companies are currently way undervalued, using two different methods and independent (and quite conservative) assumptions.

Thanks again.

-WSM
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No. of Recommendations: 2
Growth assumptions aside, you’ve convinced me that you can achieve comparable results at current prices by investing in Aflac and PG rather than crowdstrike or cloudflare. If they fall another 50% then they’ll look like growth values rather than growth stocks.

PP
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No. of Recommendations: 61
Think about how easy it is to move from Zoom to any other collaboration tool (teams, webex etc).


Hi mtg,

I'm not speaking as a Zoom stockholder here as I've been out for a long time as growth had slowed, but I think you have this example really wrong.

First of all, why would you WANT to switch from best to 2nd or 3rd best?

Second, when most everyone you want to conference with outside of your company is using Zoom (your customers, your suppliers, other companies in your field, interviewers, etc etc, basically anyone you will want to call), you will need to keep your Zoom subscription even if you are using something else for internal conferencing.

Third, since all your employees use Zoom at home, as well as at the office, and are familiar with it and love it, you will get enormous push-back, unhappiness, and even rebellion from your staff.

Maybe you should rethink "how easy it is to move from Zoom to any other collaboration tool (teams, webex etc)."

Saul
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No. of Recommendations: 4
Saul is right, I think this is a true signal of a great SaaS company. Offer a great product, get customers to use it, make it a pain to switch to a competitor. Growth was Zoom’s problem, not its software.

I also use Zoom quite a bit, and even if I chose a different software, I would still need Zoom for the people that already use it.

I agree with MAS4R, the stickiness of the company is seen across the board when it is something that is used daily and by many employees. On an IT level, it might be just loading in new software, but then the domino effect starts through the whole company. We are creatures of habit, and when you throw a wrench into the mix, problems start.

I’ve posted before that my business uses a small SaaS company to run everyday operations. They offer a great product and come out with new modules all the time that offer new integration (at and additional cost). There are cheaper competitors on the market, but even if I wanted to switch, it would be a total headache. I’m just looking at the hassle of switching as a business, not even considering how my employees would react to change. I only have to deal with 15 people, I could only imagine if there were hundreds.

That’s their hook, they got me integrated onto their product, and they make it a nightmare to switch to something else. That’s what we want our companies to do, if they are still offering a great product, you don’t even think about switching.
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No. of Recommendations: 1
In comparing Zoom to Teams

First of all, why would you WANT to switch from best to 2nd or 3rd best?


Different stakeholders at a business will have different ways of determining what is "best". End users often don't have much of a say in things; IT typically would control this decision. One of the factors they will consider is the cost of change; and if it is low then they will then consider other factors such as alignment with existing IT systems, ability to administer and control the experience, operating costs, etc...

Based on my organization (which uses Zoom); about 50% of my external meetings are already on Teams (when our customer sets up the call). We are typically doing business with larger organizations - which might skew the data point.

tecmo
...
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No. of Recommendations: 5
First of all, why would you WANT to switch from best to 2nd or 3rd best?

I agree that Zoom has a little moat, 100% based on user's experience, but it is a small one when you compare it to the real threat. Microsoft is the most successful company in doing what their customers hate the most: bundling!

Teams is "good enough", far from Zoom's best experience, but it works. And MS customers don't even know exactly how much it costs. They know is just an "not so expensive add-on" to their Office 365, Azure, Server, Desktop licenses. It's incredibly difficult, as a customer, to escape Microsoft's claws. Customers don't use nearly all they are forced to buy from Microsoft (king of shelfware), but hey, "they are so cheap", right? As for WebEx, no, they stopped in time for the most part. It's a "Zoom x Teams" game, and everybody else trying to just survive.

Rod
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No. of Recommendations: 8
Last reply from me on this as I know I will have exhausted board patience for the conversation after this I appreciated the replies and they raised some interesting differences of perspective so will address those quickly.

1. It was good to see a general users perspective vs. an IT persons perspective. I concur the change management aspects are challenging when rolling out to a large set of non technical users.

2. "First of all, why would you WANT to switch from best to 2nd or 3rd best?"
- There is really no evidence that it is in fact best. Best is determined by the customer and what the use cases are. Microsoft Teams ends up being best for a lot of people already using that platform for a number of reasons (integration to email and calendaring, storage, cost). Same could go for other collaboration tools.
- As a user of many collaboration tools my observation is that they are all easy to use and very interchangeable. Have used Zoom, Teams, Webex and others. Thats my definition of little moat but others can and do define it differently.

3. "you will need to keep your Zoom subscription even if you are using something else for internal conferencing."
- I have not heard of many doing this and if they did it would likely look like 97% of internal users use x (say Teams) and 3% of sales team staff maintain multiple subscriptions. Insert 3% for whatever the number of individuals in an organizations sale team are.
- The tools are very easy to cross over i can send a teams invite to non teams users and they can work with it fairly easily and the same goes for zoom or webex.

4. One statement was "the problem wasn't with zoom technology it was with the growth". To me this is very related as you have to probe why is the growth slowing?
- Are they fully saturated market % wise and will they only have marginal growth after?
- Have they gained most of the headway they can and learned that inducing any additional switch is not viable?
- Is the growth slowing because of lack of a moat? Pandemic led to rapid pull forward and now most entities have a platform and will see little reason to switch minus cost or other factors.
- This observation also lines up with my comment on they need to become a platform vs. a collaboration tool to really drive the future growth and have a moat.

Thank you to all for the thoughtful discussion.
MTK
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No. of Recommendations: 4
First of all, why would you WANT to switch from best to 2nd or 3rd best?

Based on what criteria? My company uses MS Teams. For a while they forbid using Zoom, primarily because of security issues. I think they have since rescinded that ban, but MS Teams is now standard and everyone uses it. Occasionally WebEx, but mostly Teams.

Just one example, but clearly Teams had advantages that our IT department liked, and therefore implemented Teams. To them, Zoom was NOT the best.

1poorguy (no position in any company who makes any product in this post)
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No. of Recommendations: 4
I'd like to clarify one point I keep reading that is incorrect. Subscription is not need for Zoom, WebEx or most other conferencing tools to join a meeting. It is needed to setup the call. It is very easy to switch over from one to another. As an organization, I would go with whoever gives me the best price. It's even easier than switching from Verizon to ATT every 2-3 years depending on who is giving a free phone for switching.
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No. of Recommendations: 2
First of all, why would you WANT to switch from best to 2nd or 3rd best?

My company went the opposite. We actually canceled Microsoft and switched to Google for excel sheets. We are still using Zoom despite canceling Microsoft. Everyone, I know uses Zoom for meetings. I think this story is similar to back when Yahoo was dominant and Google was just a little bit better in everything. Zoom was created for this and not just adopted.

To the author of the valuations of the growth stocks. Thank you!
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No. of Recommendations: 42
Fair enough but the point of this is to help keep a level mind.

It is the numbers-driven anti-dot to the "there is no bottom threads."

Most money is likely invested by big funds and institutions using traditional valuation metrics such as DCF and interest rate correlations. Therefore, exercises like this help show the difference between 2000 and today even if the price action in ARKK and most SaaS looks nearly identical by now.

I have had an exchange with StockNovice on the Mongoose where I argued that the macro is in fact primary but by that I meant that I worry about drastic changes. This is anticipating a normal tightening (which may well not happen as anticipated).

And selling is always indiscriminate anyway as evidenced by the fact that companies with outstanding finances (PLUS great growth) are being sold just as companies with poor finances.

When on a 10 year horizon a conservative estimate of ZS cash flows gives me a price that is three times better than that of MacDonalds (assuming MDC manages to maintain its performance from the last several years into the next ten) and five times better than that of Chevron, it helps drive home the point that ultimately all investing is value investing but that big returns happen over time if one focuses far down the roller-coaster.
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No. of Recommendations: 46
I suggest anyone having doubt about Saul's way read these posts carefully again:
https://boards.fool.com/oh-this-time-it8217s-different-33123...
https://boards.fool.com/why-my-investing-criteria-have-chang...

SaaS business model is really different this time since it started few years ago. We never had bunches of companies growing at 30% to 100% per year and not to mention re-curing revenue with no physical items to sell! And Yes, the best SaaS company stocks always come back from big drops.

Saul and this board are doing the right thing to focus on individual companies because that's what matters most to their stock prices in the long term. We have no control over macroeconomics or market sentiment. See: Mr. Market analogy from The Intelligent investor. Because there are different types of SaaS businesses, there will always be businesses do well in all kinds of macro conditions: recession, depression. Look at Zoom Video, Peloton, Docusign during COVID.

And even some stocks did extremely well during 1930 great depression without SaaS business model:
https://www.fool.com/investing/value/2009/06/12/the-top-10-d...
The creation of SaaS business model just makes investing a lots easier.

My biggest mistakes were selling out of growth stocks too soon or jumping in and out of great growth stocks. The result is I missed hundreds of percentages of gain.

As to cash allocation, that should be already decided right at the beginning, not after the market crashed 30% because selling low and buy high is a very bad idea.

What I noticed about psychology is that stock prices can change people thesis if their convictions are not strong enough. They started doubting if the companies are not a great companies after all because their stocks dropped a lot or went sideway for a long time when there’s nothing wrong with companies’ financial performance.

Let me give few examples: DDOG, NET, CRWD, all went nowhere or dropped a lot for few months to 1 year at one time or another. But eventually, they all did well. In the worst market crash, people got panic and sold out their positions and missed the rebound.

Saul said it many times and I had similar experience, when market fear is at maximum, when there are people going around giving us advices to be cautious, the bottom is near. What do you want us to be cautious about? Sell low and buy high? We already picked some of the best companies to invest in . There are no better alternatives. and set away enough cash to live for few years. We don't care about short term drops as long as there's nothing wrong with the companies. We sell as soon as there's change of company prospect. e.g. I sold Zoom Video, Pelton near the top. On twitter, Beth kindig said ZooM did a great job during last quarter. I commented: are you being sarcastic?(Growth rate is in terminal decline) I sold out ZM in Nov, 2020 at $430. Now it's at $170.
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No. of Recommendations: 2
With high growth firms, what I see a lot of people get wrong in valuation is truncating growth very early on. For example, revenue growth is ramped down to the inflation rate by year 10. A company growing at 50-60% today probably won't be growing at 2-3% 10 years from now. Even growing at twice that rate makes big difference. I also believe people are too conservative on how high operating margin can truly get for these companies.

Rather than thinking about this in terms of "years", think about it in terms of market penetration. Example. If a company is selling into a $100B market, they might pickup market share very quickly early on, maybe up to even 25% of the market; but after that it will be much harder to pick incremental share.

So maybe they grow slowly at first as the market figures out their product, then very quickly as they gain adoption, and then slowly again. The classic S-Curve. In this case it inflect at $25B.

Early Stages : 20% Growth Rate
Growth Stages : Next 25B in revenue : $50 Growth Rate (would take 8 years at 50% annual growth)
Tail Growth : Say 10% Growth Rate

tecmo
...
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No. of Recommendations: 20
Hi Tafola,

I'm really sorry, and I know that your post is well intentioned, but our board is specifically for the analysis of individual high growth companies, and not for technical analysis and market timing. There are other boards that would be happy to have your post, but it is way off topic here, so I will have to have it deleted.

Saul
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No. of Recommendations: 78
Well, I’m not sure if we have hit the bottom or not and it doesn’t seem to distort my investing thesis.

I owe a lot to Saul's board and hence commenting with a different perspective on why I’m invested in some of these SaaS companies and continue to be a long time holder. I’m a Software Engineer with over 20 years of experience and have worked with the largest software company in the world building some of the products and services that are being used by millions of users in the world today.

I've invested in SaaS when perhaps many folks were not aware of SaaS. My investments were purely from a tech perspective. Then, sometime in 2018, I discovered Saul's board and started learning about how hypergrowth SaaS companies have distinct advantages over traditional businesses ( including legacy software). Aspects like High Revenue Growth, Gross Margins, Net Retention Rate, Product Moat etc. A long time back I had also read Peter Thiel's book "Zero To One" which illustrated the advantages of such software businesses; do read the book it if you get a chance :).

Also, I've been among the first posters on this board to write about the technical superiority of Datadog (DDOG), Crowdstrike (CRWD), Snowflake (SNOW) and a few other companies. You can find those in some of my earlier posts.

The reason I had high confidence in those names was due to my work experience in creating cloud services and also moving legacy on-premise applications to the cloud. I experienced a lot of the pain points that every software developer faces and could clearly see how these special SaaS companies were solving them!

From a Software Developer's perspective, it is impossible in today's world to worry about Security, Monitoring, Performance, Reliability while focussing on building your own product/feature. So, for any enterprise, it makes a lot of sense to let the dev team focus on their feature work/ user stories and using the services of DDOG, ZS, CRWD, MDB for Monitoring, Security, Performance, Reliability and data storage etc.

No doubt we saw the sudden acceleration and a paradigm shift to digitization in the past couple of covid years as businesses embraced the reliability, productivity and cost savings these special SaaS providers bring to the table.

https://boards.fool.com/paradigm-shift-has-happened-34663619...


You'll find my takes on Datadog (DDOG) in some of my earlier posts when DDOG was small company. In the past few years almost every training/conference I had been to or attended online ( since Covid) included some discussion or a pointer to Datadog (DDOG)!

And talking about big data, there's no way you can ignore Snowflake (SNOW) and MongoDB (MDB).


Cheers!

ronjonb

P.S. I also like Sentinel One (S), Monday ( MNDY), Amplitude (AMPL) and Upstart (UPST)from the list of companies discussed on this board. Specially, Amplitude is a great product and simple to use whether your business is data-driven, data-informed or data-inspired. But somehow I feel it’s a business that may be acquired.

I like Confluent ( CFLT) and have some call options. Upstart (UPST) is another fascinating company that I’ve taken a small position in taking advantage of the current sell-off. The only reason I was a little hesitant to invest in it was around the AI hype. I myself have contributed to ML models that are being consumed by some of the largest services in the world and have friends who are working on some of the leading edge developments in that space. So, it is definitely a space to keep an eye on.


Long <DDOG, SNOW, ZS, MNDY, CRWD, S, MDB>. Smaller allocations and call options in CFLT, AMPL, UPST
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No. of Recommendations: 16
"What I noticed about psychology is that stock prices can change people thesis if their convictions are not strong enough. They started doubting if the companies are not a great companies after all because their stocks dropped a lot or went sideway for a long time when there’s nothing wrong with companies’ financial performance."

There was nothing wrong with Cisco's performance in 2000. People simply realized it was overpriced. Their stock plunged and 21 years later still has not recovered.

It's not 100% about investing in a good company. For example, I believe UPST is a very good company, and it's one of my bigger holdings, but if its market cap was $1T, I would say no.

When a stock price decreases, it may not cause doubt about a company's financial performance, rather it may cause doubt about the price.

I'm not saying the boards' companies are over-priced, but on the flip side, Cisco was -- it can happen even when a company has good fundamentals. Good fundamentals are not enough.
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No. of Recommendations: 26
That's not really all that is true about Cisco. Cisco got kicked to the curb by a lot of companies in subsequent years because they were too willing to sit back and sell people expensive routers with expensive consultancy fees to configure them. Cisco's stagnation was not just the stock being "overpriced". Their product was overpriced. Their offering was ripe for disruption. They were disrupted.
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No. of Recommendations: 33
There was nothing wrong with Cisco's performance in 2000. People simply realized it was overpriced. Their stock plunged and 21 years later still has not recovered.

Maybe nothing wrong with Cisco's performance in 2000 but something terribly wrong with Cisco's business model. As I remember Cisco was the original networking company that made them rich and famous but they never developed any new technology that could replace their aging networking technology to create a new "S" growth curve, instead they bought up a lot of other tired technologies like storage and WiFi routers.

What happened to Cisco is that it morphed from growth stock to cash cow which is what happens when old technologies age. It also happened to be overpriced as you point out and there were no drivers that could improve the stock price.

The most important lesson I learned from the 2000 dot com bubble is that one needs to invest in companies that will bounce back. More easily said than done. The only method that I know of is to understand the business model. Back then satellite communications like Iridium and GlobalStar were too early and the technology was not ripe for them, it would take some two decades for the technology to catch up with the dreams. By contrast, Jeff Bezos has said that online sales were successful because all the infrastructure was in place to make it feasible. My own software product, online help for Mac, was also decades too early and my company failed. The consolation prize was that it was mentioned in a Japanese patent challenge as pre-existing technology.

Hold stocks that will bounce back. Don't invest in dreams in you retirement portfolio.

Denny Schlesinger



Cisco Acquisitions by Year
https://www.cisco.com/c/en/us/about/corporate-strategy-offic...
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No. of Recommendations: 16
Good analysis, it is certainly another good data point in the overall catalog of analysis tools. Thank you for sharing.

If I may, I'd like to offer a small dose of skepticism (not in intended as criticism); The trouble with guesstimating stock price movement is that everyone tries to distill the process into a systematic, repeatable, formula that can be applied to the broader market. In my experience, this will always be the Achilles heel of such methods.

For one thing, you cannot avoid macro, there are a lot of things happening in the world, the industry, state, and in the companies themselves, let alone the broader market, to apply such a predictive model without accepting the atmosphere that drives broad movements in the market (i.e. COVID, bubbles, Fed, Great Recession/Depression, etc.).

For another, there are too many emotional and immeasurable people factors that defy rational, reasoned, reactions to corporate, industry and state affairs. The market can be wildly irrational most of the time, and rarely can be said to be predictable.

When we try to distill investing decisions to a finite point on a chart, a measurement, or a report, we lose perspective of millions of other vectors affecting people's choices. The way you see opportunities in front of you is how you see it, it is not how the rest of the world sees it. While your reasoning for calling bottom are well reasoned and supported with your data points, it is easy to fall into the trap of validating your own ideology as dogma. It is another form of anchoring.

Ultimately, if you stick to your convictions long enough, things may turn in your favor and you may look like a brilliant investor. But even a broken clock is right twice a day. Trends are formed when certain measurable things happen long enough to go from being outliers, to confirmed direction. Predicting a trend before it is measurable is fortunetelling. Spotting a trend early enough and positioning to benefit from it is investing.
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No. of Recommendations: 10
Hi Chris,
I went through your original post with interest as I found it to be perhaps the most thoughtful and instructive note on the topic of "valuations" of our growth stocks vs the broader universe that indices represent.

Given our stocks have sold off significantly from the point when you first posted it and we have had one more quarter of earnings behind us, I would be curious to see how you see the relative value now.If you refresh these stats for yourself, would it be possible for you to share some of the key stats with us as well as any change in assumptions that you think would be appropriate?

Of course it would be completely understandable if it is not possible.

Regards
Tuisona
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No. of Recommendations: 1
Apologies.
my message should have started with "Hi Eric".
Very sorry for the error.
Tuisona
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