Since 2010, there’s really been this disconnect in the market. A lot of high flying stocks, with high growth rates and revenue with perhaps little earnings per share growth or maybe even negative cash flow, had risen to nosebleed valuations in terms of prices to sales and enterprise value to sales ratios. You can’t value them on other metrics, really. Some of them might have weak balance sheets, using debt and leverage to grow their revenue.
It’s been tough to watch. The first 20 years of my career was all based on looking at stocks that were growing and making money, then valuing the stocks on their P/E ratios. It was a pretty simple approach I used based on what I learned from Peter Lynch. I never really looked at the price of sales, or EV to sales type of valuation too much.
I wasn’t even a big fan of EBITDA. I would use a P/E ratio, adjusting the earnings for non recurring items and non cash items to get our pure non-GAAP adjusted P/E ratio. It worked really well. But, then I learned to go outside that box a little bit.
I learned that if you can find these companies trading around breakeven, not really burning a lot of cash, but growing revenue nicely, and continuing operations without having to raise money in the market, that I could kind of get into that game of playing the price of sales valuation scenario.
We’ve written about that a lot, especially when we’re looking at recurring and sticky revenue models as you would see in SaaS companies, or medical device companies. For us, that’s been an interesting dynamic to watch over the last several years.
And as an investor with roots in valuing a company in terms of just the earnings and cash flow, it was really tough for me to apply that strategy, but it worked well.
We knew that one day, the pendulum was going to swing where earnings, valuation and P/Es mattered. I don’t know if we’re there yet, but as the overall markets are near their highs, we’ve seen incredible blood underneath high tech names like RingCentral, Everbridge, and other software companies. This is also the case for medical device companies, like Clearpoint. CLPT, a company we found at Geo that ran from $4 to the 30s. Now, it’s back to $10.
We knew when we were buying CLPT that they weren’t making any money. But at that time, the market was placing a premium for high growth and revenue, so we saw nosebleed valuations.
Now they’re all coming back to Earth, and some of them even after losing 50% of their value, are still selling at price to sales ratios of 10 and 15 – And still not making any money. It’s not clear if this trend is going to continue. I believe that it may, especially in the smaller capitalized, nano cap area. So, that’s kind of what’s going on now.
In the end, I’m not a market timer, and I don’t know if that’s going to continue. But what we are starting to see happening here, at least in the short run, is the market beginning to place premiums on traditional value stocks that are selling at crazy low P/Es. They might not even be growing their revenue or earnings per share, but they are very cheap with respect to P/Es, and might even have some high dividend yields.
But if that turn happens, it can happen really, really fast. And it might not even matter if the company isn’t growing, as long as they’re just staying stable and there’s just a revaluation to a PE range of 5 to 15. So, we’re keeping an eye on that
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Continue to the PodClip where I go through a list of stocks on the Selected Long Disclosures related to the theme above.