Earnings season for the portfolio companies is now in the rearview mirror, and I reviewed (below) the companies that reported their most recent quarter’s results. The results since the previous portfolio update are going to appear to be ugly as the portfolio is experiencing one of those big drops. Pretty or not, as always, I’ll call it how it is and how I see it.
PRIOR PORTFOLIO UPDATES
PORTFOLIO PERFORMANCE
| DATE | GauchoRico Portfolio (YTD) | S&P500 Total Return (YTD) |
|---|---|---|
| Jan | 3.1% | -1.0% |
| Feb | -1.2% | 1.7% |
| Mar | -13.2% | 6.2% |
| Apr | -1.5% | 11.8% |
| May | 3.4% | 12.6% |
| Jun | 28.0% | 15.3% |
| Jul | 33.7% | 18.0% |
| Aug | 73.3% | 21.7% |
| Sep | 74.7% | 15.9% |
| Oct | 100.8% | 24.0% |
| Nov | 47.0% | 23.2% |
| 3Dec | 24.2% | 22.4% |
The GR portfolio peaked on 18Oct at +109.2% YTD culminating a five-month rally. At that peak, the portfolio’s YTD outperformance over the S&P 500’s return was +76.8%. I had been saying for the past few portfolio updates that the rally can’t continue forever. The portfolio has now declined for seven straight weeks while the S&P 500 index has increased slightly; this all but wiped out the GR YTD outperformance. The drop from the all-time portfolio high to the current level is -40.8%. This drop is impressive and certainly classifies as a big drop that I wrote about in a blog post during the midst of the last big drop earlier in 2021. Now that we’re in the fifth big drop in less than four years, one might ask “when will this one end?“. Here’s what I wrote in my last portfolio update:
“No one can know when the next big drop will occur, but I can be all but certain that there will be another big drop at some point. I expect another 35%+ drop within the next two years, and I’m always prepared (mentally) for a huge drop of 50%+. Again, a concentrated portfolio of high growth companies will have more volatility than a more diversified portfolio with slower growing companies. Volatility comes with the territory when one invests this way.”
I wrote that five weeks ago when the portfolio was up more than 100% YTD. The next thing one might ask is “why wouldn’t I sell after being up 100% YTD?“. Hindsight is always 20/20, and I try not to second guess my decisions after the fact and after the consequences have become known. One could have easily asked me the exact same question during 2020 after the portfolio was up 100%; well, in 2020 the GR portfolio ended the year up more than 245%. We never know what’s going to happen in the future, but what we do know is that with a concentrated portfolio in hyper growth stocks, it’s going to be a wild ride. For those who wish to play this game, it’s better to buckle up and be prepared psychologically and emotionally.
I know quite a few investors who invest exclusively in hyper growth stocks, and I’d say that among this group, I’m likely the most aggressive with the use of margin and leverage. I try to utilize margin and leverage opportunistically and prudently. Thus, the current drop of 40.8% from my portfolio’s ATH might be equivalent to a 25% drop for the portfolios of this described cohort of investors. My highs have tended to be higher and my lows have tended to be lower; for example, when my portfolio was +109.2% YTD, the other investors who hold similar portfolios were likely somewhere between +50% and +80% YTD. Also, I can’t directly compare the percentage magnitude of my previous big drops; there are multiple reasons such a comparison would be apples to oranges. It might be better to look at the stocks in my portfolio and compare the current price to the respective ATHs. How much has each stock fallen? In the table below, I’ve also included some other stocks which I previously owned; I’ve included other stocks or indices that can help give us reference points.
| 2021 High | % Below High | |
|---|---|---|
| LSPD | $130.02 | -66% |
| UPST* | $401.49 | -57% |
| DOCU | $314.76 | -57% |
| AFRM* | $176.65 | -39% |
| MNDY* | $450.00 | -39% |
| CRWD* | $298.48 | -34% |
| BILL | $348.50 | -32% |
| NET | $221.64 | -28% |
| MDB | $590.00 | -24% |
| SMAR | $85.65 | -23% |
| SNOW* | $429.00 | -20% |
| SHOP | $1762.92 | -20% |
| DDOG* | $199.68 | -18% |
| ZS* | $376.11 | -17% |
| AMZN | $3773.08 | -10% |
| MSFT | $349.67 | -8% |
| GOOGL | $3019.33 | -6% |
| Nasdaq | -6% | |
| S&P500(TR) | -4% |
While the table can provide an overall snapshot of what’s going on with the SaaS sector compared to the overall markets, there are mitigating factors that should also be considered. The most important of these factors, in my opinion, would be the most recent business/fundamental results of each individual company. I’ll discuss each of my portfolio companies in detail later in this post, but some companies had spectacular business results (e.g. MNDY, SNOW, DDOG, and ZS), some companies had very good results (e.g. CRWD), some companies had very disappointing results (e.g. DOCU and LSPD), and some companies had very good results but didn’t satisfy very lofty expectations (e.g. UPST). So in some case a share price drop might be completely justified by the result of the earnings report while in other cases the drop is unjustified. Next, we can consider the degree to which each company ran up prior to its ATH, and we can consider how much of this run up was deserved; this can greatly impact the degree of the decline after the ATH. I do like to stay invested in the best available companies, but I also like to look at my own risk-reward assessment for each company going forward. Just because DOCU is down 57% from its ATH doesn’t automatically make it a buy in my opinion; the business result and management’s comments and discussion about the most recent result will change how much I like future prospects compared to the current share price.
In my opinion, some companies have fallen far more than they deserve given the most recent results that they just delivered. Yes, these stocks can fall more and they may, but today I reached the point where I’m willing to begin adding leverage back. If the decline continues further, I’ll likely add additional leverage. I’ve previously posted how I use leverage. Looking at the most recent revenue growth rates of some of these companies (e.g. SNOW at 110%, MNDY at 95%, DDOG at 75%, CRWD at 63%), I think it’s highly likely to make really great returns (at today’s prices) within two years even if their stocks fall another 30% from here.
2021 Notable Days for the Portfolio
Below are some of the notable days in 2021.
| Date | YTD Return | Notes |
|---|---|---|
| 01/27/21 | -2.2% | local bottom |
| 02/05/21 | +12.6% | new ATH |
| 02/08/21 | +14.0% | new ATH |
| 02/09/21 | +16.6% | new ATH |
| 02/10/21 | +16.8% | new ATH |
| 02/11/21 | +17.8% | new ATH |
| 02/12/21 | +18.3% | new ATH |
| 02/25/21 | -3.4% | -6.3% on the day |
| 03/03/21 | -6.3% | -7% on the day |
| 03/04/21 | -13.6% | -9.2% on the day |
| 03/05/21 | -17.1% | -4.1% on the day |
| 03/08/21 | -22.8% | -6.9% on the day |
| 03/09/21 | -11.0% | +15.3% on the day |
| 03/11/21 | -4.3% | +9.6% on the day |
| 03/18/21 | -10.2% | -6.7% on the day |
| 03/24/21 | -15.6% | -8.6% on the day |
| 03/29/21 | -19.0% | close to 3/8/21 trough |
| 03/31/21 | -13.2% | +6.6% on the day |
| 04/13/21 | +4.0% | +8.0% on the day |
| 05/04/21 | -10.9% | -6.1% on the day |
| 05/06/21 | -21.1% | -9.6% on the day |
| 05/07/21 | -17.5% | +4.6% on the day |
| 05/13/21 | -23.5% | new YTD low |
| 05/14/21 | -16.3% | +10.9% on the day |
| 05/20/21 | -5.3% | +7.1% on the day |
| 05/24/21 | -0.1% | 7th consecutive up day |
| 06/10/21 | +11.3% | +5.4% on the day |
| 06/17/21 | +19.8% | new ATH (finally!) |
| 06/18/21 | +23.2% | new ATH; +5.1% on the day |
| 06/22/21 | +27.4% | new ATH; +6.2% on the day |
| 06/23/21 | +28.0% | new ATH |
| 06/24/21 | +28.5% | new ATH |
| 06/28/21 | +30.8% | new ATH |
| 06/29/21 | +31.2% | new ATH |
| 07/06/21 | +33.4% | new ATH |
| 07/09/21 | +33.9% | new ATH |
| 07/14/21 | +25.6% | -4.0% on the day |
| 07/22/21 | +34.2% | new ATH |
| 07/23/21 | +36.9% | new ATH |
| 07/26/21 | +37.0% | new ATH |
| 07/28/21 | +37.9% | new ATH |
| 08/04/21 | +41.2% | new ATH |
| 08/05/21 | +49.1% | new ATH |
| 08/12/21 | +51.2% | new ATH |
| 08/13/21 | +55.9% | new ATH |
| 08/23/21 | +56.0% | new ATH |
| 08/24/21 | +65.1% | new ATH; +5.8% on the day |
| 08/25/21 | +66.3% | new ATH |
| 08/26/21 | +68.1% | new ATH |
| 08/27/21 | +72.4% | new ATH |
| 08/30/21 | +73.3% | new ATH |
| 08/31/21 | +73.3% | new ATH; +0.05% to ATH |
| 09/02/21 | +74.8% | new ATH |
| 09/03/21 | +79.2% | new ATH |
| 09/09/21 | +82.7% | new ATH |
| 09/16/21 | +83.9% | new ATH |
| 09/17/21 | +85.0% | new ATH |
| 09/21/21 | +85.1% | new ATH |
| 09/22/21 | +88.8% | new ATH |
| 09/23/21 | +92.1% | new ATH |
| 09/28/21 | +75.0% | -5.5% on the day |
| 10/12/21 | +84.1% | +4.5% on the day |
| 10/13/21 | +95.1% | new ATH; +5.9% on the day |
| 10/14/21 | +104.1% | new ATH; +4.7% on the day |
| 10/15/21 | +106.5% | new ATH |
| 10/18/21* | +109.2% | new ATH |
| 11/10/21 | +74.3% | -16.2% on the day |
| 11/15/21 | +69.2% | -6.8% on the day |
| 11/16/21 | +76.1% | +4.1% on the day |
| 11/19/21 | +64.4% | -4.7% on the day |
| 11/22/21 | +49.8% | -8.9% on the day |
| 12/01/21 | +29.7% | -11.8% on the day |
| 12/03/21 | +24.2% | -6.7% on the day |
Weekly Performance
| DATE | GauchoRico YTD | S&P500 TOTAL RETURN YTD | DELTA |
|---|---|---|---|
| 01/08/21 | 6.5% | 1.9% | 4.6% |
| 01/15/21 | 6.4% | 0.4% | 6.0% |
| 01/22/21 | 10.2% | 2.4% | 7.9% |
| 01/29/21 | 3.1% | -1.0% | 4.2% |
| 02/05/21 | 12.6% | 3.6% | 9.0% |
| 02/12/21 | 18.3% | 4.9% | 13.3% |
| 02/19/21 | 14.2% | 4.2% | 10.0% |
| 02/26/21 | -1.2% | 1.7% | -3.0% |
| 03/05/21 | -17.1% | 2.6% | -19.7% |
| 03/12/21 | -6.3% | 5.3% | -11.6% |
| 03/19/21 | -7.7% | 4.5% | -12.3% |
| 03/26/21 | -15.8% | 6.2% | -22.0% |
| 04/01/21 | -9.5% | 7.4% | -16.9% |
| 04/08/21 | -3.3% | 10.4% | -13.6% |
| 04/15/21 | 0.0% | 11.9% | -11.9% |
| 04/23/21 | 3.1% | 11.8% | -8.7% |
| 04/30/21 | -1.5% | 11.8% | -13.4% |
| 05/07/21 | -17.5% | 13.3% | -30.7% |
| 05/14/21 | -16.3% | 11.7% | -28.0% |
| 05/21/21 | -2.4% | 11.3% | -13.7% |
| 05/28/21 | 3.4% | 12.6% | -9.2% |
| 06/04/21 | 2.3% | 13.3% | -11.1% |
| 06/11/21 | 12.6% | 13.8% | -1.3% |
| 06/18/21 | 23.2% | 11.7% | 11.5% |
| 06/25/21 | 28.0% | 14.8% | 13.2% |
| 07/02/21 | 28.9% | 16.7% | 12.1% |
| 07/09/21 | 33.9% | 17.2% | 16.6% |
| 07/16/21 | 23.8% | 16.1% | 7.6% |
| 07/23/21 | 36.9% | 18.4% | 18.5% |
| 07/30/21 | 33.7% | 18.0% | 15.7% |
| 08/06/21 | 46.7% | 19.1% | 27.6% |
| 08/13/21 | 55.9% | 20.0% | 35.9% |
| 08/20/21 | 50.2% | 19.4% | 30.9% |
| 08/27/21 | 72.4% | 21.2% | 51.2% |
| 09/03/21 | 79.2% | 22.0% | 57.3% |
| 09/10/21 | 78.3% | 19.9% | 58.4% |
| 09/17/21 | 85.0% | 19.3% | 65.7% |
| 09/24/21 | 88.9% | 19.9% | 69.0% |
| 10/01/21 | 73.5% | 17.3% | 56.3% |
| 10/08/21 | 76.5% | 18.2% | 58.3% |
| 10/15/21 | 106.5% | 20.4% | 86.1% |
| 10/22/21 | 103.4% | 22.4% | 81.0% |
| 10/29/21 | 100.8% | 24.0% | 76.8% |
| 11/05/21 | 99.9% | 26.6% | 73.4% |
| 11/12/21 | 81.6% | 26.2% | 55.3% |
| 11/19/21 | 64.4% | 26.7% | 37.7% |
| 11/26/21 | 52.5% | 23.9% | 28.6% |
| 12/03/21 | 24.2% | 22.4% | 1.8% |
ALLOCATIONS
| TICKER | 12/3/21 | 11/30/21 | 10/31/21 | 9/30/21 | 8/31/21 | 7/31/21 | 6/30/21 | 5/31/21 | 4/30/21 | 3/31/21 | 1/31/21 | 12/31/20 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| DDOG | 29.8%* | 27.4%* | 15.6%* | 14.9%* | 14.4%* | 16.4%* | 15.7%* | 16.7%* | 12.0%* | 12.9%* | 10.7% | 10.4% |
| MNDY | 24.8% | 23.3% | 4.7% | — | — | — | — | — | — | — | — | — |
| UPST | 17.3%* | 17.4%* | 27.4% | 31.1% | 22.3% | 13.0% | 7.8% | 6.3% | 4.4% | 5.7% | — | — |
| SNOW | 12.9% | 11.9% | 7.9% | 5.3% | 5.3% | 6.0% | 5.6% | 6.8% | 6.9% | 3.0% | 0.5% | — |
| CRWD | 12.4%* | 13.2%* | 14.4%* | 12.1%* | 18.7%* | 19.1%* | 19.9%* | 20.0%* | 30.2%* | 27.7%* | 31.2%* | 31.5%* |
| AFRM | 8.1% | 10.8% | 7.9% | 6.5% | — | — | — | — | — | — | — | — |
| ZS | 0.8% | — | — | — | — | — | — | — | — | — | — | — |
| LSPD | — | — | 11.5%^ | 8.3%^ | 9.5%^ | 11.1%^ | 11.3%^ | 12.1%^ | 13.1%^ | 13.2%^ | 4.8%^ | 3.3% |
| DOCU | — | — | — | 6.4% | 12.5% | 13.2% | 12.6%* | 6.6%* | 5.7%* | 5.6%* | 16.2%* | 16.4%* |
| NET | — | — | — | 5.9% | 6.9% | 13.4% | 15.9% | 15.2% | 16.6% | 15.2% | 17.9%* | 17.8%* |
| DCBO | — | — | — | 1.8% | — | — | — | — | — | — | — | — |
| NEM | — | — | — | 1.3% | — | — | — | — | 1.0% | 1.1% | 1.0% | 1.0% |
| ROKU | — | — | — | — | 2.7% | — | — | — | — | — | — | — |
| GOLD | — | — | — | — | 1.5% | 2.0% | 2.0% | 2.9% | 1.6% | 1.7% | 1.4% | 3.0% |
| ZM | — | — | — | — | 2.5% | 5.5% | 5.8% | 10.8%* | 11.0%* | 12.3%* | 11.5% | 11.0% |
| PATH | — | — | — | — | — | — | — | — | 0.1% | — | — | — |
| PTON | — | — | — | — | — | — | — | — | — | 4.0% | 4.0% | 4.2% |
| BPRMF | — | — | — | — | — | — | — | — | — | 1.2% | 1.3% | 1.4% |
| Cash | -0.1% | -0.2% | 11.1% | 6.4% | 3.9% | 1.4% | 6.5% | 3.0% | -0.2% | 1.2% | 0.8% | 0.7% |
Three positions in the portfolio are leveraged with long-term call options. I have zero CRWD shares; the entire position is comprised of Jan 2023 call options ($170 and $175 strike prices) that were purchased between 5Mar and 3May 2021. The CRWD allocation changes are amplified when CRWD stock moves up or down. The DDOG allocation is comprised of a 27.9% allocation in shares plus a 1.9% allocation in Jan 2023 call options ($65 strike price). The UPST call options are Jan 2023 UPST call options ($330 strike price) comprising 1.5% of the total portfolio’s value. The portfolio contains 15.7% of its value in the form of LEAPS call options, 90.4% in stock, and -0.1% in cash; the total adds to 106.0%; the additional 6% is the negative value attributed to short puts (on UPST and ZS) which is a form of margin/leverage. In November, I sold out of LSPD, and I added ZS, the portfolio’s only new position, on 3Dec. The portfolio’s cash position is once again close to zero after I withdrew greater than 20% of the portfolio’s value; the removal of these funds is permanent and will be used for capital gains tax payments due by 15Apr 2022; the capital gains tax was the result of stocks sales during 2021, gains on options trading during 2021, and the conversion of an IRA to a Roth IRA.
The allocation table (above) shows how much the portfolio has changed since the end of 2020. There were 11 positions that I either owned at the end of last year or at some point during 2021 that are now no longer in the portfolio. At the end of October, the portfolio had only seven positions.
PORTFOLIO CHANGES
Changes since 31Oct 2021
- Sold all LSPD shares: Sold all DOCU after the 4Nov earnings release.
- Bought more UPST shares: Bought more UPST shares before earnings.
- Added significantly to MNDY shares: Used proceeds from NET sale to add MNDY shares.
- Sold ~1/3 of UPST shares: Right-sized over-allocated UPST position after earnings.
- Sold some SNOW shares: Sold ~2% SNOW shares to buy more AFRM shares.
- Added more to AFRM: Added ~2% allocation to AFRM position.
- Sold some AFRM: Sold ~4% allocation to buy more MNDY.
- Bought more MNDY: Used proceeds from AFRM to buy more MNDY.
- Bought ZS: Opened an initial position in ZS using proceeds from short put sales and margin.
EARNINGS RESULTS
Since the 31Oct portfolio update, all my portfolio companies (LSPD, DDOG, UPST, MNDY, AFRM, SNOW, and CRWD) reported their quarterly results. Below is some discussion about these results and my subsequent actions. I also bought back into ZS after exiting the stock a few years ago; I’ve only taken a small position in ZS and haven’t completed my analysis of the company yet so I won’t write about ZS in this portfolio update. However, I will say that I really like both what ZS has been delivering the past several quarters as well as the Company’s further prospects in the government sector.
LSPD Q2 FY2022 (reported 4Nov)
LSPD reported its Q2 FY22 earnings results before the market open on 4Nov. To set things up leading into earnings, a short seller issued a poorly constructed argument, with half-truths and no longer relevant issues from the distant past, for selling LSPD shares. Nevertheless, the stock sold off sharply after the report was released. Thus, with the shares down about 30% from their recent ATH, LSPD was set up nicely so soar should the Company deliver strong Q2 results.
Unfortunately, LSPD disappointed my expectations by a lot. Specifically, LSPD only added a net 6000 additional customer locations on a base of 150,000, a result that should have been much, much higher. In addition, revenue increased only 14.9% sequentially demonstrating that customers don’t seem to be flocking to LSPD despite LSPD’s integration of new acquisitions and adding new tools and features. For me, LSPD was always a 1-2 year opportunistic investment. And, since I first invested in December 2020, close to a year had already elapsed. The acquisition strategy was a big part of my investment thesis. This first part of the thesis was clearly broken for me as LSPD should have added a lot of new customers. Six thousand new customers was anemic. A second part of the thesis was the expected rebound in GMV as the economies reopen, particularly in retail, hospitality, and restaurants, three markets highly impacted by the pandemic. Time was now running out on the second part of my thesis. The final part of my thesis was the prospect of converting a large number of customers to Lightspeed Payments. Well, LSPD didn’t cut it here either; they increased Payments penetration to 11%, up from 10% in the previous quarter. This pace should be faster. I immediately sold my entire position. Fortunately, I was able to fetch about $81 for most of my shares. The shares had hit $130 a few weeks earlier, but I was very happy to get out for $81. Today, the shares are just above $44, down another 55% from where I had sold.
DDOG Q3 FY2021 (reported 4Nov)
DDOG reported its Q3 FY21 results on 4Nov. DDOG’s growth had slowed sharply during the start of the pandemic because customers reacted to the uncertainty by cutting back on spending with DDOG. When Q2 2020 was reported, management told investors that spend was already coming back and growth had reverted to the high revenue growth rates that DDOG was achieving prior to the pandemic. Well, they were right. Here are the past revenue growth rates (y/y) shown oldest (Q1 2020 which is pre-pandemic) to most recent (Q3 2021): 87.4%, 68.2%, 61.3%, 56.2%, 51.3%, 66.8%, 74.9%. DDOG is guiding 64.5% y/y revenue growth for Q4, but, if the Company beats by a similar percentage as the past two quarters, then revenue growth will accelerate to almost 80%! RPO increased more than 23% sequentially which computes to 131% growth on an annual basis; so DDOG already has a ton of revenue that’s contracted but not yet recognized indicating that growth in the coming quarters should continue strongly.
DDOG’s other metrics were outstanding as well. The number of customers spending >$100K grew 62.6% y/y. The DBNER continues to exceed 130%, and the percentage of customers using two and four modules continued to increase. Thus, both the land and the expand portions of growth are continuing to solidly contribute to hyper growth. Non-GAAP gross margins remained high at 78%, and non-GAAP operating margin expanded to 16%. DDOG is producing lots of cash for investors now with FCF margin of 21% in Q3!
In addition to the numbers, DDOG is showing rapid innovation with 10 new products and major features introduced at DDOG’s recent Dash user conference. It certainly seems as though DDOG is providing and will continue to provide its current and future customers what they want and need.
I could find nothing at all wrong with DDOG’s Q3 report, and it certainly seems that the current pace of growth should continue for a while longer. Management mentioned on several occasions during the call that cloud migration has returned to its pre-pandemic pace. Next, new products are gaining traction and the company continues to develop additional products that will contribute to future growth. Finally, DDOG has scaled its go-to-market team so the new products can be rapidly pushed through to the customer install base. DDOG is the largest position in the GR portfolio, and it’s that way because 1) the Company is rapidly growing, 2) growth is accelerating, 3) growth seems high likely to continue into the future, 4) operating leverage and cashflow generation continue to improve, 5) DDOG appears to be dominating within its markets, and 6) management is executing flawlessly.
UPST Q3 FY2021 (reported 9Nov)
UPST reported its Q3 FY21 results on 9Nov. A lot has been said about UPST as an investment in light of the Q3 results. I previously shared my thoughts on Saul’s Investing Discussions board which I’ll repost below. The following was written 2 1/2 weeks ago:
Our expectations were very high
I went into Q3 earnings with an oversized position and some options bets that would have done very well had the numbers come in as many of us expected. So, yes, our expectations were that UPST would deliver another blowout quarter as it did in Q2. It turns out that our expectations were too lofty. That led to disappointment. But, let’s be clear: the disappointment, at least mine, was mainly due to my super high expectations and not related to the actual performance of the business.
Reason for high expectations
jonwayne235 has done some amazing analysis on UPST. All that work was backed up by lots and lots of data, and the data, the analysis, and the prediction all made sense to me. So there was a ton of analysis that led me (and many of us) to have big expectations for the Q3 results. Add in what they delivered in Q1 and particularly in Q2 (and the explosion in the stock price), we were set up to have high expectations. I concluded from the analysis (based on the data) that my conviction for the Q3 result was increased, and as a result, I not only temporarily increased my allocation but also placed some moderate (about 2.5% of my portfolio) options bets on the Q3 result. We all know the outcome after earnings.
Lots of research >>> increased conviction >>> increased allocation/bets >>> pain when result doesn’t pan out
It’s a reminder to be careful with the bets and the allocation no matter how much of “a sure thing” we believe is there.
Why Q3 result was lower than expected
There were several reasons why UPST’s Q3 result (loans and revenue) was lower than we expected.
1) Loan sizes dropped. This was outlined in detail by WSM here.
I think a key takeaway is that UPST believes that average loan size will rise again, but they just don’t know when.
2) Attempted fraud lowered automatic loan approvals. And it inflated the “Upstart login” search numbers which affected jonwayne235’s model linking Google search to number of loans. It seems clear that UPST had to apply resources to deal with the current fraud attempts, and these diverted resources lowered the loan numbers for Q3. The actual fraud had a minimal effect on the business (i.e. negligible amounts of dollars were stolen). Furthermore, these fraud detection/prevention efforts during Q3 should also help to detect and prevent fraud attempts going forward.
UPST is not SaaS
Some stated that UPST is not SaaS and therefore its business model is inferior. Correct that UPST is not SaaS, and perhaps some will now invest exclusively in companies with a SaaS for all eternity. However, there are great businesses outside of SaaS, and I argue that UPST is one of them.
UPST more lumpy from Q to Q than SaaS
As investors in UPST, we can expect more of the unexpected when it comes to UPST. Q2 was unexpectedly great. A large reason for that great Q2 result was a change in the algorithm which approved a higher percentage of loans. We can’t expect them to have such a superior algorithm every quarter. In Q3, we had continued shrinking of average loan size and resources diverted to deal with fraud; this was another unexpected result. I think we will see more surprises going forward; some will be beneficial for the quarter in question while others will reduce the results for that quarter. It will be virtually impossible to predict these X factors. So if predictability and a lack of volatility in Q to Q results is an absolute requirement for investment then maybe UPST is not for you. With UPST I will look past a great or bad quarter knowing that the company is on track to meeting and exceeding my long run expectations.
Why I still like UPST
So why do I like UPST? As a former product manager, I start with the value proposition. There’s a value proposition for the loan applicant, and there’s a value proposition for the bank partner. For the loan applicant, UPST offers a lower interest rate (primary benefit) with a fast and easy application process (primary differentiator). This value proposition is extremely strong as shown by how quickly UPST has been able to grow loan number. The value proposition for bank partners is also very powerful: for banks/credit unions, UPST’s AI underwriting provides a superior risk model (primary benefit) allowing for lower credit losses and higher margins, all offered as instant, automatic approval process (primary differentiator). The banks will be able to increase profitability while simultaneously increasing loan volume. Now that’s quite a superpower that UPST is delivering to the banks/credit unions. It makes me wonder what will happen to the banks that don’t implement UPST. So UPST is providing a win for the bank, a win for the borrower all while taking a cut (win for UPST). If we focus on the business and project that UPST will do for other lending market segments what it’s already doing for unsecured personal loans, we can see that UPST’s powerful disruption will be applied to inefficient parts of the multi trillion dollar lending market. So with such a solid value proposition and only a tiny fraction of the total market captured, I feel that I must be invested.
So I reduced my allocation after the result from about 32% to about 18%. I knew going into Q3 earnings that 32% was too high of an allocation, and I was planning on cutting it after the Q3 result (unfortunately I cut if after the drop and not after the sharp rise that I was expecting).
MNDY Q3 FY2021 (reported 10Nov)
MNDY reported its Q3 FY21 results on 10Nov. As shown in the above allocations table, MNDY is a relatively new position to the GR portfolio. I had added significantly to the position after selling out of LSPD on 4Nov. After MNDY’s Q3 result and after the stock price dropped, I added even more.
MNDY only recently went public, but the Company went through the IPO process rather then going public through a direct listing. I strongly prefer companies that have a 2+ year history of audited, quarterly financial statements. Many companies that go public through a SPAC do not provide such a financial history which makes me leery as an investor. I initially got interested in MNDY because not one but several investors who I respect were invested. Upon looking at the numbers, it seemed clear that I should take a position. In fact, the numbers look so good that I’ve decided to make the MNDY allocation very large. Now let’s turn to the results.
The most impressive set of numbers, in my opinion, is the pace of customer adoption. The most meaningful metric here is that addition of customers who spend >$50K. In Q3, this number reached 613 up from 470 sequentially!!! That’s a 30% increase in one quarter, and it wasn’t because of an acquisition; it was organic. And it wasn’t a fluke either. In the prior six quarters, MNDY had sequential >$50K customer additions of 40%, 27%, 43%, 28%, 37%, and 38% (most recent first). MNDY is taking the market by storm, and these numbers show that MNDY is giving the market something that it really wants. ASAN, which is MNDY’s main competitor, is not posting anywhere near this kind of customer acquisition growth. In fact, MNDY is now positioned to pass ASAN in quarterly revenue; two years ago, ASAN had almost twice the quarterly revenue compared to MNDY.
Looking to revenue growth, MNDY just reported 95% y/y revenue growth. This was essentially flat growth from the prior quarter. It’s encouraging to see that despite this blistering growth, it didn’t slow. MNDY’s gross margins are 90%, the highest of any of the GR portfolio companies. Thus, MNDY has a very high capacity for profitability and FCF once operating leverage is realized. For now, MNDY is still investing heavily into its operations as it should support the growth opportunities that it has in front of it. As investors, we should note that the non-GAAP operating margin improved to -11% from -72% in the same quarter last year! Thanks an amazing improvement, and, at this pace of improvement, it shouldn’t be long until MNDY shows non-GAAP profits.
The numbers and the trajectory looks a lot better than DDOG’s so why isn’t MNDY my largest allocation? In my opinion, my visibility into DDOG’s future growth seems much clearer because DDOG is a larger, more dominant company. In contrast, MNDY is small and perhaps more likely to be disrupted; however, I will probably become increasingly confident as MNDY continues to execute in the coming quarters. MNDY is based in Israel which isn’t the most stable region of the world. Finally, MNDY’s trading volume is smaller making the stock more volatile and a quick exit from the position perhaps more costly.
AFRM Q1 FY2021 (reported 10Nov)
AFRM reported its Q3 FY21 results on 10Nov. As I’ve mentioned previously, my investment in AFRM is about the partnerships/deals that AFRM has now put into place and what these means for future financial numbers. The financials reported by AFRM don’t yet reflect the gross merchandise volume (GMV) that AFRM will be getting in the future. Thus, the partnerships with Walmart, Shopify, Target, The Home Depot, and now Amazon should drive explosive growth. The big news that was announced recently is that AFRM landed an exclusive BNPL (buy now, pay later) partnership with Amazon. The partnership extends through this holiday shopping season as well as next year’s. Yes, AFRM had to give up stock warrants to AMZN to land this deal, but the deal contributes to making AFRM a dominant if not the dominant player in the BNPL space. AFRM’s CEO announced during a television interview that the Affirm-Amazon partnership went live on Amazon the day after the earnings release.
I believe that the critical mass of merchants on the Affirm platform coupled with the critical mass of consumers on the platform give AFRM its biggest competitive advantage. More merchants attract more consumers to join while more consumers attract more merchants to join — a virtuous cycle. The size and growth of merchants contracted with AFRM is an important metric to follow. AFRM now has 102K merchants up from 29K the previous quarter and 6.5K a year ago! The bulk of these merchants were gained as a result of AFRM’s partnership with Shopify. Shopify has thousands of smaller merchants each of which won’t drive meaningful GMV to AFRM. But AFRM now has the largest merchants in the United States including Walmart (the biggest), Amazon (the second biggest), and several others with annual sales exceeding $50B per year. In aggregate, in excess of $1T in consumer spending flows to merchants that provide a BNPL option via AFRM! The consumers on the AFRM platform is also growing rapidly. There now number about 8.7M consumers which is up 22% sequentially and up 124% y/y! I expect that this massive increase in potential available consumer spending through the AFRM platform will lead to explosive growth. These merchant partnerships and the strength of AFRM’s growing ecosystem are my primary reasons for being invested in AFRM.
There are risks associated with AFRM. One of the largest may be the quality of AFRM’s underwriting. AFRM does take on credit risk so if AFRM lends to a large number of consumers who end up defaulting, the business could be negatively impacted. So far defaults have been low, but we also haven’t had a recession that caused consumers to default in large numbers. The 2020 recession wasn’t a good test because the government provided so much financial assistance enabling consumers to service/repay debt in spite of job losses. The second risk is AFRM’s dependance on selling its debt to investors through securitizations or directly. If their pipeline to sell debt dries up then AFRM’s ability to offer financing to consumers could freeze up as well. Third, AFRM is more vulnerable to an economic slowdown than other GR portfolio companies. Since AFRM’s revenue is driven by GMV, a slowdown in consumer spending would affect AFRM’s growth. However, since AFRM’s GMV base is still a tiny fraction of what’s available and since AFRM just recently signed up massive retailers, AFRM should manage good growth even during an economic slowdown.
Since the earnings release, I’ve made some adjustments to my AFRM allocation. I initially added about 2% allocation to the position but later reduced it by 4% allocation. I changed my mind for two reasons. First, when I tested AFRM’s BNPL on my own Amazon account, I noticed that the option to use AFRM was there but not very prominent. This lack of prominence of the AFRM BNPL option is in contrast to what is offered at checkout from Walmart or Target for instance. Second, the drop in MNDY shares in the first several days of December led me to add to that position; I needed a source of funds to make the additional MNDY purchase and that source came from AFRM shares. Should the recent decline in my portfolio stocks continue, I will continue to weigh the risk-reward for each position.
CRWD Q3 FY2022 (reported 1Dec)
CRWD reported its Q3 FY22 results on 1Dec. The results were very good with total revenue growing 63.5% y/y and subscription revenue growing 67% y/y. Subscription revenue is much more important that professional services revenue. ARR also grew 67% y/y and topped $1.5B for the first time. The other KPIs seemed to be on track with the DBNER once again staying above 130%, module adoption by the customer base continuing its trend higher, and customer acquisition continuing at a high rate (12% sequentially and 75% y/y). While revenue growth deceleration continued, there were some signs of renewed optimism. Operating margin of 14% and FCF margin of 32% were very strong. Most exciting was the new government partnership which opens up a lot of opportunity in the coming year. The U.S. federal government (as well as state and local governments) appear fully committed to protecting against cyberattacks, and the bulk of spending on these initiatives has not yet begun. CEO Kurtz seems back to his brash bashing of the competition after a one quarter hiatus; I take this as a signal that business is good. Management also stated that the pipeline is the strongest it’s ever been.
CRWD has also positioned itself well with partnerships that will likely suck the air out of any efforts on the part of competitors to do something similar. Strategically, CRWD is making a lot of good moves, and I must give management credit for executing well on this front. With another very good quarter behind it, CRWD, in my opinion, still deserves a 10-12% allocation in the portfolio.
Some might ask why I added ZS to the portfolio. ZS is also in the security space. Why do I need two security companies and if I had to choose one over the other would I prefer CRWD or ZS? ZS’s revenue growth has been accelerating while CRWD’s revenue growth has been decelerating, but both are at about the same level (63.5% for CRWD and 61.7% for ZS). ZS’s prospects over the coming year may be more assured than CRWD’s prospects. One question for investors should be what’s going to happen to growth going forward. My opinion is that ZS will likely continue to accelerate while CRWD might maintain its growth or decelerate slightly. However, ZS’s stock price is much more richly valued that CRWD’s stock price: CRWD EV/S = 35.7 versus ZS EV/S = 58.7. Both have great, dominant businesses with coming tailwinds, and they have similar growth rates. I think that CRWD has a better business model but perhaps its growth has been dinged slightly by competition from SentinelOne and Palo Alto Networks; ZS doesn’t seem to have such competition. In this case, I’d say that CRWD’s valuation makes me favor CRWD, and, therefore, I plan to keep my ZS position small compared to my CRWD position. However, as their stock prices move and their valuations change, I’m likely to adjust my risk-reward view.
SNOW Q3 FY2022 (reported 1Dec)
SNOW reported Q3 FY22 earnings on 1Dec. Contrary to some predictions, revenue growth didn’t decelerate but came in at 110% y/y growth. In fact, this was an acceleration compared to the prior quarter’s y/y revenue growth result of 104%. Management explained the outperformance in Q3 to several very large customers spending more than expected. Management expressed some disappointment in not being able to provide more accurate guidance for Q3; they said that they shoot for a 5-7% beat so hitting a 9.6% beat for the quarter was not expected and a failure in their forecasting. As the customer base gets larger, SNOW believes that it will be able to more accurately guide forward their results. As an investor in the Company, I was very pleased with the financials including revenue and RPO growth, other KPIs such as customer growth. Below are some other important takeaways from the earnings call:
- Data cloud growing fast: The number of datasets in SNOW data sharing cloud grew 41% sequentially, and the number customers participating in the sharing grew to more than 200 during Q3. Management said data sharing is starting to have an impact in the results. Here’s a quote in response to an analyst’s question about the progress of data sharing:
as you see from the metrics that we report on, there is a very, very steady aggressive growth happening quarter-on-quarter. But we sort of haven’t reached that tipping point yet where sort of the floodgates are open and things are just expanding at a meteoric rate. But we’re anticipating that that will happen at some point. It’s very nonlinear in the way the adoptions are going to develop.
CEO Frank Slootman on 1Dec Q3FY22 earnings call
- International growth continues: Y/Y revenue growth from EMEA and APJ was 174% and 219%, respectively, which outpaced overall revenue growth of 110%. There’s still lots of opportunity for international growth will should continue to outpace overall growth.
- Large customer spend expansion ahead still: We know that SNOW had previously said that it typically takes customers nine months to ramp up their spending. But once they’ve ramped up the spend, can spending keep increasing? CFO Scarpelli revealed during the call that SNOW’s 223 Fortune 500 customers are currently paying SNOW $1.25M/yr on average, and the 148 customers who currently pay SNOW $1M+ are currently averaging $3.5M/yr spend on SNOW. He also said that he believes that the potential revenue from the large customers is $5.5M per year. When we multiply that out, we get an unrealized annual potential of about $950M of additional expansion in spend from their 223 current Fortune 500 customers. But SNOW will continue to land additional large customers which will further increase the spending potential.
To summarize, SNOW continues solidly in hyper growth mode with no signs of slowing and several reasons to believe that growth will continue very strongly for longer. SNOW shares are priced for future strong growth so any material slowdown would likely send the shares lower. However, we know that SNOW’s customer adoption can and will at times be lumpy. For that reason, I’m willing to ride through an occasional weak quarter and share price volatility so long as I see that SNOW is making directional progress in implementing its strategy and vision. Important aspects of that vision will include evidence that 1) data sharing is increasingly valued by the marketplace, 2) data sharing clouds are rolled out into additional verticals (i.e. in addition to media and financial services verticals), and 3) spending increases of data storage and compute are becoming more frictionless. My investing thesis is that hyper growth should be maintained (and maybe explode) because positive ROI decisions to expand and add workloads will be frictionless. I expect these concepts to be leading indicators of revenue growth.
OPTIONS TRADING
Last month, I wrote about some options bets that I had made going into this past earnings cycle. The bets that I described last month (LSPD and UPST) did not work out. In fact, the losses from these bets wiped out about half of the options trading profits that I had accumulated during 2021. Not disastrous but also not fun. For me, the lesson was (and it’s one that I need to relearn on occasion!) about bet sizing (I had lost some large bets on ZM options in December 2020).
Bet Sizing
I made earnings bets on LSPD and UPST. I kept the bets on LSPD small and the losses from the LSPD options bets on the portfolio’s results were negligible. The UPST bets were larger with 2.5% of my portfolio invested in short-term UPST calls. These bets also went to almost zero but I knew they could so the loss was deemed possible and acceptable going in. However, the size of the bets grew larger than I originally intended because of two other decisions:
- I decided to hold short-term $370 puts on UPST through the earnings result. I normally close most such short-term short put positions prior to the catalyst event. With UPST shares trading near $170, these short puts are down more than $200 per share. These losses have wiped out about half of my options trading profits from 2021.
- I decided to convert my Rollover IRA to a Roth IRA. This account was very heavily investing in LSPD and UPST. I decided to make the conversion prior to LSPD and UPST earnings so that when the results caused the share prices to rise, the gains would never be taxable. As we saw, it didn’t play out that way. So I’m going to pay income tax on the prices of the LSPD and UPST positions prior to the earnings.
For me, it’s a reminder to weigh all aspects of the upside and downside and to size bets accordingly.
FINAL THOUGHTS
Here we are in early December, and we have the markets talking about concerns and risks. It certainly seems that the market has concerns every single month. Some concerns are new and some are the same. Inflation. Omicron. Or whatever else might grab the headlines. It’s always something, yet the portfolio companies marched on with spectacular or very good results. Those companies that don’t show great results get replaced by other companies. That’s what we do: maintain the very best companies in the portfolio. The recent declines in portfolio stocks will eventually be overcome, and the portfolio will once again reach new all-time highs. When that will happen no one can know, but it will happen unless there is a true apocalypse. The next portfolio update will be posted after the end of 2021.
The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.