As the intended outcome of this blog is to drive investment decisions, I think it is important to step back periodically and track portfolio returns. All of my blustering about software infrastructure companies, secular trends and durability of growth would be meaningless if they didn’t translate into tangible portfolio growth. For transparency, I publish the holdings in my personal portfolio and update allocations weekly. These holdings incorporate the individual company research and commentary provided on this blog. I also track the portfolio’s YTD return and include that metric as the primary measure of performance.
The portfolio is where the rubber meets the road, so to speak. While I don’t run a fund, the detailed analysis I share on this blog allows me to make investment decisions. All of my personal income is drawn from this portfolio. Performance over time is critical and I manage the portfolio actively. The holdings shared as part of the Software Stack Investing portfolio represent the vast majority of my real-world investments.
This blog and service are free – some readers have asked why. There is no hidden agenda. I share my analysis and the portfolio allocations with the public to force my own research process and to solicit valuable feedback. My investment decisions are influenced by the positive or negative feedback I receive from readers. If I put forth an investment thesis for a stock and and other investors push back, that can change my perspective. Positive reinforcement is helpful as well. With that in mind, let’s take a look at how 2021 played out and what learnings investors can apply going forward.
Portfolio Performance
The SSI portfolio performed beyond expectations in 2021, posting a 45% gain overall. Coming off of a 158% gain in 2020, I would have been content just to maintain 2020 upside and perhaps realize a slight improvement. The peak of the portfolio in 2021 was even higher, briefly touching 80% in mid-November. At that point, valuation multiples for software companies were at historic levels. At the tail end of the year, we experienced a rapid sell-off in high growth stocks. In spite of the drop, I am more than happy with a 45% increase for 2021. The compounding of gains over the last two years has grown the value of my portfolio by roughly 3.75x. Those kinds of gains in two years are unprecedented and should temper expectations going forward.
This past outperformance also allows me to reconcile the poor start to 2022. After just three days of trading, the portfolio is down 17% in 2022. After two strong years, this kind of volatility is acceptable. It is also a little familiar. After a huge 2020, by March of 2021, the portfolio was down as much as 12% for the year. There were similar headlines referring to macro conditions, ongoing pandemic concerns and inflated valuations.
Yet, the portfolio eventually worked its way through these issues by focusing on holding the best companies. These companies executed through the headline issues, continuing to add customers, roll out new products and expand existing customer spend. While the volatility will likely continue in 2022, I don’t expect the fundamental performance of these companies or the demand environment to change significantly. Stock price performance in 2022 will likely not match that of prior years. Yet, I expect these companies to continue to grow at high rates and eventually justify their valuations.
I also appreciate that some macro conditions really do appear to be changing. For one, the unprecedented levels of fiscal stimulus over the last two years likely did inflate growth assets. Interest rates will probably also rise, impacting valuation multiples due to forward discounting models. Inflation, supply chain issues, pandemic persistence and other factors could also play out in unfavorable ways. However, I have decided that these influences are largely outside of my control and that it is very difficult to position a portfolio to successfully navigate them. Also, while these factors are taken as truths at this point, predicting overall market direction can be tricky and new developments (like Covid in 2020) emerge continuously that can redirect the narrative.
All I can do is focus on the sector I have chosen and try to identify the companies that will outperform expectations over the long term. This involves looking for companies that are well-positioned in a growing market segment, rapidly extending their product offerings, attracting and expanding customer spend, improving operating leverage and applying innovative leadership. Companies that share these traits should experience high revenue growth and be able to sustain it for longer than expected. The compounding of high revenue growth rates over several years will eventually overcome a near term valuation multiple reset. At some point, the valuation bottom will be hit and stock price will increase proportionally to revenue growth going forward. Fundamentally, that is what a sales multiple (or multiple of earnings) implies.
Getting back to 2021, comparing the SSI portfolio growth to other benchmarks shows a strong level of outperformance. For obvious reasons, tracking against benchmarks is important. Otherwise, what is the point of all this effort researching individual companies and general industry trends? My current assumption is that actively managing a concentrated portfolio of companies that I intimately understand will allow me to outperform comparable indices. Further, I think my focus on “pick and shovel” providers in the software infrastructure sector will benefit from tailwinds in the broader move to digital experiences.
Other sectors likely offer companies with upside for discerning investors, whether that is FinTech or EV in manufacturing. I have chosen software infrastructure for my focus area, based on my background leading software development. Warren Buffet famously advised “Never invest in a business you cannot understand.” I benefit from a strong grounding in the mechanics of building modern software applications, securing them and delivering digital experiences at massive scale. These are outcomes that software infrastructure providers enable. I have also been a customer of these services and intimately understand the buying considerations.
| Year | SSI | S&P 500 | NASDAQ | ARKW | IGV |
| 2021 | 45% | 27% | 22% | -19% | 12% |
| 2020 | 158% | 16% | 44% | 157% | 53% |
Comparing the SSI portfolio performance, we can first look to the broad indexes. The S&P 500 (SPX) and NASDAQ (IXIC) are both fairly diversified and represent a minimum level of performance in my view. If we can’t beat the S&P 500 index, then we may as well invest our money in that index and forget about it. For those investors who don’t have the time or inclination to research and create a concentrated portfolio, an index makes sense. For them, a highly diversified portfolio can reduce risk. It avoids sector specific issues and spreads out the impact from individual company wipe-outs. However, for investors willing to invest the time to deeply research individual companies and closely track their progress for any changes to the investment thesis, I think a concentrated portfolio can outperform the indices.
As you can see from the table above, the SSI portfolio handily beat the S&P 500 and NASDAQ indices in both 2021 and 2020. This is the outcome I would expect. More interesting is to compare performance to popular ETFs that are concentrated in the same software sector. For this, I picked ARK’s Next Generation Internet ETF (ARKW) and the iShares Expanded Tech-Software Sector ETF (IGV). These two ETF’s share a similar investing philosophy to SSI and have some overlapping holdings.
Comparing to the IGV, the SSI portfolio outperformed by about 3-4x in each year. Interestingly, the ratio of 2020 to 2021 was similar for SSI and IGV, being about 4x greater in 2020. As I’ll discuss in the take-aways section, I think this further underscores two important points. First, concentration in the fastest growing companies matters. IGV holds many of the more established software infrastructure companies, like Microsoft, Adobe, Oracle and Palo Alto Networks as top holdings. They do include Datadog, Zscaler, Docusign and Crowdstrike in their Top 25, but none of these are even in the Top 10. Also, the portfolio is very diversified, with the Top 5 holdings making up just 37% of the portfolio (with concentration dropping off rapidly from there).
Comparing to ARKW, that ETF matched SSI performance in 2020, but underperformed in 2021. While ARKW had strong picks in 2020, the lackluster performance in 2021 could be attributed to lack of change. While many of ARKW’s holdings experienced strong momentum in 2020, some slowed down significantly in 2021. Several of these stocks were arguably Covid beneficiaries, where revenue pull forward became clear as 2021 progressed. Examples are Zoom (-45% in 2021) and Teladoc (-54%). ARKW even holds some companies in the SSI coverage universe, like Twilio (-22%) and Docusign (-31%). While the ARK team is very savvy at identifying secular trends and large technology shifts, they seem less inclined to make changes to holdings if the story shifts. Their performance may well snap back in 2022. Fund manager Cathie Wood recently publicly stated that ARK funds “could deliver a 30-40% compound annual rate of return during the next five years.” Given that we share a positive view on the growth potential for innovative companies in the software sector, I find this projection bullish.
As I will discuss in the next section, I think that concentration in fewer stocks and a willingness to make significant changes to allocations are important factors to sustain higher returns. A “buy and hold” strategy with a stock can be the path of least resistance, as it removes the research burden to identify an alternative and avoids the risk of switching to a worse performer.
If the investment thesis changes, though, investors have to be willing to take action. It is this avoidance bias that can create problems for portfolio returns. Emotionally and psychologically, it is just easier to stick with a stock. This effect is even more pronounced when the stock is at a low, as the value argument starts to make sense. The stock begins to appear cheap. It can also create a value trap. As I will discuss, my experience has been that reducing allocations to companies during periods of underperformance yields a better result.
Position Specific Activity
Looking at individual stocks, my best performing holding for 2021 was Datadog. I opened this position in February, following their strong Q4 2020 results. In a recap of Q4 earnings, I discussed how I had been waiting for Datadog’s revenue growth to normalize after a Covid-influenced pause in Q2 2020. Looking forward for 2021, it became clear that Datadog could return to its normal cadence of high revenue growth combined with improving operational leverage. Additionally, the product development funnel was charging ahead, with their entry into the security market coupled with observability extensions into incident management and developer workflows.
I started building a 14% allocation to DDOG by late February and ramped that up to 20% by April, really leaning into the stock as the price dipped into the $80’s in March. That strategy turned out well, as DDOG ended the year around $178, doubling from the March lows. The cost basis for my allocation to DDOG is $94, which was up just under 90% through the end of the year. It is now my largest position at 33% of the portfolio. Even with the 18% drop in the first three trading days of 2022, my position is still up 55% over less than a year.
For my second largest position, Cloudflare, I owned the stock through all of 2021. I entered the year with a 20% allocation. At year end, that stands at 25%. The stock started the year at $76 and ended it around $131.50 for about a 73% gain. In mid-November, NET had shot up to $220 and its trailing P/S ratio briefly topped 100. The market was overly optimistic about the outsized market potential and new product line-up introduced during Birthday Week in late September. We have stepped back from that nearly 3x peak and are down about 19% in 2022. The stock is now up 39% since the beginning of 2021.
Yet, the company’s performance and market potential during this period hasn’t changed. I value Cloudflare’s breakneck product development cadence and ever-increasing addressable market. With their unique network-focused architecture that delivers all compute and data storage services in parallel from every one of their 250 globally distributed PoPs, I think Cloudflare has strong competitive advantages in place that will enable disruption of many IT services. The stock has dropped 52% from its ATH price over the last two months. A return to the prior high would represent more than a doubling. While it’s fair to acknowledge that the market had gotten ahead of itself with a 100 P/S for a 50% grower, as Cloudflare’s revenue keeps compounding, it should eventually retest those highs.
Rounding out the Top 4 of my portfolio are Snowflake and Zscaler. Combined with Datadog and Cloudflare, these make up almost 90% of the portfolio’s value. This reflects the portfolio’s concentration. I entered both of these stocks in 2021 as well. For Snowflake, I had been tracking the company since their September 2020 IPO. I wanted to monitor a few quarters of performance before considering a position. That turned out well, as the stock peaked in December 2020 around $400 and then dropped for the next 6 months. By May 2021, the stock dipped below $200 and I began to buy. I accumulated what is now a 16% allocation, with a basis of $218. With the stock closing the year at $339, that represents a 55% gain.
While Snowflake’s execution has been strong, I became particularly excited about the company as I dug into their data sharing strategy. With Snowflake, business partners can easily exchange data in a compliant and seamless fashion, replacing the overhead of transmitting files or setting up APIs. This is creating network effects, as existing customers encourage their partners to join the ecosystem. Additionally, the data marketplace is enabling companies to create enhanced data sets for sale, further driving usage of the Snowflake platform.
They are also adding new capabilities for data engineering, analytics support and machine learning, accessible in a programmable environment adjacent to the core data platform’s compute and storage. These all combined to drive an outstanding quarterly report for Q3 FY2022 on December 1st, where Snowflake blew out all performance estimates.
Finally, I started building a position in Zscaler in February 2021 and ramped that up to 12% of the portfolio by May. My basis is $198 and the stock finished the year at $321 for a 63% gain. I think Zscaler is well-positioned to participate in the transition of corporate networks away from physical firewalls towards a software-defined network configuration based on Zero Trust. While other companies offer Zero Trust solutions and are positioned to participate in other aspects of security, like endpoint protection, I think that Zscaler has a unique architecture driven by their network of distributed PoPs (similar to Cloudflare). Because they own and operate their network (versus renting space from the hyperscalers), they have full control of the hardware stack and can scale to address the largest workloads. Additionally, their network connectivity helps offset costs that CIOs would face with a DIY network configuration based on firewalls and leased network circuits between offices and data centers.
On the downside, I entered 2021 with a 14% allocation to Docusign with a basis of $159. I exited that position in March – April, as it became clear that Docusign’s high growth in 2020 wasn’t sustainable at similar levels in 2021. My exit price averaged about $200 for a 26% gain. While the stock returned to an ATH of $310 in September, it ended the year at $152 following a very disappointing Q3 report in December. Docusign’s revenue growth in Q3 slowed to 42% (from 50% in Q2) and they lowered guidance for Q4. My early exit turned out to be a good decision as most of DOCU’s price erosion of 31% for the full year occurred after its peak in September. I will continue to monitor the stock, as I think automation and observability of legal contracts has potential, but will take some time to play out.
I can’t say that I called every change in advance. At the beginning of 2021, Twilio was my largest allocation at around 20%. As other stocks outperformed, the relative allocation to TWLO began diminishing. Following Twilio’s disappointing Q3 report in which organic revenue growth dropped significantly, I began selling the stock. Fortunately, I still had a very low basis, holding the company since 2018. However, the opportunity cost for holding TWLO in 2021 was significant, as TWLO ended the year down 22%. It may rebound in 2022, if the organic revenue deceleration from Q3 levels out or turns back upward. However, I can’t take that risk, as there are other companies in the portfolio that are executing more consistently. I can always re-enter if growth stabilizes and margins improve.
| Symbol | Percent Allocation | 2021 Gain* |
| DDOG | 33% | 89% (From entry) |
| NET | 25% | 73% |
| SNOW | 16% | 55% (From entry) |
| ZS | 14% | 63% (From entry) |
| MDB | 6% | 4% (From entry) |
| CRWD | 4% | -3% |
| TWLO | 2% | -22% |
*2021 Gain is either full year or from basis for new positions.
Reviewing my holdings at the end of 2021, a willingness to make changes to allocations in light of new information becomes evident. Over the course of the year, I initiated positions in Datadog, Snowflake and Zscaler (and MongoDB in December). While I had tracked these companies previously, I was waiting for either clear evidence of revenue growth sustainability or sufficient buffer from their IPO. Incidentally, those two signals can be related, which is why I usually refrain from entering an IPO immediately. I like to observe at least 1-2 quarters of performance after the IPO to ensure that growth is consistent, as some companies stretch for the best story at IPO.
For MongoDB, I had owned the stock in 2020, but exited later in the year, as I worried revenue growth might not return to elevated levels after the Covid slowdown in the first few quarters of the year. In 2021, revenue growth has been accelerating again. With the significant jump in Q3 FY2022 (reported in early December) to 50% year/year revenue growth, I decided to re-enter the stock and look forward to continued expansion over the next year.
| Symbol | Percent Allocation | 2021 Gain* |
| NET | 22% | 73% |
| TWLO | 20% | -22% |
| DOCU | 14% | -31% |
| TTD | 12% | 14% |
| ESTC | 10% | -16% |
| CRWD | 8% | -3% |
| FSLY | 6% | -59% |
| TDOC | 5% | -54% |
*2021 Gain is for the full year.
Examining the SSI allocations when we entered 2021, the portfolio looked very different. These holdings were big winners in 2020, with all of them posting more than a 100% gain for the year of 2020. The 3 worst performers in 2021 were up 306% (FSLY), 140% (TDOC) and 200% (DOCU) respectively for 2020. If “winners keep on winning”, it made perfect sense to hold these companies. However, at some point, the story changed. In all cases, the sustainability of high revenue growth became questionable. Fastly demonstrated this in late 2020 and Teladoc and Docusign in 2021. In these cases, I began quickly reducing my allocation the first quarter it happened and then closed out the position upon the second.
This strategy clearly saved the portfolio in 2021 and explains the outperformance relative to ARKW, which has largely kept their allocations to 2020’s winners. This is where I think it is imperative for investors to closely track their holdings. For a concentrated portfolio, this is even more important. If the narrative shifts on a company that makes up over 20% of your portfolio, it is critical to change your allocation quickly. This approach allowed me to retain a roughly 3x gain in FSLY from my entry point in early 2020 with a basis of $24.50. In spite of the stock falling significantly from its ATH in October 2020, by the time I sold it, I still had a substantial gain for a 9 month holding period.
Had I not made any changes to the portfolio through 2021, it would have ended the year up just 1% versus the actual gain of 45%. I may very well re-enter any one of those stocks if the story improves again. I opened a new position in Datadog in 2021 after waiting out the one-time Q2 2020 hit. MongoDB is a second pass for me and I think it will perform well over the next 12 months. The key is to remain objective and adjust a stock’s allocation if you feel the story has changed. Picking stocks is not like tracking a professional sports team. We don’t get extra credit for being die-hard fans.
Transitioning to 2022
Looking forward to 2022, I think the recent sell-off actually provides some upside potential. If anything, as long as software infrastructure companies keep performing, it’s reasonable to assume these stocks can retest their peak price from 2021 at some point. With the current allocations, a return to the ATH price for each stock would increase the SSI portfolio valuation by 58%. This takes into account the dismal performance on the first few trading days of 2022.
As we have already seen in 2022, macro concerns and volatility are looming large, with the threat of higher interest rates. These factors drove a significant valuation reset for high multiple stocks over the past two months. The question will be whether this trend will continue through 2022, or we are approaching some level of overall valuation stability. If the market is forward looking, one could argue that the impact of higher rates has been taken into account at this point. However, if inflation spikes higher, the Fed may take more drastic action and further spook the market.
Regardless, I don’t plan to make changes to my portfolio strategy in reaction to these macro concerns. The only adjustments I plan to make are to the relative allocations of each stock. I will likely lean further into some companies and pull back from others, following a similar pattern as early 2021. I will make these adjustments in the first half of 2022, as we start to get year end earnings reports and an initial look at projections for the current year. I will be looking for the same criteria, including durability (or acceleration) of revenue growth rates, continued customer engagement, expanding product offering and operating leverage.
I’ll discuss some of these factors below and will reinforce these investment drivers in blog posts through the year. As I discussed above, the first portfolio shift I am making is to increase my allocation to MongoDB. I like their growth trajectory, the expanding product footprint and the large addressable market. After being somewhat dismissed in tech circles for several years, I think MongoDB is finally getting respect as a suitable data platform for modern software applications and is well-positioned to break-out in terms of usage. I will likely increase MDB to a mid-sized position in my portfolio over the next months and then wait for more data points.
Investor Take-aways
Reflecting on the SSI portfolio performance during 2021 and the changes that I made, I can draw some key learnings. While I had a sense for these, going through the actual comparison of my portfolio at beginning and end of year was very enlightening. I recommend this process to any investor. It provided me with more conviction in my strategy and confidence in some practical tactics.
For example, I sometimes hesitate to make an allocation change for a particular stock. Looking at 2021’s performance, though, it is clear that allocation changes helped the portfolio maximize returns (moving into DDOG, SNOW, ZS) and avoiding some pitfalls (moving out of TDOC, DOCU, FSLY). Knowing that my intuition seems to be pretty good will help me be confident with future moves of these types.
Here are some observations and key learnings from 2021.
Concentration Benefits
While most financial analysts would advocate a highly diversified portfolio, I am finding that the opposite is true to maximize returns. The BIG caveat here is risk, as a sector wide impact could destroy a concentrated portfolio, particularly in the short term (like now). However, I think that a bet on a sector with clear tailwinds is a safe play. In my case, that is software infrastructure, which leverages my background leading software engineering at large consumer Internet organizations. Other investors may have a background in other sectors – whether you worked in that space or just invest the time to understand it. I think the key advantage is focus. The mechanics, trends and buying drivers for a sector can be difficult to really discern, but persistence and consistency will pay off.
Once you pick a sector, finding the companies that are the leaders is important. There can be a significant premium assigned by the market to the companies that are growing the fastest and perceived to have the most potential. Narrowing the set of investments to 6-10 or less allows maximum time to really understand each company. You should know the company intimately, not just financials, but product, competitors, customers, leadership and go-to-market channels. I really can’t imagine one person able to do this for more than 10 companies.
This is particularly important to determine if the story has changed for a company and you need to make an adjustment to an allocation. If you don’t intimately understand a company, then you won’t really own your investment thesis and be susceptible to outside influence. Also, it’s easy to get lost in the noise of too many earnings reports, product announcements and competitive moves. All of which make it challenging to build the conviction to force a portfolio change. Inertia is the problem here and it’s an easier path to just maintain a position and hope for a rebound.
Stay in your Lane
Related to the point above about picking a sector for a concentrated portfolio, for me at least, it’s important to stay in my lane. By this, I mean focusing on the software infrastructure sector. In 2020 and 2021, I invested in some companies that use technology, but are in a different market category. Two examples are Teladoc and The Trade Desk. While these companies create software to drive their services, their customers are health care providers, media publishers and ad agencies. I can’t reasonably evaluate the buying decisions for these products. Further, I can’t really discern the competitive moat. While they are “SaaS” like, they deviate from my core focus. I understand the buying decisions for software engineering, data processing and security teams.
One caveat to this advice is if investors identify a strict process for selecting companies that may span a broader set of sectors. Investment criteria may dictate a target growth rate, level of gross margins, operating leverage, subscription model, customer expansion and other factors. A good example of this is the well-known investor board “Saul’s Investing Discussions” on the Motley Fool. Contributors to this board offer an extensive knowledge base of criteria for evaluating companies. To me, this represents a strict “lane” as well. Investors who follow these philosophies have performed very favorably over the years, outperforming the indices consistently.
Product Development Cadence Drives TAM
While financial performance is important, I gained an appreciation for the impact of product development agility and addressable market expansion. These factors can generate a premium for a stock’s valuation, as the market perceives the underlying company’s future opportunity is greater. Specifically, having more products to sell to customers and entry into adjacent markets increases the durability of revenue growth. In effect, a company can postpone the drag of the “law of large numbers” by backfilling the inevitable slowdown in sales of mature product offerings with rapid growth in new ones.
Additionally, an accelerating product release cycle can create a competitive moat. Other providers in the market will not be able to maintain feature parity. Even if a hyperscaler enters the market with a competing product, it is less likely to capture significant share if the smaller provider keeps leaping ahead with a more robust offering. Also, adjacent product segments help the company support a vendor consolidation argument. This allows them to sell the customer a platform, versus a point solution.
I explored the valuation premium associated with expanding TAM in a blog post from October that used Cloudflare as the example. I have also touched on the benefits of adjacent market entry and the vendor consolidation argument in my coverage of Datadog’s Q3 results. I will be publishing an update on MongoDB soon as well. With their new product positioning as the Application Data Platform, MongoDB is making a compelling argument that development teams could reduce the number of transactional database types that they maintain and consolidate all workloads onto MongoDB.
Customer Activity
When a company exhibits a thoughtful product development funnel and entry into adjacent markets, the results are often manifested in customer activity metrics. Specifically, we see strong levels of new customer additions and net expansion rates. New customers may start small, perhaps with a single product offering. Over time, they add new product subscriptions, until they are using several products. This increase in spend each year for existing customers is called the net expansion rate (or net retention rate). Beyond adding new product subscriptions, customers can also increase spend based on the growth of their own business. As their digital operations scale, customers often increase their usage of an existing product and expand their subscription level. Both of these factors combine to drive a high expansion rate.
In terms of metrics, I like to see companies with growth in customer additions of 20% or more each year. Ideally, this exceeds 30%. For the net expansion rate, I think 120% is the minimum, with a rate over 130% being ideal. The “hat trick” is when a company can maintain a high rate of customer additions, existing customer spend expansion and new product launches. For me, the new products provide the fuel for future expansion, and arguably can attract new customers.
I call this the “land and expand and expand” model. While “land and expand” has been popularized for SaaS companies, I think the third dimension of product expansion is important to consider. If a company isn’t rapidly and thoughtfully extending their product reach, then they will succumb to the law of large numbers as they saturate their existing markets. Further, the company should show meaningful evidence of customer adoption of new products after some period of time following launch (usually a year). This may be based on published metrics about the number of product modules used by customers, subjective descriptions of new product adoption or references to customer wins that involve new products.
Datadog provides a textbook example of this “land and expand and expand” flywheel. In discussing their Q3 results, I highlighted this effect. Datadog delivered total customer growth of 34% year/year and DBNRR over 130% in the most recent quarter. Further, they have been rapidly expanding the number of product modules with pricing. At the end of 2020, Datadog listed 9 top-level products with pricing. A year later, they show 14. While not a reported metric, that represents an increase of over 50%. Further, Datadog regularly shares the percent of customers who use 2 or more, 4 or more and occasionally 6 or more products. These percentages have been increasing rapidly each year.
Leadership
I prefer to invest in software infrastructure companies in which the founder (or co-founders) are still running the company. Ideally, they have a software engineering or product background, or at least had a hand in shaping the company’s initial product offering from the ground up. This is critical for a couple of reasons. First, it establishes credibility with the user community (to whom the company is selling) and within the company’s own internal engineering organization. This credibility engenders trust, confidence and ultimately talent retention.
Second, the founder intimately understands the problems being addressed by their company’s solutions. They don’t have to rely on a product team to explain or prioritize the needs of the user community to whom they sell. This allows meaningful oversight of the product development roadmap and transparency of technical complexity. It also drives rapid delivery cadence. If the founder thinks they could implement a solution themselves in a few months with a small team, it is difficult for the delivery manager to claim it will take a year.
Third, if the founder is still in charge of the company, they have a burning desire to ensure it will continue to be wildly successful. They are personally invested and ego is involved. This implies that the internal organization will be leveraged as much as possible. When challenges arise, a founder leader will work all weekend to find a solution. A non-founder leader might spend part of the weekend figuring out a sufficient excuse. While non-founder leaders can deliver, I think vision and drive are diluted as soon as the founder hands off the reigns.
Some of my favorite software companies have a product-oriented founder (or founders) who is still in charge. Examples in the SSI portfolio are Datadog, Cloudflare, Zscaler, Twilio and Crowdstrike. Lacking a technical founder still in charge, I like to see companies where the founder is heavily involved in technology direction (Snowflake) or a CEO that went through a similar building process at their prior company (Snowflake, MongoDB). I am less inclined to favor a CEO with a financial or sales background, who was installed by a PE firm or pulled from the VC community.
Developer Mindshare
Developers are at the heart of enabling digital transformation for their enterprises. As their role evolves and expands, they increasingly have influence over software purchase decisions. Software infrastructure and tooling companies can no longer rely on salespeople to drive customer adoption using a top-down sales motion. Rather, the company must figure out how to reach and market to developers. With most solutions available through a cloud subscription and a credit card, the on-boarding process must be seamless. Additionally, the product must be well-documented and easy to spin up.
Software infrastructure providers that can win the hearts and minds of developers will benefit from lower sales overhead. Bringing on new customers for a trial engagement can be very low touch. Once the customer is engaged, an enterprise sales team can still work with them to optimize usage, find new use cases and provide enhanced training options. I discussed these tactics in a blog post from early in 2021, called Building for Developers.
MongoDB employs this tactic successfully. They are famously labeled the “most wanted database” in Stack Overflow’s annual developer survey. Their open source community database has been downloaded 210 million times. The cloud product, Atlas, is completely self-serve for developers who want to try out MongoDB on their next application. These factors all helped drive MongoDB’s 37% growth in new customers year/year in the last quarter. It also contributed to the 84% increase in revenue growth for their cloud product, Atlas.
Architecture Matters
Finally, while it should be obvious to someone with a software engineering background, architecture really can matter for a software infrastructure company. If applied effectively, it can create a significant competitive advantage for a provider and a means to differentiate them from other market participants. This usually takes the form of some unique approach to building their technology or distributing their service.
A good example is provided by Cloudflare (and Zscaler to an extent). With their owned and operated global network of PoPs, Cloudflare is in full control of the routing of traffic over their network. They can optimize performance down to the machine level. Additionally, their compute and data storage solutions are deliberately distributed. All services run on all PoPs in parallel – users don’t need to designate a geographic region in which to host their application or connect their users.
This architectural design creates much more complexity for launching new software and security services. But, the parallelism provides much greater performance and simplicity. This is allowing Cloudflare to enter new markets, like security, data distribution and video conferencing, delivering solutions that will ultimately perform better than those currently offered by incumbents. I discussed these advantage for Cloudflare and the impact on product development in several posts, including Decentralization Effects and coverage of their recent Q3 earnings report.
Final Thoughts
These aggregated insights will be applied to my portfolio allocations going forward. Investors are free to borrow these ideas and morph them into their own investing strategy. I will also continue updating my portfolio holdings each week on this blog and provide commentary for portfolio adjustments in both blog posts and email newsletters. Investors are welcome to mirror my holdings if they wish. And, as always, if you have thoughts or feedback, feel free to comment or email analysis@softwarestackinvesting.com.
NOTE: This article does not represent investment advice and is solely the author’s opinion for managing his own investment portfolio. Readers are expected to perform their own due diligence before making investment decisions. Please see the Disclaimer for more detail.
Peter,
You are too good to provide any suggestions to you, really appreciate your contribution for all of people who insist to invest their most of liquidity assets to software companies.
Just like you said about the Marco, I don’t know much than you even I have master degree about Economics.
The only thing I’d like to said is , while the cost of raise money getting more expensive. People might give more credit on companies who may produce money.
So which means winners take all. The multiple will show more differences between winners and losers(or not so successful one).
Thanks again Peter,
Which all software investors will get through this difficult time.
Rick
Thanks for your feedback, Rick. I appreciate your thoughts and reinforcement, both publicly and privately.
I’ve just read about the Taylor Rule on Investopedia. To stop high inflation, you need an interest rate about 1.5 x the rate of inflation, e.g. 15% interest for 10% inflation. That’s my own simplification, and there’s a lot more on Investopedia, including a bunch of math. Rick, do you think the rule will have to be applied to stop inflation getting higher? I know it might not be a reasonable question, as “predictions are hard, especially about the future” (Niels Bohr and Yogi Berra, apparently).
Is it possible, Peter, that with this new commentary you exceed even your own lofty standards for excellence? From Day 01, you have offered on SSI excellent insights about companies, insightful remarks about technologies, helpful guides about possible investments… but this new post is an unqualified superior manifesto as to what and who an investor is and should be.
01. “This past outperformance also allows me to reconcile the poor start to 2022. After just three days of trading, the portfolio is down 17% in 2022. After two strong years, this kind of volatility is acceptable.”
This recognition is crucially significant, singular, and lonely. Most investors seek external cues whereas your metrics are internal; this recognition helps sustain a flexible mindset (a “Scout” to use Julia Galef’s term).
02. “Yet, the portfolio eventually worked its way through these issues by focusing on holding the best companies. These companies executed through the headline issues, continuing to add customers, roll out new products and expand existing customer spend. While the volatility will likely continue in 2022, I don’t expect the fundamental performance of these companies or the demand environment to change significantly.”
If you identify and own the best of the best, and they still are the best, why sell? Perhaps you would take the net cash proceeds and buy the second best or the third best? Why? Perhaps you will buy whatever works now in the market, forsaking quality and time misguidedly in favor of short-term performance. And then when something you really want to own (or own more of) screams “BUY!” you will find you have no cash available to fund that preferred investment.
03. “I also appreciate that some macro conditions really do appear to be changing. For one, the unprecedented levels of fiscal stimulus over the last two years likely did inflate growth assets. Interest rates will probably also rise, impacting valuation multiples due to forward discounting models. Inflation, supply chain issues, pandemic persistence and other factors could also play out in unfavorable ways. However, I have decided that these influences are largely outside of my control and that it is very difficult to position a portfolio to successfully navigate them. Also, while these factors are taken as truths at this point, predicting overall market direction can be tricky and new developments (like Covid in 2020) emerge continuously that can redirect the narrative. All I can do is focus on the sector I have chosen and try to identify the companies that will outperform expectations over the long term. This involves looking for companies that are well-positioned in a growing market segment, rapidly extending their product offerings, attracting and expanding customer spend, improving operating leverage and applying innovative leadership. Companies that share these traits should experience high revenue growth and be able to sustain it for longer than expected.”
If you are an investor (buy to hold for a minimum of 1 year) then you will not chase after the stock du jour but use the time to learn even more about your preferred long-term investments. The better you know a company, the easier it is to hold through difficult periods such as the past 3 days…. the past 2 months. If you own the best of the best (as you deftly illustrate above), you will recognize the share price loss is transient, ephemeral, not a stopping point. An opportunity for your portfolio for those investors with intestinal fortitude and the ability to forge a solitary path to portfolio success. Such as you.
I could continue quoting your text but readers should discover your insights first-hand. A suggestion: Consider your commentary above, all 6100 words of it, as the Preface in your forthcoming _Investing in Information Technology_ book from Wiley Publishers.
Happy New Year. May 2022 prove healthy, safe, and prosperous for you and your family.
David
Hi David – Great comments as usual. I really appreciate how you pull out nuggets and then add your own perspective. Regarding point 2, I agree. I think some investors get caught in the mindset that the second or third best option is undervalued by the market, and therefore, further profits can be made. The problem is that if the market thinks the other players should be undervalued, that state will likely persist (unless the story changes, of course).
It’s funny that you mention a book. I have tossed around that idea. I could easily pull together several blog posts and probably fill 200 pages. 🙂
Amazing – too bad its free! Happy to pay if it ever moves behind a paywall!
This was a great post especially the point about technical leadership. If you had the time it would be worth going back in time and looking at inflection points of leadership and what the effect was on sharenoroce—i.e. when did the company transition from technical/product CEO to import/sales/professional CEO?
Thanks for the feedback. That is a great suggestion for a future post!
Peter, congratulations on the outstanding performance of your portfolio, and thanks for the article.
Dear Peter,
I can not only compliment you, and your reader’s comments, but your consistent clarity has always helped to “ground” me.
While not holding a portfolio as concentrated as you (due to inexperience and a little hesitation), I thank you for your efforts, insights and I’ll say again, clarity.
Best in the new year, and looking forward to more delightful commentary!
Yours,
Marc
Thanks lot for the educational and insightful recap and congrats on your stellar performance!
I can only agree with the earlier comments that it was a wonderful post and additionally want to highlight one thing that made me feel enlightened:
‘I call this the “land and expand and expand” model. While “land and expand” has been popularized for SaaS companies, I think the third dimension of product expansion is important to consider.’
For some reason this it took this simple notion of “3D SaaS” to make me fully realize how crucial product (and thus TAM) expansion are to allow companies to postpone the law of large numbers. I don’t pretend to be a macro expert either but I think we can probably say that the times have been gracious to SaaS companies recently. Going forward I suspect the market might want to separate the wheat from the chaff and then this third dimension you identified is likely to be given even more increasing importance.
Thanks again, wishing you happy and prosperous 2022!
Great stuff, thanks again!
Hi Peter, do you suggest put entire personal equity portfolio in growth portfolio practically ? Or do you maintain a diversified equity portfolio besides these SAAS stocks ? Thanks!
For me, over 95% of my personal equity portfolio is invested in 6-8 stocks. These are concentrated in the software infrastructure space. This allows me to follow each company very closely. I don’t recommend this approach for everyone as it offers little diversification and requires a heavy time commitment. But, I think a concentrated portfolio can beat the indices consistently.
Thanks Peter. I see DDOG occupies 33% and NET occupies 25% of your December 2021 portfolio. If someone is going to create a high growth portfolio now (it should be pretty good timing due to the recent sell off) to try, would you think it is still good idea to allocate so high weight to DDOG and NET at this point ? Thanks!
Hi Jack – If I were starting from scratch, I would build a portfolio around NET, SNOW, DDOG, MDB and ZS. It would be safe to split the allocations evenly among the five companies. If you wanted to layer in extra allocation for the most long-term growth potential (TAM), then they are listed in the rough order from biggest potential market (NET) downward.
Thanks a million Peter!
Thank you for your updates to your investing journey. And I understand you do this for free and don’t give out specific advice. i do have some questions about what your views are on some specifics regarding Crowdstrike and why you’ve entered and reduced allocation of late.
I remember when you wrote that you didn’t like investing into security due to the lack of tangible ROI. In addition to this I see how you may lessen you conviction in Crowdstrike due to their pace of innovation/TAM expansion and the type of sales process that isn’t Developer led.
My questions are:
When the greenfield TAM for current offering is as large as it is for Crowdstrike, how much does pace of innovation and developer led sales process matter to you?
I see Crowdstrike as a Cloud Category Crusher with a large moat, given their AI driven Threat-graph. Per the Crowstrike Website, Powered by the proprietary CrowdStrike Threat Graph®, CrowdStrike Falcon is correlating approximately 1 trillion endpoint-related events per day in real time from across the globe, fueling one of the world’s most advanced data platforms for security, as of Sep 8, 2021.
Might these inherent limitations in business model that Crowdstrike has simply create lumpy revenue growth and might require more patience before getting out?
Specifically, do you agree that first mover advantage here is powerful enough to take share over what Sentile One might obtain?
Best,
Jason
Hi Jason – thanks for the feedback. I still think Crowdstrike has a lot of potential and likely will play out well in 2022, after moving sideways over the last year. As you mention, I have been trying to reduce my exposure to pure security plays, for the reasons you reference. I prefer companies that offer security services, but bundled with or in addition to other offerings. I think this provides them with a bit more durability. I think security will evolve into a feature of other services, versus a stand-alone offering. For example, Zscaler is a security solution, but built on top of network services. Same with Cloudflare. Datadog has layered security over an observability platform, leveraging the same agent that is required for monitoring application performance. I also reduced my allocation to CRWD because I wanted funds to shift into MongoDB. I like MDB’s accelerating revenue profile and new product positioning.
Security is a market that is extremely dangerous by definition. Hackers have to constantly find new ways to hack into systems. Therefore, security companies needs to constantly be adapting and innovating. Because of this, it is near impossible to establish a monopoly in a security company. Can you name one? If you want to start a security company, you had better be prepared to make new products every year because there’s always going to be a way for the next hot security company to steal your revenue streams. Security evolves much faster than any enterprise tech in general and you will simply not be investing in a viable long term company. I learned my lesson when I was fresh out of college and I invested in a security company. It crashed miserably and I was reduced to eating canned sardines.
Hi Peter,
I want to add my heartfelt thanks to all the others you have received. What you do — and the way you share it with others — is without equal.
I am the furthest thing from a techie — I teach writing. So I’d like to say, from the perspective of my expertise, that I’ve seen your writing grow in terms of clarity and accessibility, especially over the last four or five posts, and I’ve been amazed to find myself understanding more than I ever imagined about your professional world. You strike the perfect balance! There might well be a book in here (the trick, as always, is to find the right angle/hook).
Anyway, to my question: I see how investors lean on the notion of TAM in valuing a company’s stock, even while understanding that a professed TAM can be highly aspirational. I’m wondering if there’s an equal and opposite force pressing against the TAM — that is (reality) any built-in limitations in how much one of your companies can grow? Do you think DDOG, NET, SNOW, and so on are eventual candidates for trillion dollar companies, or are they likely to hit a wall earlier, for one reason or another?
Thanks again,
Erik
Hi Erik – thanks for the feedback. I particularly appreciate the observations about the evolution of my writing.
Regarding TAM and durability of growth, I keep looking at the hyperscalers. We are seeing AWS, Azure and GCP growing revenue at rates of 40% or more annually at revenue run rates of $20B to $60B. Those revenue sizes and growth rate would qualify for trillion dollar valuations, if they were stand-alone companies. I think the software infrastructure companies that you name (DDOG, NET, SNOW) should be able to maintain the same growth rate at large scale. I also think they can support revenue of that size over the next 5-10 years. The pace of data creation and growth in new digital experiences is not slowing down.
Hello from Thailand, Peter! Thank you for sharing your learnings, and congrats on a great performance on a difficult year!
I know Elastic fell out of your favor in the last few quarters. But the price vs growth now is so tempting. (I give Elastic cloud revenue growth of 80% -> 55% -> 45% -> 38% -> 32% and their enterprise 30% -> 22% -> 18% ->15% ->13%, not super durable growth like saas you liked.)
I think the new CEO could rev up the sales engine which I believe was never the expertise for Shay. (ESTC has quite a low Glassdoor score for sales employees).
I, as a non-coder, have a burning set questions I would like to ask you..
– On Observability and security, are they “good enough” for regular enterprises, or are they only good enough for SMBs in general? Like, do they even stand a chance competing vs the likes of DDOG. How about an older player like Splunk?
– Does the Lucene-based technology hold them back or they are way beyond what the basic technology offers already?
– Are they better in any way (price, ease of setting up). I see one benefit is to not have too many vendors (just use elastic for search/observability/SIEM in one go).
Thank you so much for all your posts. I really really enjoyed them 🙂
Hi – thanks for the feedback. I have always liked Elastic’s technology and versatility. Unfortunately, this hasn’t translated into durable revenue growth. I applaud Elastic’s open source posture. This allows their solutions to be applied to a variety of use cases in observability. Customers can customize the search platform to address their own unique needs.
I think the challenge is that the market for fully packaged observability and security solutions is much larger than for an open source platform that can be customized to suit a customer’s needs. The latter requires engineering resources, which are in short supply. I think this creates a limit for Elastic versus competitive solutions like Datadog. With the smaller market, through, Elastic may still be able to continue to grow at a reasonable rate.
Peter, I saw an article on SeekingAlpha about comparing DDOG and DT:
https://seekingalpha.com/article/4480436-dynatrace-a-better-investment-than-datadog
Want to see what’s your take on it ?
Thanks
Needless to say, I don’t agree with the assessment. A few quick comments:
– Datadog is out-executing Dynatrace on every growth metric that matters.
– Third party product reviews can’t be a useful indicator if they don’t translate into sales. I doubt that modern engineering teams are being duped into buying Datadog instead of Dynatrace.
– Datadog is innovating and expanding its product offerings at a faster rate, entering new market segments like security and developer operations.
– For the Gartner APM report, I would look at the relative change in position of the two companies year/year. This shows Datadog’s velocity of feature improvement.
– I always prefer a founder/CEO with a technology background.
– Given the above, I don’t think it’s prudent to favor Dynatrace as an investment simply due to valuation.
Thanks Peter. Really appreciate your insights!
I find it notable that several people who respond to the Seeking Alpha commentary share more useful insights than its author. And Peter shares several qualitative metrics that highlight crucial differences between Datadog and DynaTrace. The author relies primarily on quantitative metrics; all of which are ephemeral (the numbers update quarterly) and all of which favor Datadog. The single quantitative metric that seemingly favors DynaTrace over Datadog? Valuation. Except not really.
Let’s agree that he (the author) is correct on all tenets of his argument: That DynaTrace’s tech products are better, that DynaTrace serves a better and larger market – enterprise vs SMB (a fallacy), that despite its powerful price rise, DynaTrace shares somehow are overlooked, and that the valuation premium Datadog enjoys vs DynaTrace will diminish, if not reverse altogether. In that scenario, professional investors would buy DynaTrace/DT and sell short Datadog/DDOG…
– If the author is correct and each company’s shares rise but DT shares rise more, then DDOG’s diminishing premium adds lessened risk and increased net return to the professional’s portfolio
– If the author is incorrect and DDOG shares retain their valuation premium (if not also expand it), then his tactic proves wrong. And the investor loses an increasing sum of money for the time the tactic remains open.
Professional investors obviously esteem Datadog/DDOG shares more highly than DynaTrace/DT shares. How do we know this objective truth?
01. Investors reviewed frequently the respective numbers and qualitative arguments and bid Datadog/DDOG shares higher and to a valuation premium.
More tellingly, as in it refutes the author’s argument
02. Over the past 3 months, during a wild and frightening bear market in IT company shares, DynaTrace/DT declined $35 (to ~$45 from $80) or 43% whereas Datadog/DDOG shares declined $80 (to $119+ from $199+) or 40%. In other words, Datadog/DDOG shares not only declined less on a %age basis than DynaTrace/DT, its valuation premium widened!
(To compare apples with apples, I excluded DynaTrace’s post-earnings deeper low of $41 on Wednesday; we can include that low after next Friday’s close to see how Datadog/DDOG trades the day after its next earnings report.)
When comparing two investment opportunities, always buy the better opportunity; better product, better management, better track record, better numbers, better narrative, better liquidity, better investor receptivity; its shares rise with alacrity and decline begrudgingly. But never buy on just one lonely metric, a cheaper valuation. There usually is a reason for cheap – and it is not because it is overlooked. Seems to me investors take DynaTrace/DT’s measure every day and find the shares *comparatively* wanting.
My palm is on my face. Take seeking alpha with a huge grain of salt. Let’s be honest here — the author is a CFA and has no experience with any of the products. Dynatrace is an extremely old company and has very third rate products when compared to Datadog. As an engineer, I have done head to head comparisons of their products. Dynatrace sells to “legacy” companies. If you are an engineer, you’ll know that almost none of the most forward looking companies use Dynatrace. If your company started in the cloud, it will use Datadog or something modern. At the end of the day, what makes a company? It’s the people. I can tell you that Dynatrace does not have the best people today. They have been around for much too long and have had a lot of churn in their organization. It is very hard to find great people when you have been around for so long and you’re not a leader.
Thanks for the great updates as always Peter. I think I can safely say on behalf of all your readers that we really enjoy every piece of thoughtful analysis that you put out.
Thanks Peter, can I quote you as part of a post on Saul’s board ? I want to stress in that post your point about making changes if one is trying to run a super concentrated portfolio.
You state that leaving stuff as was at the end of 2020 would have meant a 1% return in ‘21 rather than the 45% you achieved.
I did 1% last year after a stellar ‘20 not quite as good as yours but still well over 100%.
I changed certain thing generally for the worst last year and have a bunch of other stuff in my portfolio such as mercado libre which had not such a great year.
The emphasis I want to stress is that running such a portfolio as yours does take work and an ability to make decisive decisions on a timely basis. If this is not possible for the person trying to do it to do then they should not run this type of portfolio . It is simply too dangerous in terms of wealth management.
I am a reasonably old man now and knowing myself has been the greatest asset in journey as an investor. That, along with finding you, muji and Saul’s board.
Thanks for all your work.
Jonathan
Hi Jonathan – thanks for the feedback. I appreciate it.
Yes – it would be fine to quote me on Saul’s board. I agree with your points – it does require a large time investment to keep up with our companies, the industry, general software development trends, etc. Those can shift quickly, particularly around individual company performance. Because of that, it is critical to be very active and have the conviction to make changes.
Hi Peter,
Here is a post that I plan to make on Saul’s at MF. First, I want to do so with your consent. Second, I hope that I have correctly represented your insights (which, as I say below, lead to a rather eye-popping conclusion about MongoDB’s potential). I feel that Saul’s is another great resource and they should be up to speed on your take.
Here’s my post, responding to someone on Saul’s Investing Discussions who expressed concern about the slow rate of growth of new customers at MDB.
“My insights into your concern about the “slow” growth of new customers at Mongo DB comes mostly courtesy of Peter Offringa at Software Stack Investing. He makes a couple of points in his most recent post that are extremely pertinent.
First, that MDB has been steadily adding about 2,000 customers QoQ for some time. Although the percentage of additions naturally goes down as the numbers grow, the quantity itself is pretty consistent.
Much more importantly, Peter highlights a major change in MDB’s product positioning, announced last July: “With the launch of their Application Data Platform, MongoDB has positioned the product to address several more data storage models, including relational, search, time series, graph and even analytics use cases.” Where MDB’s offerings had previously been limited to applications workloads that used a document model (NoSQL), they now have many more solutions to offer their customers.
If I may again quote Peter: “If MongoDB can pull off this product extension, then they transition from capturing a few percent of workloads in a large customer to the majority of workloads over time. That could be a 10x increase in spend with existing large customers over the next several years – an opportunity that didn’t exist before 2021. This will likely be the growth driver going forward, beyond simply adding new customers.”
I see the contention that this new product extension could result in 10x increase in spend by existing (and probably new) customers as eye-popping. Given the increasing revenue brought in by their Atlas cloud services, it seems like this expansion could already be happening.
Again, I’m not a techie. Sharing my best understanding, with thanks to Peter Offringa.
I hope I haven’t done you wrong, Peter. Thanks, again,
Erik
Hi Erik – thanks for the feedback and you can certainly reference my work on another board. I think you represented the salient points. I would also add that the consistent growth of about 2,000 customers a quarter for MongoDB over the past 4 quarters is similar to Datadog’s consistent addition of 1,000 – 1,200 customers over the same period (disregarding the latest quarter for a fair comparison). I think Datadog has experienced explosive revenue growth over the past year because large customers have been increasing their spend significantly to expand into multiple product offerings. The same opportunity exists for MongoDB’s large customers to contribute a greater percentage of total revenue, as they migrate more workloads to the MongoDB application data platform. MongoDB’s large customers only make up 4% of the total, versus about 10% for Datadog, providing a lot of upside expansion potential.
Hi Peter,
Would like to hear your thought on ZS earning.
Thanks!
Hi – I think the billings growth slowdown is the main issue that is worrying investors and causing today’s drop. Overall, I thought the results were okay – some good parts, some flags. I like the continued revenue growth in Q2 and implication for Q3. The full year revenue increase was less than the raise in Q1 ($45M vs. $60M), so they must be expecting some slowdown in growth. Given the strong results in billings and revenue growth the last 4 quarters, I think some slowdown is reasonable. They are probably a 50% revenue grower longer term. Of course, once the market senses deceleration, it punishes the stock more than may be justified.
Pros:
– Continued revenue acceleration and implication for same growth next quarter.
– Strong growth in > $1M customers
– RPO grew 91% to $1.95B
– Valuation. If we project to end of FY23 (July 2023 or 1.5 years), the valuation is favorable. FY 2022 (July 2022): My target $1.1B for 63.4% growth. Current MCap is $29.0B, meaning Forward P/S is 26.4. Next year – FY 2023 (July 2023): My target is $1.65B (for 50% growth). That implies a Forward P/S of 17.6. For 50% growth and profitable, a 35 P/S might be reasonable. That implies stock increase of 100% in 1.5 years (July 2023). May be less, but that seems like reasonable risk/reward.
Cons:
– Billings growth dropped from 71% y/y last quarter to 59% this quarter. Full year raised 7% to 46-47%. Implies full year will land in the high 50% range for billings growth.
– Billings slowdown partially attributed to slowdown in Federal spend. Might be a one-time deferral.
– Tough comparison back to Q2 FY21 billings growth of 71%.
– Slight beat on Non-GAAP income from ops. They should be driving more incremental improvement in leverage. But, they are also spending more post-Covid.
– The raise to annual revenue growth was smaller this quarter. Raise of 6%, versus 9% in Q1, and $40M – $45M, versus full $60M
With this, I decided to trim my position pre-market. I will probably hold here. I think the growth potential over 1.5 years is compelling, but also have to respect the market. I moved proceeds into DDOG and NET.
Hi Peter,
What are your thoughts on SNOW earning?
Thank you!
Joanne
Hi Joanne – I just answered this in another comment on the same post.
Hey Peter,
Would really appreciate your thoughts on SNOW earnings.
Thanks!
Hi – I won’t recap all the results, saving that analysis for a future post. Overall, I was happy with Snowflake’s earnings report. Like everyone, I was rattled by the headline view of the forward revenue projections and the deceleration in growth. However, after hearing the explanation relative to platform optimization and expectations for impact to near term revenue generation, I am satisfied. I had previously projected 80% revenue growth for FY2023 (in my October 2021 post) and am fairly confident they will hit that for this coming year with the standard beat/raise cadence.
More importantly, I think these moves provide more support for long term revenue growth durability. After dropping to a revenue growth rate of 80% this year, I think it is conceivable that annualized revenue growth remains above 50% annually for several more years. This is underscored by a few factors:
– High NRR. While it will drop below 170%, we can expect it to remain at or above 150% for quite some time. On the earnings call, leadership disclosed that for 6 out of 10 of their largest customers, product revenue spend grew faster than the company’s overall growth. Assuming this pattern repeats for future large customers, it will continue to pull up NRR.
– New customer growth rate is high (up 44% y/y), providing the fuel for future expansion.
– High tolerance for spend on this service. Leadership highlighted 7 new customer deals this quarter over $30M in TCV. Last quarter, they called out a $100M deal. The size of these deals substantially exceeds other software infrastructure services, providing more room for growth as Snowflake crosses $1B in annual revenue.
– New workloads. By adding data applications on top of the core data engine, they are expanding the use cases that can be addressed and hence the target market spend.
The key consideration for the reduction in price is whether Snowflake’s service is a commodity at this point. A commodity service can only compete on price and lower prices don’t automatically accrue all the benefits to a single provider. In Snowflake’s case, given high barrier to entry and their feature differentiation, incremental usage stimulated by lower prices should funnel back to Snowflake’s platform. Additionally, network effects are an important consideration. As more data lands on Snowflake’s platform, then the gravitational pull for new workloads within an enterprise or new participants within an industry ecosystem will continue to increase. While Snowflake is reducing prices, they do retain pricing power.
I don’t plan to make any changes to my allocation. I will watch their execution closely this year, though, to make sure this thesis plays out.