Another earnings seasons is in the books so it’s time to review the recent results and reassess the positions in the portfolio. As I’ve alluded to since January, I’ve thought about and come to some conclusions about my own investing goals. I recently wrote a blog post about investing goals/objectives considerations. After some consideration, I’ve decided that asset preservation will take on increased importance (increased from no priority). This change is a personal one, and it will have consequences for my investment decisions as well as my portfolio returns. I will be investing some of my capital in companies other than those that I think will grow the fastest. In addition, I expect to hold a larger cash position than I previously have. As a consequence, I expect that the average CAGR of the portfolio will be lower going forward. I will still invest a good portion of my investible assets into hyper growth companies, and I will still analyze these investments.
PRIOR PORTFOLIO UPDATES
PORTFOLIO PERFORMANCE
On a YTD basis, the portfolio’s continues to underperform the S&P 500 as it has all year long. Looking at the end of month YTD returns, it appears that not much has changed in the past five months. When one is down 60% to 70% then moving from -70% back up to -60% is actually a 33% increase. In fact, between the YTD low of -70.4% on 24May and 10Aug, the portfolio rallied 36.1%. Unfortunately, many of those gains have been given back recently.
| 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% |
| Jun22 | -65.8% | -20.0% |
| Jul22 | -63.6% | -12.6% |
| Aug22 | -62.3% | -16.1% |
| 2Sep | -64.3% | -16.8% |
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% |
| 06/03/22 | -64.7% | -13.2% | -51.4% |
| 06/10/22 | -66.4% | -17.6% | -48.8% |
| 06/17/22 | -68.8% | -22.3% | -46.5% |
| 06/24/22 | -61.8% | -17.3% | -44.5% |
| 07/01/22 | -63.9% | -19.1% | -44.8% |
| 07/08/22 | -61.0% | -17.5% | -43.5% |
| 07/15/22 | -64.9% | -18.3% | -46.6% |
| 07/22/22 | -64.7% | -16.2% | -48.6% |
| 07/29/22 | -63.6% | -12.6% | -51.0% |
| 08/05/22 | -61.0% | -12.2% | -48.8% |
| 08/12/22 | -60.0% | -9.3% | -50.7% |
| 08/19/22 | -62.5% | -10.4% | -52.1% |
| 08/26/22 | -60.8% | -14.0% | -46.8% |
| 09/02/22 | -64.3% | -16.8% | -47.5% |
ALLOCATIONS
| 9/2/22 | 8/31/22 | 7/31/22 | 6/30/22 | 5/31/22 | 4/30/22 | 3/31/22 | 3/18/22 | 2/28/22 | 1/31/22 | 12/31/21 | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| CRWD | 19.2%** | 19.4%** | 17.0%** | 23.9%** | 23.8%** | 21.9%** | 15.4% | 14.1%* | 8.3%* | 6.4%* | 5.9%* |
| DDOG | 18.6% | 19.1% | 28.8%** | 40.4%** | 41.4%** | 39.4% | 33.4% | 33.4% | 35.7% | 36.8% | 31.7%* |
| SNOW | 15.7%** | 14.0%** | 16.9%** | 23.3%** | 21.8%** | 12.8%** | 9.8%** | 10.0%** | 18.1%** | 18.4%** | 15.5%** |
| MELI | 3.5% | 3.3% | — | — | — | — | — | — | — | — | — |
| NET | 3.4% | 3.4% | 2.8% | 3.7% | 4.9% | 4.4% | 4.2% | 4.0% | 3.9% | 3.2% | — |
| TTD | 2.9% | 2.8% | — | — | — | — | — | — | — | — | — |
| LNG | 1.8% | 1.7% | 0.5% | — | — | — | — | — | — | — | — |
| MDB | — | 3.7% | — | — | — | — | — | — | — | — | — |
| UPST | — | — | — | 0.1%* | 0.2%* | 2.7%* | 3.0%* | 3.7%* | 4.6%* | 3.5%* | 14.7%* |
| ZS | — | — | — | 4.5% | 4.7% | 22.5%* | 16.9%* | 16.0%* | 16.2%* | 12.6%* | 4.3%* |
| S | — | — | — | — | 6.8% | 6.3% | 4.9% | 5.4% | 5.1% | — | — |
| MNDY | — | — | — | — | — | 3.5%^ | 9.4%^ | 10.5%^ | 9.1%^ | 26.0%^ | 27.5%^ |
| AFRM | — | — | — | — | — | — | — | — | — | 3.8% | 7.4% |
| Cash | 35.1% | 33.2% | 34.1% | 4.0% | -3.7% | -7.3% | 6.2% | 6.8% | 2.3% | -5.6% | -4.0% |
The allocation details described below are as of the end of August. Two of the nine positions in the portfolio are leveraged with long-term call options. CRWD: of the 19.4% allocation, 17.7% are shares and 1.7% are Jan2024 $200 calls. SNOW: of the 14.0% allocation, 13.2% are shares and 0.8% are Jan2024 $300 calls. Note: there are some rounding errors in the preceding shares/call options splits. The portfolio is comprised of 2.5% in long call options, 65.0% in shares, 33.2% cash, and -0.6% in short put options.
In the last portfolio update, I discussed how the portfolio had gotten to be uncomfortably concentrated. For several months, I’ve been contemplating adding some new positions, preferable some not in the software space, to the portfolio. Since the last update, I added LNG, MELI, TTD, and MDB (but I sold MDB after its Q2 results).
PORTFOLIO CHANGES
Changes since 2July 2022
- CRWD: Added to CRWD shares.
- DDOG: Sold about 1/3 of the shares and all of the long-term call options after earnings.
- LNG: bought a new position.
- MDB: bought a new position and sold all after earnings.
- MELI: bought a new position.
- SNOW: sold covered calls against about 30% of position (shares called away after earnings for around $170/sh including covered call premiums). Bought back some shares for about $170.
- TTD: bought a new position.
- UPST: Sold the remaining tiny position.
PORTFOLIO COMPANY UPDATES
DDOG (Q2 FY2022 reported on 4Aug):
DDOG had been reporting almost flawless results for several quarters going into the Q2 FY22 result, and I had an oversized position to reflect the previous results, the trend, and my conviction. After the Q2 result, I sold about 1/3 of my position because DDOG, in my view, no longer deserved an oversized position above 20%. Let’s examine the latest quarter.
Revenue growth decelerated from 82.8% to 73.9%. That level of growth is still outstanding, but it’s clear that DDOG’s business is feeling some headwinds. Management stated that DDOG’s large customers were cutting back on their spending with DDOG. SMB customers continued to spend at historical levels. New products showed very strong uptake, gross retention remained in the mid to high 90%s, and dollar-based net retention remained above 130%. DDOG also added a record 1600 net new customers when considering the 200 customers that were lost from Russia and Belarus. The long-term driver of DDOG’s business continues to be cloud migration and digital transformation; these drivers are intact and this was corroborated by the strong results from the hyperscalers’ (AWS, Azure and GCP) results. However, it’s clear that DDOG’s customers can and do cutback on their APM and log management spending when hard times fall upon them. Thus, DDOG is being extra conservative in guidance for the back half of this year: DDOG had raised their annual revenue guidance by $90M after Q1; after Q2, DDOG only raised guidance by $10M. This also means that if we enter a deep global recession, then we can expect DDOG’s customers to further scrutinize spending which would further decelerate DDOG’s revenue growth. The CFO made some comments that affect operating margin and cash flow: DDOG has returned to in-office attendance for employees, travel, and events; all of these increase operating expenses and lower profit margins and cash flows. So, part of the massive increase in operating margin and cash flow over the past two years was due to temporarily lower expenses.
NET (Q2 FY2022 reported on 4Aug):
NET reported its typical quarter of revenue growth: 53.9%. In fact, the last eight quarters have all landed between 50% and 54% growth. NET swung back to a breakeven non-GAAP operating margin. The Company is forecasting a positive operating margin for the back half of 2022, but I’m not holding my breath for the type of rapid FCF growth that we saw from CRWD and DDOG in recent years and that we’re now seeing from SNOW. NET has high ambitions across many areas, and it’s going to cost a lot to capture share in those areas. NET also spends significantly on CapEx, more so than many other software companies. In FY2021, NET spent about 14% of revenue on CapEx, and in the most recent quarter CapEx grew significantly faster than revenue (73% vs 54%). So even once NET covers all its Operating Expenses, it will still need to cover an additional 14-16% of revenue before it can generate any cash for investors. For me, NET’s quarter is par for the course, and my view remains unchanged. NET will remain a small position in the portfolio because I can’t be sure that as an investor, I’ll ever see the Company generate high FCF. But I keep NET in the portfolio at all because its ambitions and potential are enormous.
SNOW (Q2 FY2023 reported on 24Aug):
After the slowdown that DDOG reported in early August, I thought that SNOW would likely meet a similar fate. I hedged my large position by selling covered calls against about 30% of my shares. Those shares were ultimately taken from me for about $170/sh (factoring in the options premiums that I received). Well, SNOW’s result was better than I expected and probably better than most other investors expected. Product revenue growth continued to decelerate slightly to 83.1% from 84.5% in Q1 and 100.7% in Q4. Deceleration was expected because of SNOW’s implementation of improved compute efficiency. In addition, SNOW’s consumption-based revenue model was thought to be vulnerable to customers scaling back on spending. On the contrary, SNOW’s customers did not slow spending; this was emphasized multiple times by SNOW’s management on the earnings call:
…the largest organizations in the world continue to increase their use of Snowflake. These indicate that companies globally are prioritizing Snowflake right now.
Scarpelli – CFO
We’re looking at a very, very exciting times where things are becoming possible that we couldn’t even dream of just a few short years ago. So, this is why we feel that this is not one of those expenses that people are going to casually cut back on, because it’s strategically compelling and important.
Slootman – CEO
…overall, our top customers continue to grow. And I haven’t seen that slowing down, the NRR.
Scarpelli – CFO
So, SNOW isn’t seeing material slowdown that other software companies (e.g. DDOG) saw in their recent results. SNOW appears to be more resilient during tough times as pointed out by Slootman:
I actually think the dynamic that you’re describing [the analyst asked if SNOW is concerned about customers slowing workload transitions to Snowflake given the tough macroeconomic environment], I mean, we’re going to see the exact opposite of that. We think people, because of the nervousness that they may have about the macro, they’re going to accelerate to a cloud computing platform. And the reason is these are elastic models. These are consumption models, right? So, it’s much better to be in the elastic model where you only pay for what you use and you can run on demand than when you have to make large upfront commitments to vendors. So, if anything, I think people are going to get a move on instead of hold off.
Slootman – CEO
Clearly, SNOW’s management team isn’t seeing the softness that other IT software companies have reported. Full year guidance was raised by a small amount but raised nonetheless. In addition, SNOW has a lot of large contracts up for renewal in Q4, so despite a tough comparison to last year’s Q4, Scarpelli is confident that Q4 is going to come in very strong. While the current and near term outlook for SNOW look better than I had been expecting, it’s the longer term opportunity that needs to be realized to make SNOW a worthwhile investment as SNOW is a very expensive stock with a very bright future already priced in. So far, SNOW has been living up to the lofty expectations by not only delivering very strong growth but also expanding the workloads for which SNOW can be used to improve enterprise functions. This ever-growing set of suitable (to run on Snowflake) workloads must meet both technical as well as financial requirements. Furthermore, as Snowflake further develops new capabilities and lowers the cost of running workloads, the barriers to entry grow larger and larger. Also, SNOW’s ecosystem as exemplified by Powered by Snowflake customers (grew 39% QoQ!) and stable edges/data sharing (stable edges grew 112% YoY and 21% of SNOW’s customer have at least one stable edge) continue to grow rapidly and strongly contribute to customer lock-in.
CRWD (Q2 FY2023 reported on 30Aug):
CRWD reported Q2 FY23 on 30Aug. My expectations were high going into the earnings results because PANW delivered a very strong quarter and NET indicated that cybersecurity demand was high. Revenue growth continued its slow deceleration to 58.5% yoy growth from 61.1% in the prior quarter. All of the key performance indicators/metrics continued to be solid. Customer growth was again solid as was adoption of additional modules among the customer base; net retention was at a seven quarter high putting it between 125% and 128% while gross retention hit a second consecutive new record high. The FCF margin dipped to 25% after being above 30% in each of the three prior quarters, but the CFO said that CRWD expects >30% FCF for full FY23 so the last two quarters of the year should be good. CRWD has essentially attained its long-term operating model so there will be little operating leverage remaining to realize, but CRWD is still growing revenue at about 60%, and 30%+ of the revenue should contribute to FCF. In summary, CRWD continues to be a cash-generating, high growth business with customers who are willing to not only stick with CRWD but also buy more and more every year. I’m pleased to have CRWD as a top holding in the portfolio.
MDB (Q2 FY2023 reported on 31Aug):
I opened a new position in MDB in mid-August (before the 31Aug earnings report). Previously, I had been against owning MDB because after years of being in business the Company was not making significant progress toward operating profitability (i.e. showing no significant leverage). In addition, MDB has been growing more slowly than my other large positions (i.e. DDOG, CRWD, and SNOW) that have been showing better success with their business models. So what changed my mind? Upon closer examination, MDB had been making some very slight improvements in operating margin, Atlas is growing significantly higher than the overall business (80%+ for Atlas versus mid-50%s for MDB as a whole), and MDB is clearly dominant in its space with a long runway of growth ahead. MDB could be worth a small position assuming that the Company could continue to improve its operating margin. I had reason to believe that this was possible because 1) there was a trend of slight operating margin improvement, and 2) Atlas with 60% of the business and growing at more than 80% could contribute to elevate overall growth going forward which should further boost operating margins. Thus, I took a 3.5% position.
The earnings report, while not all bad, was not what I needed to see. I want to invest in companies that will eventually show a profit and increasing levels of FCF. That’s the goal of any company in a capitalist system. MDB reported that they’re not seeing any change to the sales motion, no sales cycle elongation, etc. However, MDB has a consumption based business model, and consumption took a hit in Q2 and into August. This will likely continue as the macroeconomic environment remains challenging. In the long run, though, I would expect consumption patterns to revert to historical levels. In the meantime, operating leverage has not only stopped progressing but it’s headed in the wrong direction. While I understand that companies need to invest to take advantage of and go after a massive market opportunity, I look for companies that do this while also making progress on their journey to profitability. DDOG and CRWD have done this, and SNOW is in the process of doing it. With MDB there’s certainly a big market opportunity, and the Company is definitely making great progress in capturing it. What’s less clear is if and when the profits will start flowing into MDB’s coffers. My assessment is that either 1) management is managing for growth and domination at the expense of everything else, 2) MDB’s business model doesn’t allow for profits to be made while the Company is in hyper growth mode, or 3) both. DDOG, CRWD, and SNOW are proving that their business models allow for hyper growth in revenue while also improving operating margin and growing FCF. That’s what I look for, so MDB is out.
New Non-SaaS Investments
LNG, MELI, and TTD are small positions that I added to the portfolio recently. As I’ve mentioned, I’ve been considering investing in some companies outside of of the software space. In addition, the characteristics of these smaller positions should include dominance within their markets, superior business models, little chance of getting disrupted, and an expectation of reasonable long-term growth. I’ve owned shares in MELI and TTD previously, and each has an established track record of success.
I waited to buy MELI until after I saw the earnings report (3Aug) because the Company operates in eCommerce and after seeing the dismal report from SHOP I wanted to be sure that MELI wouldn’t follow a similar path. MELI had an outstanding quarter. MELI operates in Latin America which has seen frequent periods of currency instability and inflation; in spite of these challenges, MELI has managed to show hyper growth on a U.S. dollar basis for years. MELI also receives a growing percentage of its revenue from its fintech business; the ongoing success of its fintech operation is something to watch.
TTD has a slower revenue growth rate (35-45%) than a company that I typically like to invest in. TTD operates a platform that lets its customer create, manage, and optimize data-driven digital advertising campaigns. TTD is particularly strong in connected TV which is growing much more rapidly than the rest of the advertising market. While an economic recession could crimp advertising budgets, TTD should fare better than most because an increasing percentage of its business comes from connected TV. Political ad spending in Q3 and Q4 should be strong due to the U.S. midterm elections. In addition to decent top line growth, TTD has a long history of delivering strong earnings and cashflow.
LNG is not my typical investment, but I have been looking for good companies that have long-term prospects. LNG owns and continues to build infrastructure needed to liquify and export natural gas. In 2022, about 11% of the world’s liquid natural gas is produced by LNG. The natural gas that’s plentiful in the U.S. can be transported to LNG’s terminals and exported to regions that lack sufficient natural gas. LNG recently entered into a handful of large, long-term (20-30 year) contracts to supply regions in Europe and Asia. Natural gas is a transition fuel that will help move the world to renewal energy, but this process will take a few decades.
FINAL THOUGHTS
The tough times that began about 10 months ago are continuing. There seems to be no more certainty about a rosier future ahead than there has been all year. The prospect of higher interest rates and the possibility of a recession certainly aren’t helping growth stocks. No one can know how long this malaise will last, but it will eventually end. I intend to remain mostly invested (>50%) in high growth companies that are the leaders in their space and that I know will be able to weather any storm that the economy throws are them. I also hold an unusually high cash position some of which I’d like to deploy into investments, but I’m in no rush. If I were 15 to 25 years younger with net funds to invest every month then I’d hold little cash, but, since I’m older and live solely off my investments, I prefer to have a high cash cushion.
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.