Priorities in order: business quality, growth runway, valuation.
Never before in business history have companies been able to grow their revenues at 50%+ for years on end (software has enabled this growth; SaaS model has enabled visibility to recurring revenue).
Businesses with predictable revenue will obtain much higher valuations than cyclical businesses with lumpy revenue.
Software gross margins 70-80%+. CAC is peanuts vs. customer lifetime value, therefore spend aggressively now to obtain customers who pay off for years. Hence valuing companies on current earnings doesn't make sense since most earnings will be in the future, and they are spending heavily on sales and marketing now to create future cash flows and (eventually) earnings.
Many companies are already FCF positive, with negative earnings due to heavy sales and marketing spend. Therefore must value companies based on future cash flows, not current earnings.
Evaluation method (starts at 19:45)
- Look at current revenue & FCF + revenue & FCF multiples
- Estimate 5 year revenue CAGR = revenue at t+5 (analyst, company predictions)
- Estimate t+5 margins = FCF at t+5
- Estimate growth reduction and therefore multiple compression for revenue & FCF multiples at t+5
- Look at t+5 EV or market cap vs. today's EV or market cap. If CAGR is 15%+ do further research and potentially invest
Order of analysis
- Quality of business: model, moat, margins (fundamentals)
- Quality of management
- Valuation
- Price chart (accumulation, free fall, run up, etc.)
- Market is efficient most of the time, but not at extremes
- Hence opportunities are found in emotional times
- Corollary: price free-fall of stock during normal market conditions often means there's something you haven't found
- Make buy/sell decisions