We are in the midst of another earnings cycle. We got our first clues after the three cloud titans (AMZN, MSFT, and GOOG) reported their results at the end of April. MicroSoft’s Azure grew 49%, Google’s GCP grew 44%, and AWS grew 37%. AWS and GCP decelerated slightly while Azure accelerated a little, but these results show that the transition to the cloud was still strong during the fourth quarter of 2021. And considering the scale at which these businesses operate, the results provide a positive backdrop for the smaller SaaS companies. IBM (reported on 19Apr) and SAP (reported on 21 Apr) also called out considerable strength in their cloud businesses. Other software companies, including DDOG and NET, reported very strong results, nothing in the results or forecasts that would suggest any slowdown in the business fundamentals. Today, CRM reported results that were typical CRM style (small beat), and the stock is up more than 8% after hours.
I’ve discussed big drops in a previous post. Below is a list of the big drops of the GauchoRico Portfolio since 2018.
| PEAK — BOTTOM | % DROP | Days: Old Peak to New ATH |
|---|---|---|
| 4Sep2018 – 24Dec2018 | -37% | 176 |
| 26Jul2019 – 22Oct2019 | -37% | 207/291* |
| 18Feb2020 – 16Mar2020 | -45% | 84 |
| 9Jul2020 – 16Jul2020 | -14% | 25 |
| 5Aug2020 – 11Aug2020 | -25% | 27 |
| 13Oct2020 – 10Nov2020 | -27% | 65 |
| 22Dec2020 – 3Jan2021 | -14% | 45 |
| 12Feb2021 – 13May2021 | -35% | 125 |
| 18Oct2021 – 24May2022 | -81% | ??? |
This 81% drop (which is so far the bottom of this drop) is now the largest since I began investing in the early 1990s, and it’s clearly now in a separate category from the drops of the past five years. Yes, for the GauchoRico portfolio, the current drop is larger than the dotcom bust (2000/2001), the Great Financial Recession (2008/2009), and my own financial disaster (2015/2016). The stocks that are or were in the portfolio when this drop began in late October 2021 have fallen by huge amounts (listed in order of percentage drop from each stock’s all-time high; these are also as of 24May): UPST: -91%, AFRM: -88%, MNDY: -78%, NET: -77%, S: -72%, SNOW: -68%, ZS: -66%, DDOG: -57%, CRWD: -53%. Whoa! These are some massive declines. Even blue chip tech companies are down large amounts from their ATHs: NVDA: -53%, TSLA: -49%, AMZN:-45%, GOOG: -30%, MSFT: -26%. There have been few places to hide in the stock market selloff, and even bond holders have been taken to the woodshed.
So when is this drop going to be over? I only wish I knew. It’s possible and maybe even probable that there’s more pain to come. Here’s one perspective that may be useful to read. It includes a look at how Salesforce (CRM) and NetSuite faired during (and after) the Great Financial Recession. I also wrote a case study on CRM about 2.5 years ago. So, we could have even more SaaS multiple compression and/or we could see revenue growth slow due to a recession or in response (by the companies choosing to invest less in growth to ensure survival) to a recession. Each of these could send SaaS stocks even lower. This possibility led me to reduce my leverage significantly. Perhaps, I did it near the worst time, but doing so ensures the portfolio’s survival.
So what is an investor to do? That’s up to each investor to decide depending on their analysis, circumstances, and risk tolerance. I’ve often said that with growth investing we can expect a 50% or greater drop at some point. Earlier in 2021, I did consolidate into high growth companies that are cashflow positive and dominating their markets (taking funds from smaller companies with less financial strength and without market dominance). I continued this consolidation more recently. However, the vast majority of the portfolio is still invested in high growth software companies. I know one investor who went to cash in January. That’s something that can be very hard to do, especially when the portfolio has already dropped more than 25% from the highs. Another investor friend went to cash a few weeks ago after seeing his portfolio drop an additional 35% since the start of 2021. Both of these investors are looking pretty smart today, and they’re doing significantly better than I am during this drop.
PRIOR PORTFOLIO UPDATES
PORTFOLIO PERFORMANCE
| DATE | GauchoRico Portfolio (YTD) | S&P500 Total Return (YTD) |
|---|---|---|
| Jan22 | -31.7% | -5.2% |
| Feb22 | -32.6% | -8.0% |
| Mar22 | -35.1% | -4.6% |
| Apr22 | -49.6% | -12.9% |
| May22 | -66.5% | -12.8% |
Weekly Performance
| DATE | GauchoRico YTD | S&P500 TOTAL RETURN YTD | DELTA |
|---|---|---|---|
| 01/07/22 | -24.1% | -1.8% | -22.2% |
| 01/14/22 | -30.5% | -2.1% | -28.4% |
| 01/21/22 | -39.5% | -7.7% | -31.8% |
| 01/28/22 | -39.3% | -6.9% | -32.3% |
| 02/04/22 | -33.6% | -5.5% | -28.2% |
| 02/11/22 | -25.2% | -7.2% | -18.0% |
| 02/18/22 | -33.0% | -8.6% | -24.4% |
| 02/25/22 | -35.8% | -7.8% | -28.0% |
| 03/04/22 | -42.4% | -8.9% | -33.5% |
| 03/11/22 | -48.4% | -11.5% | -36.9% |
| 03/18/22 | -37.9% | -6.1% | -31.8% |
| 03/25/22 | -37.6% | -4.3% | -33.3% |
| 04/01/22 | -33.7% | -4.3% | -29.4% |
| 04/08/22 | -41.6% | -5.5% | -36.1% |
| 04/15/22 | -40.8% | -7.5% | -33.3% |
| 04/22/22 | -49.0% | -10.0% | -39.0% |
| 04/29/22 | -49.6% | -12.9% | -36.7% |
| 05/06/22 | -58.6% | -13.1% | -45.5% |
| 05/13/22 | -62.4% | -15.1% | -47.3% |
| 05/20/22 | -67.0% | -17.7% | -49.3% |
| 05/27/22 | -64.9% | -12.2% | -52.6% |
ALLOCATIONS
| TICKER | 5/31/22 | 4/30/22 | 3/31/22 | 3/18/22 | 2/28/22 | 1/31/22 | 12/31/21 |
|---|---|---|---|---|---|---|---|
| DDOG | 41.4%** | 39.4% | 33.4% | 33.4% | 35.7% | 36.8% | 31.7%* |
| CRWD | 23.8%** | 21.9%** | 15.4% | 14.1%* | 8.3%* | 6.4%* | 5.9%* |
| SNOW | 21.8%** | 12.8%** | 9.8%** | 10.0%** | 18.1%** | 18.4%** | 15.5%** |
| S | 6.8% | 6.3% | 4.9% | 5.4% | 5.1% | — | — |
| NET | 4.9% | 4.4% | 4.2% | 4.0% | 3.9% | 3.2% | — |
| ZS | 4.7% | 22.5%* | 16.9%* | 16.0%* | 16.2%* | 12.6%* | 4.3%* |
| UPST | 0.2%* | 2.7%* | 3.0%* | 3.7%* | 4.6%* | 3.5%* | 14.7%* |
| MNDY | — | 3.5%^ | 9.4%^ | 10.5%^ | 9.1%^ | 26.0%^ | 27.5%^ |
| AFRM | — | — | — | — | — | 3.8% | 7.4% |
| Cash | -3.7% | -7.3% | 6.2% | 6.8% | 2.3% | -5.6% | -4.0% |
Five of the seven positions in the portfolio are leveraged with long-term call options. CRWD: of the 23.8% allocation, 20.5% are shares and 3.3% are Jan2024 $180 and $200 calls. DDOG: of the 41.8% allocation, 39.6% are shares and 1.8% are Jan2024 $120 calls. SNOW: of the 21.8% allocation, 21.2% are shares and 0.6% are Jan2024 $300 calls. UPST: of the 0.2% allocation, 0.1% are shares and 0.1% are Jan2023 $330 calls (essentially a lottery ticket at this point). Note: there are some rounding errors in the preceding shares/call options splits. The DDOG, S, and NET positions are all shares. The portfolio is comprised of 5.8% in long call options, 97.9% in shares, -3.7% cash, and 0% in short put options.
PORTFOLIO CHANGES
Changes since 18Mar 2022
- SNOW: Increased SNOW position.
- CRWD: Deleveraged CRWD before the end of March by converting call options back to shares. Then, when the price fell again, leveraged CRWD by selling shares and buying Jan2024 call options.
- MNDY: Exited MNDY.
- UPST: Exited almost all UPST shares.
- ZS: Trimmed ZS prior to earnings and then cut ZS considerably on the stock price strength after earnings.
PORTFOLIO COMPANY UPDATES
Of the eight companies that I had in my portfolio at the time of my last portfolio update (18Mar), six have reported results. S and CRWD will report results later this week.
DDOG (Q1 FY2022 reported on 5May):
DDOG remained on track reporting 82.8% y/y revenue growth which was similar to last quarter. The Company also raised the full year guidance, now projecting 57% growth compared to the 49% growth that was projected at the end of Q4; thus, DDOG is following a similar trajectory compared to 2021. FCF grew by more than $23M sequentially and 192% y/y. In addition, the other KPIs looked great, and management continued to state that everything is going as well as in recent history. There seem to be no direct indications yet that DDOG’s customers might curtail spending on DDOG. The Company continues to roll out new features and seems to be getting more than its fair share of contracts from Federal government agencies. The only question in my mind is how low will the market and the macro environment take the valuation multiple. It’s a question I don’t think anyone can answer. I have no hesitation in retaining my largest allocation in DDOG.
NET (Q1 FY2022 reported on 5May):
NET continued to grow at its steady mid-50%s rate (53.7% which was identical to the prior quarter). My primary concern remains the same: NET isn’t improving operating leverage with scaling and there are no plans to improve that in the near term. The Company plans to continue to spend any potential FCF on growth. Why is it that other companies like DDOG, CRWD, and ZS show strong FCF and FCF growth? These other companies can grow even faster and post quickly growing profits. And it’s not like NET has a lower valuation multiple either. Therefore, the only reason for someone to stay invested in NET is because that person believes that the TAM (total addressable market) is so large that growth will remain durable for a very long time. They are waiting for cash flows far into the future. High growth while waiting for cash flows far into the future is not something that the market is rewarding in this increasing rate environment. I have considered selling my NET position, but I haven’t done so yet.
UPST (Q1 FY2022 reported on 9May):
I sold virtually all of my UPST after the latest earnings result. Yes, UPST is profitable and has great potential. That’s still true. But UPST’s management had previously said that COVID-19 stimulus was a headwind so when that stimulus was taken away, UPST should have seen a boost. Also, they also previously stated that a raising rate environment shouldn’t negatively affect Upstart. That tune changed, and the Company cut the full year guidance. My concern about banking customers being cautious about turning over AI to underwriting have become my base case. I’m essentially out.
MNDY (Q1 FY2022 reported on 16May):
I sold almost all of my MNDY position prior to earnings. My concerns about MNDY had been growing. Those concerns are 1) that MNDY operates in a market that doesn’t have a history of posting great operating margins, 2) that MNDY is in a competitive market (related to concern #1), 3) that MNDY spends too much on operating expenses, particularly on sales and marketing, 4) that MNDY isn’t required to report audited financials quarterly, and 5) MNDY is relatively thinly traded. Concerns #1 and #3 are particularly worrying in an environment where new capital may well be more difficult and costly to raise. Despite MNDY’s relatively low valuation multiple (for a SaaS company), I decided that MNDY’s risk-reward has deteriorated considerably.
SNOW (Q1 FY2023 reported on 25May):
SNOW’s growth rate decelerated significantly in Q1 but that was preannounced and expected. Customer growth was a bit slower than I’d like but it’s hard to know anything about the quality of the customers that were added. Hopefully, these were customers that will be huge in 1-2 years from now. SNOW is demonstrating that their business is scaling. Operating margin was 1% last year and management said that they expect operating margin to increase to 16% for the year. As an investor, I expect operating margin and FCF to increase each year going forward. I do believe that SNOW has a very long hyper growth runway ahead of it, and I’m still expecting SNOW to become a juggernaut like a Google or Facebook.
I did cut my allocation from 18% to about 10% a few months ago. I’ve now reversed that decision and made SNOW one of my top three holdings.
ZS (Q3 FY2022 reported on 26May):
ZS had good revenue growth of 62.6%. The conference calls was very positive and the analysts were congratulatory. Despite these good results, I sold about two-thirds of my position on the stock price strength in the days following the earnings result. I sold because I have some concerns that probably won’t manifest for a while.
ZS’s long sales cycle has always been a negative as it’s better to have a low friction sales motion. During the past six months, ZS landed just a handful of Federal agencies while DDOG landed several dozen. Was this due to the long sales cycle or is ZS having other challenges landing new Federal customers. I don’t know the answer, but ZS has the best FedRAMP certification in the cybersecurity space so I’d expect ZS to land more than its fair share. Maybe those customers are in the pipeline and coming soon. Or maybe not. ZS posted another quarter of low billings growth. Now, billings has been light for several quarters. Cybersecurity is said to have significant tailwinds as confirmed by PANW’s huge 40% billings growth last quarter. If the industry has tailwinds and is growing fast, why are ZS’s billings low? We will get more information later in the week after we see S and CRWD results.
I have significant exposure to the cyber security sector with positions in CRWD, ZS, and S. Even DDOG and NET have security aspects to them. If one company is showing relative weakness, it can be a yellow flag. So I cut the ZS allocation way down. If billings don’t improve for ZS their revenue growth rate will suffer next year.
S and CRWD (will report on 1Jun and 2Jun):
My expectation is that CRWD will report an excellent quarter. In this environment, CRWD had better show strength particularly given PANW’s recent result. S is in the same environment so the results should be strong as well; however, S is smaller company in a competitive market so it must spend significantly on sales and marketing. While the company has a strong balance sheet, it is also burning cash. Thus, S is in a much weaker position than CRWD because it needs to consider its cash runway and may not be able to take advantage of M&A opportunities. If the stock prices remain depressed and interest rates continue to rise, S may come under pressure to spend less. In times like these, the strong tend to get stronger. I have considered cutting my S allocation but have not done so yet.
FINAL THOUGHTS
It’s been a rough seven months, and my decisions to maintain leverage hurt the portfolio’s performance considerably in 2021 YTD. I did finally decide to reduce the leverage which will ensure survival of the portfolio but will also reduce the potential rebound. I try to put the October 2021 portfolio ATH out of my mind as I know in hindsight that the valuations ran up too far and I don’t expect to regain the high water mark for a long, long while. Yes, this is a reset in mindset, and it forces me to try to focus on the companies’ businesses and the gains ahead rather than on what once was. The marco environment is as ugly as I can remember, at least since 2008 when the entire global financial system was under threat of collapsing. Recently, the CNN Fear & Greed Index hit 6 which was not as low as in December 2018 and March 2020, but near the bottom. The companies that are still in the portfolio have all continued to perform really well, and I retain significant optimism about their businesses. As I’ve written above and in the previous portfolio update, I’m keeping most of my investment dollars in strong category leaders that I expect will continue to remain in hyper growth and dominate (and that are virtually assured to survive). While this remains a really tough time to be a stock investor, I fully expect the growth in stock prices will resume at some point.
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.