Are you happy to hold on to your investments forever?
Warren Buffett once said: “If you’re making a good investment in a security, it shouldn’t bother you if they closed down the stock market for five years.”
With the US stock market in a bear market, these words ring louder than ever. But, I would go even further and suggest that the truly long-term investor shouldn’t bother even if the stock market closed forever. Yes, you heard that right- forever.
Even if we are never able to sell our shares, a truly good investment (bought at the right price) should still pay off over time as companies pay their shareholders dividends.
For example, let’s say you bought shares of the Singapore-listed hospitals owner Parkway Life REIT back in 2007 at its offering price of S$1.28 per share. After you made your investment, the Singapore stock market completely closed down and you were left holding on to your shares with no way to sell them. Since then, you would have collected a total of $1.46 per unit in dividends (technically, a REIT’s dividends are called distributions, but let’s not split hairs here).
Today, even if you are not able to sell your shares, you would still have more than made up for your investment and continue to be entitled to future dividends.
This is the goal of the long-term investor. I do not hope to simply sell off an asset at a higher price to a higher bidder; instead, I’m comfortable holding the asset for its cash flow.
But what if your stock doesn’t pay a dividend now? The same concept should still apply. This is because companies may be in different phases of their life cycle. A growing company may not pay a dividend when it’s growing rapidly. But after some time when excess cash builds up in its coffers over time, it can start paying that cash to patient shareholders.
If the stock market closed down forever, patient shareholders of these “non-dividend-paying” companies will still ultimately start receiving dividends, which ideally should eventually exceed what they paid for the shares.
However, not all investments pay off. Some investors may have paid too much for a stake in a company. And some high-growth companies that may look promising may never generate enough cash to reward shareholders.
In times like these, I think of another quote from Buffett: “It’s only when the tide goes out that you learn who has been swimming naked.”
In today’s market, investors who only bought a stock hoping to sell it to a “greater fool” at a higher price with no actual cash flow fundamentals behind the stock are unlikely to make back their capital.
Whenever I invest in a stock, I always think about how much cash flow it can potentially generate and whether I can make back what I paid for it simply by collecting the cash flow that I am entitled to over the years. This way, I will never be bothered about dips in share prices as I know I will eventually get more than paid off even if no one offers to buy the shares in the future.
So do you own productive assets you are happy to own forever?
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned. Holdings are subject to change at any time
Wix recently held its investor day. Here are some of the highlights from its presentation and what I will be watching going forward.
Wix recently held its investor day where it shared its plans for the future and the competitive landscape surrounding its business.
Here are some of the highlights from its presentation.
Software as a service (SaaS) content management solutions winning market share
In the early days of the Internet, coding was the only way to set up a website. This is time-consuming and requires technical know-how.
The second phase of the Internet saw the emergence of content management solutions (CMS-es), such as wordpress.org and Magneto. If you started a blog before, you might be familiar with such tools. In fact, The Good Investors blog – what you’re reading now – is made using wordpress.org. It is an easy solution and requires minimal coding skills.
However, wordpress.org still has its limitations as users still have to source for their own website hosts and use multiple plugins for different functions. All of which are time-consuming and require some education on our part. It is also a little challenging to build more complex websites, such as e-commerce sites, on legacy CMS platforms.
That is why full-stack SaaS CMS-es such as Wix and Shopify are becoming increasingly popular.
A SaaS CMS provides out-of-the-box solutions for hosting, security, deliverability, and performance. It also allows designers to easily input different functionalities such as online bookings, e-commerce, and payments etc.
In the last 10 years, the number of websites built using SaaS CMS-es such as Wix has grown 20X.
Source: Wix Investor Day 2022
SaaS CMS sites now contribute nearly 10% of all websites globally, compared to only 0.5% a decade ago.
And there’s still plenty of market share that SaaS CMS providers can win over, especially when you consider that companies such as Wix and Shopify are developing technologies that can seamlessly help businesses switch from their legacy CMS to a SaaS CMS.
Self Creators business already profitable
Wix’s business can be broken down into two main customer groups: (1) Self Creators and (2) Partners.
Self Creators are customers with whom Wix has a direct relationship. They go on the Wix.com website and build their websites by themselves. Partners are agencies or professional website builders that help their clients build a website using Wix’s solutions.
Wix started its business targeting mainly self creators who needed a simple website for their small businesses. Today, the Self Creators segment is already a highly profitable business, with a 20% free cash flow margin in 2021.
Source: Wix Investor Day 2022
The Self Creators segment is also already a scaled business that generated US$1 billion in revenue in 2021. Wix expects this segment to grow by 5% to 8% this year after accounting for macroeconomic challenges. But management’s target for the segment over the next few years after this year is annual growth in the high-teens percentage range. Management also expects the segment’s free cash flow margin to improve to the mid-twenties percentage range in three years, and to around 30% in the longer term.
Partners segment growing faster than the Self Creators segment
The Partners segment is a fairly new business, and accounts for just 21% of Wix’s overall revenue.
However, the segment is growing fast. Partners build websites for their clients every year, which generates consistent subscription revenue for Wix. As such, partners generate more Wix revenue each year as long as they keep building and maintaining more clients’ websites. The two charts below illustrate this dynamic.
Source: Wix Investor Day 2022
The chart on the left shows yearly booking retention for annual Self Creators cohorts each year. The lines are roughly flat which indicates that these cohorts spend roughly the same amount on Wix products year after year. The chart on the right shows the same information for Partners. The lines go up each year, which suggests that each cohort of Partners brings in more revenue for Wix over time. This demonstrates that Wix’s relationships with Partners are much more valuable over the long term due to the growth in bookings over time.
As such, Wix expects the Partners segment to grow faster than the Self Creators segment. Not only will existing Partners cohorts contribute more over time, but Wix is also spending heavily on marketing to win new partners each year. The table below shows the business profile of the Partners segment and management’s long-term projections for it.
Source: Wix Investor Day 2022
In 2021, revenue for the Partners segment grew a whopping 75% from 2020. However, the unit economics was still poor as expenses were relatively high. But with scale, Wix expects the Partners segment to reach a free cash flow margin in the range of 30%.
Long term projections
Wix also provided its long-term targets for the overall company when combining both the Self Creators and Partners segments.
Source: Wix Investor Day 2022
As a whole, management expects revenue to grow by around 10% this year and around 20% in the next few years with a long term free cash flow margin target of 30%.
What I’m watching
From what I’ve seen, Wix’s management is confident in the company delivering high free cash flow in the future. When you put the numbers together, management is targeting to around US$500 million in free cash flow by 2025.
If Wix can achieve that, its market capitalisation, which sits around US$3.5 billion at the moment, will likely be much higher by then.
However, there’s one thing I’m monitoring: The number of shares that the company is awarding to employees. This could significantly dilute investors.
Wix’s weighted average diluted share count rose from 35 million in the first quarter of 2015 to 57 million in the first quarter of 2022. This a 63% increase. Some of the increase was due to the issuance of convertible bonds, but most of it was because of stocks awarded to employees.
With Wix’s stock price falling to a multi-year low in recent times, the number of shares the company issues for employee compensation could increase. To attract talent, Wix may also need to offer pay packages that include more shares to make up for the fall in its stock price. This could potentially lead to an acceleration in dilution.
Bottom line
With a large untapped addressable market, best-in-class software, and a growing partnership business, Wix is well placed for long-term revenue growth and operating leverage. And with its market cap at just US$3.5 billion and the potential for US$500 million in free cash flow in three years, we could easily see double-digit compounded annualised growth in its market cap.
However, the amount of dilution could potentially dilute returns for shareholders. Although I think Wix’s long-term return looks very promising for shareholders, I’ll be keeping an eye on that weighted average diluted share count number.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Wix and Shopify. Holdings are subject to change at any time
The market has fallen hard in recent times. How does this affect companies and what should investors be looking out for?
With stock prices falling sharply in recent months, here’s how businesses may be impacted.
Higher dilution
It is common practice for tech companies to offer employees stock-based compensation (SBC). This can come in the form of stock options or restricted stock units that vest over time.
SBC is useful for companies in a few ways. First, it incentivises employees to stay for the long-term to reap the rewards of stocks that vest over time. Second, it allows employees to participate in the growth of the company’s stock price. Third, it aligns employees’ interests with shareholders as the employees become shareholders themselves. Fourth, it helps companies to save cash as it is a non-cash expense.
The down-side though is that SBC results in a higher number of outstanding shares in a company, which dilutes existing shareholders. The amount of dilution is usually dependent on the stock price at the time. Take for example a company that offers an employee a pay package that includes $100,000 in shares. If the share price is at $100 a share, the employee gets 1,000 shares. But if the stock price is at $50 a share, the employee will get 2,000 shares. When stock prices are lower, the higher number of shares issued results in higher dilution for the company’s other existing shareholders.
With this in mind, it is important for investors in a company that uses SBC to keep an eye on the growth in the outstanding share count in the future.
More expensive capital
Numerous companies took advantage of soaring stock prices in the last two years to raise cash. For instance, SEA Ltd, raised US$3.5 billion through a secondary offering last year by issuing 11 million new shares at a stock price of US$318 in late-2021.
Today, SEA Ltd’s stock price has fallen to around US$70 per share. In order to raise the same US$3.5 billion today, SEA will need to issue around 50 million shares. This is nearly five times as many shares that were issued in late-2021 and would mean significantly more dilution for SEA’s existing shareholders.
With capital getting more expensive, in both the bond and the equity markets, companies will need to be more prudent with their cash. Cash burning companies will need to find ways to reduces losses or turn cash flow positive in order not to have to raise cash at expensive rates.
Buybacks may be attractive
Conversely, companies that have lots of cash or have a very cash-generative business can take this opportunity to reduce its outstanding share count. Buying back stock when the price is down can be effective in increasing shareholder value. Warren Buffett’s Berkshire Hathaway is a classic example of a company that has taken advantage of a relatively low stock price to accelerate its share buybacks.
But even software companies are joining the party. For example, Zoom is looking to take advantage of its cratering stock price by buying back shares. In its latest earnings announcement released on 28 February 2022, Zoom said that its board of directors had authorised a stock repurchase program of up to US$1 billion. With a price-to-free-cash-flow ratio of less than 20, this seems like a great opportunity for Zoom to reduce its share count for shareholders.
The bottom-line
Falling stock prices can have both a negative or positive impact on companies. Companies that have cash on hand for buybacks can benefit from this bear market. On the other hand, companies that are short of cash may end up having to raise money at unfavourable terms.
We often hear the phrase “cash is king.” It is in times like this that these words ring truer than ever.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in , Zoom and Sea Ltd. Holdings are subject to change at any time
With the stock market crashing, what should investors do now?
The stock market has been brutal this year. The S&P 500 is down 18% year-to-date and the tech-heavy NASDAQ is already down 29%.
But that’s just the tip of the iceberg. Many stocks have been hammered much worse than the indexes. Big names such as Meta Platforms, Paypal, and Netflix are down 44%, 61% and 72% year-to-date.
Smaller tech companies such as Zoom, Fiverr, and Shopify have fallen by 53%, 72%, and 76% respectively. And these are just to name a few. There are numerous other stocks that are down 70% or more in the last four and a half months.
Investors who enjoyed stellar returns in the past few years have clearly been given a rude awakening this year. In light of this and with investors starting to feel unsure of what to do next, I’ve compiled some common questions I’ve seen online and tried to answer them according to my own investing approach.
Question: What should long-term investors do?
With such steep and sudden declines in stock prices, some investors might be wondering what is the best thing to do now?
As a long-term investor, I am not concerned about what stock prices do over the near term. I prefer to focus on the price that the stock can reach when I’m ready to sell my investments years or decades from now.
For instance, if I bought Stock XYZ at $1000 a share and believe it will be worth $3000 in a decade’s time, then do I really care how it reaches there? Does it have to go up in a straight line? The answer is obviously “No”.
I’ll make the exact same profit in a decade if it zig-zags its way to $3000 a share as if it went up in a straight line.
So instead of worrying too much about the decline in my current net worth or current stock valuations, I’m focusing on the business fundamentals and how much these businesses can be worth in the future.
Question: What aspects of the business should we focus on?
Although stock prices may be going down, my focus is not on the stock price but on business fundamentals.
Is the business growing? Does the management team exude confidence in the long-term growth potential of the business? Are there signs of operating leverage coming into play?
All of these help me build a picture of what is possible for my investments over a long term period.
Question: Should I invest spare cash now?
Steep market declines also provide an opportunity for investors with money on the sidelines to start buying ownership stakes in companies at cheaper valuations.
For example, Shopify co-founder and CEO Tobi Lutke recently announced that he will be ploughing in another US$10 million into shares of his own company. He clearly is taking advantage of the lower business valuations to further increase his stake in the company he founded.
Investors who have cash can use this opportunity to invest in companies that could potentially be worth much more in the future. I’m not saying that stocks will not go down more from here, but at these prices, I think that the long-term outlook is rosy.
Question: Were stocks too expensive before and just reasonably valued after this washout?
There are many stocks that I think were vastly overvalued in the past that will never return to their all-time highs. These are meme stocks, stocks that had too much optimism baked into them, and stocks that may have gotten too overvalued due to hype around them on social media platforms.
These stocks will never return to their former heights. But on the other corner, there are many quality businesses that I believe are in deep value territory. These are companies that have best-in-class technology and management, and are disrupting industries or just simply executing brilliantly and winning market share. In today’s environment, some of these companies are trading at low valuations compared to what they can potentially achieve in the next decade or so.
Investing in these companies at current valuations will possibly reap double-digit annualised returns for multiple years.
Final words
Although it is unpleasant to see your portfolio so deep in the red, this is part and parcel of investing in the stock market.
Warren Buffett once said that the true investor welcomes volatility. It offers investors the chance to buy stocks at depressed prices and to sell at unreasonably high prices. With some stocks trading at unreasonably low levels today, I think Buffett’s words are ringing truer than ever.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Meta Platforms Inc, Netflix, Paypal, Zoom, Shopify, and Fiverr. Holdings are subject to change at any time
A couple of weeks back, I was fortunate to be invited to have a conversation with John and MJ on their Youtube podcast called The FIRL Podcast.
During the nearly two hour session, we had a chance to chat about a wide range of topics, such as investing in REITs, Singapore’s stock market, growth versus value stocks, and much more.
I hope you enjoy the conversation as much as I had fun doing it.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I may have a vested interest in some companies mentioned. Holdings are subject to change at any time
Meta Platforms is facing challenges on multiple fronts. Can it overcome them?
Let me start off this article by saying that I have a vested interest in Meta Platforms – the company formerly known as Facebook – and I’m still optimistic about its future. But I am also cognizant of the many challenges that the company faces.
In light of this, and with the company’s stock price falling hard in recent months, here are some of these challenges and my thoughts on what the company needs to do to overcome them.
Flattening user engagement
In the fourth quarter of 2021, the parent company of Facebook and Instagram reported a decline in the number of daily active users.
This was the first-ever quarter where daily active users for Facebook ended the quarter lower than where it was at the start of the quarter.
While the daily active users declined just 1 million from 1,930 million to 1,929 million, it is still a worrying stat.
Facebook has built a giant network that has gotten stronger with each additional user. However, a decline in engagement could lead to a vicious cycle. This is because the engagement levels are only as strong as the content that is on the Facebook platform.
If users leave, it reduces content. Less engaging content results in more users leaving, which in turn leads to even lesser content. This could have a downward-spiraling effect on Facebook. Although the risk of this problem becoming out of control is low, it is still a possibility.
Meta Platforms’ CEO and co-founder, Mark Zuckerberg, pointed out during the latest earnings conference call that shifting consumer preference for TikTok has been one of the big challenges for Facebook and is one of the reasons why the daily active user count has declined.
With Facebook currently contributing a large chunk of Meta Platforms’ overall advertising revenue, this is a real existential problem for the company.
I think Zuckerberg and his team have taken some practical steps to address the issue, such as rolling out Facebook and Instagram’s very own TikTok copycat short-form video service, Reels, which has proven to be a major hit. Reels is growing fast and Zuckerberg has even named Reels as “the biggest contributor to engagement growth.”
There is still a long way to go to compete with TikTok as many people who use both apps tell me that TikTok has better short-form content on its platform. Nevertheless, Meta has the advantage of having a larger user base now and if executed well, Reels will be able to wrestle some of that attention back to Facebook.
Changes to ad tracking
With increasing scrutiny towards data protection, there have been significant changes made to prevent the tracking of user behaviour.
In 2021, Apple released changes to iOS which limited Meta Platforms’ ability to track user behaviour outside of its own 1st-party websites. The changes resulted in a lower ability for advertisers to measure the efficacy of ads.
This has significantly handicapped Meta Platforms as many Facebook and Instagram marketers depend heavily on ad tracking. Facebook advertisements are often for performance marketing, which is driven by immediate results. Without the ability to track the efficacy of their Facebook marketing campaigns, marketers may lower their net spend on Facebook and Instagram.
Meta Platforms’ management said during the latest earnings call that it anticipates the iOS changes to have a US$10 billion revenue impact in 2022. In 2021, Meta Platforms’ total revenue was US$114.9 billion, so US$10 billion is a high single-digit percentage of the company’s overall revenue.
Although the near term impact is significant, the good news is that management is taking some steps to address the issue. Sheryl Sandberg, COO of Meta Platforms, said:
“So when we talked about mitigation, we’ve said there are two key challenges from the iOS changes: targeting and measuring performance. On targeting, it’s very much a multiyear development journey to rebuild our ads optimization systems to drive performance while we’re using less data. And as part of this effort, we’re investing in automation to enable advertisers to leverage machine learning to find the right audience with less effort and reduce reliance on targeting. That’s going to be a longer-term effort.
On measurement, there were two key areas within measurement, which were impacted as a result of Apple’s iOS changes. And I talked about this on the call last quarter as you referenced. The first is the underreporting gap. And what’s happening here is that advertisers worry they’re not getting the ROI they’re actually getting. On this part, we’ve made real progress on that underreporting gap since last quarter, and we believe we’ll continue to make more progress in the years ahead.”
There is still a lot of work to do but given management’s long-term track record of excellence, I am optimistic that the team is up for the challenge and has taken the right steps to improve its ad targeting and tracking.
Rising costs
Lastly, there will be rising costs due to Meta Platforms’ investments in its metaverse projects. Investors are concerned about the amount of money that the company would be burning on these projects. In 2021, Meta Platforms burned through US$10.2 billion on its “Reality Labs” segment, which houses the company’s metaverse-related projects. Zuckerberg mentioned that he thinks building this segment will cost US$10 billion a year for a few years. Even for a company as large as Meta Platforms, this is a big investment to make.
Even though Meta Platforms is in good financial shape now, what investors are more concerned about is whether this investment will pay off or would it be better spent on share buybacks, dividends, or other investments.
I think the revenue potential for the metaverse, if materialised, is enormous and Meta Platforms is in a good position to win its share of the spoils. But only time will tell if the company can execute. For now, I’m happy to trust Zuckerberg’s vision for the future.
Final thoughts
Meta Platforms is facing challenges on multiple fronts. The stock price is currently reflecting that with the stock price well below its all-time highs and down more than 30% year-to-date.
On a positive note, Zuckerberg and his team have, over the life of Meta Platforms’ existence, overcome numerous other challenges before. The company’s stock is also trading at just 15.5 times trailing free cash flow and the company has US$48 billion in cash and short term investments.
This translates to a chunky 6.5% free cash flow yield. At this price, I think the risk-reward potential looks very promising.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Meta Platforms Inc. Holdings are subject to change at any time
Tencent distributed its stake in JD.com to its shareholders. If you’re a Tencent shareholder, here’s what you need to know about the e-commerce giant.
Tencent distributed most of its stake in JD.com to its shareholders earlier this year. If you are a shareholder of Tencent, you would notice new shares of JD.com deposited in your account.
What now?
Investors who were given the JD.com shares can now decide if they want to hold on to the shares or simply sell them.
Here’s what you should know before making a decision.
What is JD.com
JD.com is one of the largest e-commerce companies in China. The company started as a traditional brick and mortar retailer in 1998 before transitioning online in the early 2000s. JD.com focused on selling its own electronics inventory and built out a wide logistics network.
Today JD.com is also a marketplace for third-party sellers who want to leverage the company’s massive base of more than 500 million annual active users.
Unlike Alibaba which is an asset-light business that relies heavily on third-party logistics players, JD.com primarily uses its own logistics capabilities after years of investments building warehouses and expanding its logistics network. This makes JD.com a formidable force in China’s e-commerce scene.
Growing fast
The e-commerce giant recorded a 27% increase in net revenue to RMB 951.6 billion in 2021. Its annual active customer accounts also grew 20.7% to a whopping 569 million.
From 2018 to 2021, JD.com’s net revenue compounded at 27% per year and annual active customer accounts grew 23% annually.
There have been broad-based growth across JD.com’s business. All of its segments – including retail, logistics, and new businesses – have recorded strong growth.
Innovation and competition
JD.com is well-known as an e-commerce brand that specialises in electronics. But building from that niche, the company has executed admirably to expand into different product categories.
The tech-focused company has also seen its early investments in logistics paying off as it is now able to offer quick deliveries and has control of its own fulfilment. It also offers its logistics capabilities to its third-party sellers and other customers who want to leverage its sprawling fulfilment network.
JD.com competes with other e-commerce companies in China such as Alibaba and Pinduoduo, but JD.com has been able to hold its own against these other giants.
Innovation also seems to be ingrained in the company’s DNA as JD.com has consistently used technology and data to improve its logistics capabilities and it is also constantly moving into new businesses to leverage on its large user base. It is now building out its JD Health business for telemedicine and has also established a strategic partnership with Shopify to allow Shopify’s merchants to list their products on JD.com. Shopify is a Canada-based global e-commerce software services provider.
Bearing fruit
JD.com’s early investments are starting to bear fruit. It started to generate a chunky stream of free cash flow in the last couple of years.
In the last two years, JD.com generated a combined RMB 61 billion (US$9.6 billion) in free cash flow. This includes JD.com’s increased investments in capital expenditures for business-expansion this year.
Valuation
With China stocks still out of favour, JD.com’s shares are now trading well below their all-time highs. As of 21 March 2022, JD.com’s share price of HK$239 translates to a market cap of HK$748 billion (US$96 billion). At this price, JD.com trades at around 23 times trailing free cash flow.
Conclusion
The distribution of JD.com shares by Tencent to its shareholders have left many investors holding on to shares of a company that they may not be very familiar with. The above summary provides investors with a quick brief of the company and its fundamentals and its valuation.
Although there is still a lot of uncertainty surrounding China at the moment, I think JD.com shares at this valuation still provides investors with a good risk-reward ratio. Nevertheless, each investor is different and investors should do their own due diligence and make a decision based on their own portfolio situation.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Of all the companies mentioned, I currently have a vested interest in Tencent and JD.com. Holdings are subject to change at any time.
With stock prices of growth companeis falling hard, did investors overpay for them last year? Or are stocks now just too cheap?
Investors who have had a vested interest in high-growth stocks in the past year, myself included, have (to put it mildly) experienced steep drawdowns.
This begs the question, did we overpay for these companies?
Many high-growth stocks in early 2021 were trading at high valuations and it was not uncommon to find such stocks trading at price-to-sales (P/S) multiples of more than 30. Their P/S multiples have since collapsed. Was that just too expensive or are multiples too cheap now?
Mapping the future
To answer this question, we need to make certain assumptions about the future. Let’s make the following conservative assumptions.
First, in 10 years’ time, a company’s valuation multiple will contract and will then trade between 25 to 40 times free cash flow. Second let’s assume the business in question can have a 20% free cash flow margin by then.
The table below shows a scenario of a company that initially had a P/S multiple of 50 and managed to grow revenue by 40% per year for the subsequent 10 years.
Source: My Calculation
Without diving too much into the details, in the above scenario, I worked out that investors who paid 50 times revenue for the company would still enjoy a nice gain on the investment in 10 years of between 60% and 180%(depending on the free cash flow multiple it trades at in the future).
To be clear, I also included a 3% annual increase in share count to account for stock-based compensation which is commonplace for high-growth companies.
Looking at the table above, we can see that just because a company traded at a high multiple, does not mean it is doomed to provide poor returns. If the company can keep growing revenue at relatively high rates while eventually producing a healthy free cash flow margin, investors can still make a respectable return.
Bear in mind, many of the companies that were trading at 30 times revenue or higher in 2020 actually achieved faster growth rates than 40% in 2020 and 2021. This means their future revenue growth rates can fall below 40% for investors to still achieve fine returns.
It is also worth pointing out that many companies that were trading at high multiples also command high gross margins and have the potential for higher free cash flow margins than 20% (which was my assumption in the example above) at a mature phase. This means that even if the company grows revenue at a slower annual pace than 40%, investors could still make a handsome return.
Sieving the wheat from the chaff
Although the above calculations give me confidence that paying up for a company can provide good returns, not all companies have such durable growth potential.
During the bull run of 2020, there was likely too much optimism around mediocre companies. These companies don’t actually have the addressable market or the competitive advantage for them to keep growing to justify their high valuation multiples. These companies will likely never be able to return to their peaks.
When paying a high price for a company, we need to assess if the company has a high probability of growing into its valuation or if it is simply overpriced.
Final thoughts
Just because stock prices are down now doesn’t mean those who paid a high price would not eventually yield good results. Zoom-out and look at the long-term picture. If a company can keep growing its business, then a high stock price may be warranted and still provide very respectable long term returns.
But at the same time, be mindful that not all companies will exhibit such durable growth. Make sure to assess if your companies are the real deal or just pretenders.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned. Holdings are subject to change at any time
The latest earnings update from Zoom and what it tells us about the company’s future.
ZoomVideo Communications (NASDAQ: ZM) reported its financial year 2022 (FY2022) fourth-quarter results earlier this week.
During Zoom’s earnings call, management expressed optimism around the company’s new product, Zoom Contact Centre, and the strong growth trajectory of Zoom Phones. The earnings call transcript is worth a read for more insight into the business but in this article, I want to specifically dive into some of Zoom’s key numbers and earnings projections and share my views on the company’s current stock price.
Sequential growth decelerates but is expected to pick up in FY2023
Zoom was one of the major beneficiaries of COVID-19 lockdowns as people resorted to video conferencing tools to communicate.
But since peaking in 2021, Zoom’s growth rate has been decelerating due to a combination of churn and slower customer wins. In fact, Zoom reported a sequential decline in the number of customers who employed more than 10 employees in the fourth quarter of FY2022. This was a result of churn as some of these customers did not renew subscriptions as social-distancing measures were relaxed.
The table below shows Zoom’s revenue figures on a quarterly basis:
Source: Zoom quarterly earnings reports (revenue numbers are in millions)
Zoom’s sequential revenue growth has been on a steady decline since the 102% spike seen in the second quarter of FY2021. Zoom is also projecting flat sequential growth for the first quarter of FY2023. Although the trend above looks worrying, I believe that Zoom’s sequential growth will start to improve in the second half of FY2023 as customer churn reduces.
This is because the world is now crossing the 2-year anniversary of the start of COVID-induced lockdowns in many parts of the world. This is a period when some of Zoom’s customers will decide whether or not to renew their contracts.
Zoom’s customer base is usually very sticky. But in this unique situation, churn is especially high as some customers who started subscribing to Zoom during the lockdowns do not intend to stick around after COVID.
Once Zoom moves past this relatively higher churn period, the company’s churn rate will likely decrease. Beyond this, new customer wins can also start to improve Zoom’s top-line, rather than just replace leaving customers.
Growth in remaining performance obligation
Another good sign is that there was a sequential acceleration in Zoom’s RPO (remaining performance obligations) growth. RPO essentially refers to revenue that Zoom will recognise in the future.
The table below is a compilation of the company’s RPO over the past 12 quarters.
Source: Zoom quarterly earnings reports (RPO numbers are in millions)
RPO growth accelerated in the fourth quarter of FY2022 compared to the previous sequential quarter. This is a sign of successful customer wins which sets Zoom up nicely for the future.
Management guidance for FY2023
Zoom’s management also provided guidance for FY2023 that indicates around 10.8% growth in revenue for the year. The table below shows Zoom’s full-year revenue growth rate and guidance for FY2023.
Source: Zoom earnings reports
Taking into account the projections for revenue of US$1.07 billion in the first quarter of FY2023, revenue for the remaining three quarters of FY2023 will need to grow sequentially in order to hit management’s revenue projections for the year. Based on my calculations, Zoom’s revenue will have to increase by slightly more than 4% sequentially each quarter, starting from the second quarter of FY2023.
I believe Zoom can achieve growth by winning customers for its core product of video conferencing or selling some of its newer less-penetrated products such as Zoom Phones and Zoom Contact Centre. It is also worth pointing out that Zoom has exceeded its own projections every quarter since its IPO.
My thoughts on valuation
Zoom’s stock price has cratered from a peak of more than US$560 seen in October 2020 and the company currently has a market capitalisation of around US$36 billion.
At the current stock price of US$122, Zoom has an enterprise value-to-free cash flow (EV-to-FCF) ratio of around 21. This is a discount to other mature, highly-cash-generative software-as-a-service (SaaS) companies. The chart below shows Zoom’s EV-to-FCF ratio compared to these other SaaS companies such as Adobe, Salesforce, and Servicenow.
Although the projected revenue growth of 10% is nowhere near as fast as other software companies, Zoom is trading at what I believe to be an unfairly low valuation. Revenue growth can also possibly accelerate in the future given that Zoom Contact Centre is a new product (launched last month) that management is excited about and Zoom Phone is in a high-growth phase.
Zoom has become a value stock as much as a growth stock at the current stock price. Given this, I think there’s room for the stock to climb in the future.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Of all the companies mentioned, I currently have a vested interest in Zoom, Adobe, and Salesforce. Holdings are subject to change at any time.
Stocks rise and fall all the time. If you think the stock will be worth more in the future, ignore short-term drawdowns and focus on the long game.
What if I told you that you could invest in a stock at a $90 price today and sell it for more than $3000 in 22 years time? You’d probably bite my hand off for such a deal.
That’s exactly what you could have achieved if you invested in Amazon.com 22 years ago in late-1999 and held the stock till today.
Source: Ycharts
A $1000 investment back then would have turned into more than $33,000 today. The chart above shows the trajectory of Amazon’s stock price over that 22 year period.
It looks like a pretty clean upwards trajectory but the stock price performance was actually anything but smooth. The chart below shows Amazon’s stock price from late-1999 to 2002 just after the dot com bubble burst.
Source: Ycharts
Amazon’s stock price tumbled from more than US$90 to around US$12. Although this was the steepest drawdown, Amazon’s stock price experienced numerous other steep drawdowns over the past 22 years. The chart below shows how far Amazon’s stock was below its all-time high over the past 22 years.
Source: Ycharts
Amazon took close to 10 years to regain its 1999 peak. And even after breaching that peak, Amazon still experienced numerous drawdowns from those peaks, with those drawdowns frequently reaching close to 30%.
This is the harsh reality of the stock market. Stock price rise and fall all the time and even the best companies can experience significant stock price declines along the way.
However, investors who bought Amazon at the highs of 1999, and maintained their long-term focus even after that massive subsequent drawdown in 2000-2002, would still have come out with excellent returns.
Today in 2022, with some stocks experiencing similarly steep drawdowns from their all-time highs, Amazon is a good reminder of how long-term investing pays off.
Instead of focusing on prices today, think about where the stock’s business can be in 10 or 20 years’ time. If you think the business will be stronger and the company will be worth much more, then ignore the prices today and focus on the future.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Amazon Inc. Holdings are subject to change at any time.
