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Why do I look at the SaaS/Tech industry as a whole?
SaaS/Technology industry is my primary circle of competence. This is the industry that I have the most insights about. I build and use a lot of different software daily, so it’s easy for me to dive into SaaS/Tech companies and get a sense of what they are doing, relate it to my daily life and gain insights into whether some SaaS business is something I want to spend my time learning about and exploring for an investment opportunity.
In general, I want to know about all the SaaS companies, that way, at least I have seen all of them and I have more chances of finding really good ones that are not priced fairly. Looking at the industry as a whole also informs me about the mean and median valuations in the industry, so that I can avoid getting myself into really crazy valuations. It also gives me a guide to whether I am getting a business with a better growth profile for a significant discount as compared to the industry.
This is also a form of idea generation as I will notice new businesses that enter the industry and I get to identify new opportunities.
How often do I look at the industry?
I try to keep myself updated about the industry every 2 weeks, and in some cases every month if I am really busy with my life.
What insights do I look for in the industry?
In general, I try to get a feel for the SaaS metrics for the industry, identify patterns that give me quantitative and qualitative insights into a company through a metric.
I also use a valuation approach to sort companies in a way where I get the maximum value for my investment. I call this a “Proprietary” valuation approach that balances growth and value and the results are sorted in an order of GARP(Growth At Reasonable Price).
Following is the image with the latest metrics for the SaaS industry
Following is the image with SaaS industry ranked by LTM GARP Valuation
Following is the image with SaaS industry ranked by NTM GARP Valuation
Following is the image with SaaS industry ranked by FCF Yield
I like to slice the same data using another GARP metric known as FCF Yield.
Free cash flow yield is a financial solvency ratio that compares the free cash flow a company is expected to earn against its Enterprise Value. The ratio is calculated by taking the free cash flow divided by the current Enterprise Value.
Think of it in terms of bond/savings interest rates, according to the table above Dropbox has a yield greater than 7%, compared to keeping your money in a bank that has a laughable yield(currently).
Generally, older/stable companies will have higher FCF yields and newer companies will exhibit lower yields.
That’s awesome, so how should I use the above table?
A good way to make use of the table to gain insights is to pick up a business you know something about, observe its metrics from the tables and compare them across different businesses in the table. This will give you a feel of how certain businesses are better than others on certain metrics. Now, if you know what the metrics mean, you can use that insight to find a better business.
For example, if you like to look at Rule of 40 metrics for businesses, you can find a business that is better based on that metric. You may want to analyze the business based on some other metrics from the above table before you get comfortable and understand the business a little deeper based on the metrics.
Yay, I found something, am I done? No. This is just the starting point. After this, you dive deep into the business and voraciously learn everything about them, find out if this is something you want to own for the long term.
Some of the things I look for are covered in my deep dives. For example, look at the Samsara deep dive.
How do I think of businesses in terms of their growth?
I classify the businesses I own into the following types:
- Hyper-growth businesses which grow more than 40% each year
- High-growth businesses which grow in the range of 20%-40% each year
- Medium-growth businesses which grow in the range of 10%-20% each year
- Low-growth businesses which grow in the range of 1%-10% each year
Among these, I have a preference to own hyper and high growth businesses. I do own some medium-growth businesses too. Low growth is not my preference. This is because I want to own a business, learn everything about it and ride the business through its upward trajectory for 3-5 years at a minimum if possible. While doing this, as I am early in life, I want to build significant capital appreciation from my investments over the next 20 years. Low-growth and to some degree medium growth, simply does not fit my goals(So my discussion on these will be very limited).
Let's Look at some viable picks according to their growth from the above GARP valuation table:
Hyper-growth businesses which grow more than 40% each year
- CRWD, DDOG, OKTA, TWLO, ZI
High-growth businesses which grow in the range of 20%-40% each year
- PLTR, ZI, HUBS, JAMF, FROG, DT, SQSP, NOW, CRM, ZM, OLO, FRSH, HUBS, SHOP, SMAR
Medium-growth businesses which grow in the range of 10%-20% each year
- VEEV, ADBE, ADSK, WDAY, ZM
Take care and reach out if you have questions https://twitter.com/SaaSCompounder
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Thanks, take care.
Chet @ Modern Growth Investing