It’s been a busy couple of months since the last update: I’ve started a new job, spent two epic weeks visiting the U.S. for the first time and re-vamped the website so that I’m no longer reliant on a paid blog-site provider (thanks Matt!) Meanwhile, global affairs kept churning out ever more surprising stories. We had the shortest tenure in history for a U.K Prime Minister, a major cryptocurrency exchange spectacularly blew up (its accounts amounted to nothing more than a sparse Excel sheet), and Elon Musk did some things (at this point I’d happily go without hearing his name for a few years).

[New York at Night.jpeg] There are some great businesses out there… not a bad view either

Away from the mania, it’s been nice to detach myself from the daily throes of market noise and, amongst other things, re-evaluate my approach to investing. This year hasn’t exactly been a good one for the portfolio and I wanted to examine why that was, what the learnings are and whether I should adjust my approach going forward. My conclusion on the latter is a resounding ‘yes!’

[Warren Buffett Stupidity Quotes.png] With the exception of the first quote, a good summary of where I’ve gone wrong in 2022.

Why? Let’s start with the biggest mistake I made; quite simply, I overpaid. One of the fundamental principles of the SaaS-investing community (of which I considered myself a part), is that business performance ultimately trumps stock valuation. However flawed that may sound in today’s rational environment, for a time, and certainly since I began investing in the sector in late 2019, it worked. Money was cheap, investors (me) assumed low rates would continue in perpetuity, public SaaS business were issuing beats and raises galore, and everything was looking golden.

Looking back, my mindset was embarrassingly naïve. Here I was, a newbie to the stock market, and having completely fluked my way to substantially outperforming the broader indexes over two years, I thought it was just going to carry on! On reflection, I was just experiencing the benefits of an extremely concentrated portfolio in a very tech-friendly monetary environment. Valuation truly didn’t matter! As with all things though, if it’s too good to be true…

Global inflation and the increase in central bank rates that it’s caused has brought everything back down to earth. Given the affect that this has had on all stocks, not just tech, it’d be easy to conclude that the right approach is to just bear the brunt of the pain and, presuming that each holding continues to effectively execute each quarter, keep adding to my positions as opportunities present themselves. And for many people that will be the right approach. They have confidence in the businesses that they hold, and that they hold them at favourable valuations. While I had confidence in the businesses that I hold, crucially, even considering the vast drawdowns over the past few months, I no longer believe I’m holding them at a reasonable valuations.

This is the part that’s tough to admit: I didn’t do enough work. In part, I can blame my lack of experience: for much of the first year or two of my investing journey, I hadn’t heard of valuing a stock using discounted cash flows. From 2020 onwards though, my only explanation for buying what I now view as substantially overpriced shares is complacency - it’s easy to sit back when things are going well.

Aside from long periods of contemplation, my shift in approach to valuation has been aided by digesting various investing material. I’ve highlighted some of the sources that I found most thought-provoking below:

  1. Betting Better in Markets & Life w/ Annie Duke (Podcast)
  2. MBI Deep Dives
  3. William Green’s book, Richer, Wiser, Happier: How the World’s Greatest Investors Win in Markets and Life

In an ideal world, the greater risk you take on, the greater the potential reward. Unfortunately the reality is different. MBI’s SaaS models have forced me to reckon with the fact that at peak valuations in 2020 and 2021 and even more recently, I was taking on a disproportionate amount of risk relative to a very slim chance of reward; Annie Duke’s podcast episode helped me think about the biases present in my decision-making (though being aware of these biases isn’t the tough part) and to explicitly ‘think in odds’ when approaching investment decisions; the host of that podcast, William Green, highlights a separate key lesson in his book; that, speaking generally, the best investors in the world leave as large a margin of error in a purchasing decision as possible to account for the likelihood that they are wrong.

It may seem that I’ve swung from a ‘growth’ to ‘value’ oriented mindset just as the indexes have swung from favouring the former investing style to the latter. While that may be true at this moment in time, it’s a shift that I don’t see budging with future market vicissitudes because it’s one that I can stick with. Ultimately, valuation as a component of stock-picking matters more to me than I’d previously cared to acknowledge, and I believe it’s wise to fix this part of my investment process sooner rather than later. That doesn’t mean I’m going to discard SaaS stocks entirely but it will mean that I will hold only those that I think have a fair chance of outperforming the expectations inherent in their valuations going forward, and even those, at a concentration that I view as proportional to the chance of that outperformance. I feel very fortunate that I have the opportunity to make such a shift at a time when my portfolio is still (just about) beating the market over the past 3 years.

As a result of all this pondering and the details laid out in the ‘adjustments’ section, for now, I’ve placed the majority of my holdings in an index tracker. I intend to trim this over time as I improve my investing skill in different sectors and find attractive opportunities. In the meantime it diversifies my holdings whilst hopefully giving a better return than a savings account.

Business Updates

At the end of August I posted:

“As with most months so far this year the direction of travel is likely to hinge on comments made by senior Fed officials about the aggressiveness in their approach to tackling inflation. Until its effects start showing up in earnings reports though, I’m not inclined to pay them too much attention!”

Well, following Q3 earnings season, it’s safe to say software has finally been hit! Earnings kicked off with the tech heavyweights reporting cloud slowdowns early on:

Cloud Year over year growth (%) Sequential growth increase/decrease (%)
Amazon Web Services (AWS) 27 -2.9
Microsoft Azure (constant currency) 42 -4.0
Google Cloud Platform (GCP) 38 1.6

All 3 highlighted customers optimising their cloud consumption in the face of tough economic headwinds. Unlike 2020 though, it’s not just businesses trimming the fat on excess costs; both Amazon and Microsoft mentioned the impact of rising energy prices on operating costs. Due to the increasingly competitive cloud environment (are Oracle becoming relevant again?) it was my assumption that these costs were unlikely to be passed through to customers, though the AWS slowdown didn’t bode well for usage-based businesses like Snowflake and Datadog and so it transpired.

I’m outsourcing the individual stock updates this month, as Stock Novice has already done a stellar job of covering earnings updates for Crowdstrike, Datadog, Cloudflare and Snowflake. Although I agree with his general sentiment on Crowdstrike and Snowflake’s quarters, I felt both Datadog and Cloudflare had encouraging reports in light of the current macro, particularly with the latter raising monthly pricing towards the end of November, something that will boost free cash flow for Q4 and should deliver an overall positive FCF position for the final 6 months of 2022.

YTD return vs benchmarks

(Index source: Koyfin)

Portfolio Nasdaq S&P 500 FTSE 100
-53.15% -26.50% -14.59% 2.32%

Portfolio

Holding Ticker(s) Weighting (%)
Nasdaq 100 XNAQ 46.1
Crowdstrike CRWD 11.7
Snowflake SNOW 10.2
Datadog DDOG 6.1
Cloudflare NET 5.8
Amazon AMZN 4.7
Cash - 15.3%

Adjustments:

There’s been a lot of upheaval behind the scenes over the past couple of months as a result of investment account consolidation which resulted in a prolonged cash-holding period while funds were transferred from one brokerage to another (my previous broker didn’t support in-specie stock transfers). This meant a cash position of ~50% from mid-September to early November.

While the broader market has declined since then, the benefit gained by re-buying at a lower price may well be offset in the long-term by the abysmal pound-to-dollar exchange rate that U.K. investors are currently forced to pay when buying stocks in businesses across the pond. This came to my attention when selling down my previous accounts’ holdings; the pound had fallen so much since my initial U.S. stock purchases that they have provided a slight hedge against it! There’s a chance the opposite situation will now play out whereby after re-purchasing stock near the all-time low exchange rate, the market gains confidence in Rishi Sunak’s revamped government and, by some later point when I’m ready to sell, has pushed the pound’s value back up. Then again, it might not…

Either way, I began buying back shares of Datadog, Snowflake and Cloudflare early in the month (I decided against re-opening positions in MongoDB and TakeTwo). After U.S. CPI data was released on the 10th, and the Nasdaq had its best two-day percentage gain since December 2008 I took the opportunity to sell the rest of my small position in SentinelOne. Despite inflation coming in lower than expectations, and indications that the next rate hike will be 50 basis points rather than 75, Jerome Powell, chair of the Federal Reserve, has made it clear that rate rises will continue to be the norm in order to achieve the fed’s 2% inflation goal.

Adjustments over the next month are likely to involve trimming my SaaS positions further and redeploying this cash into the index tracker.

Closing Remarks:

It’s been a whirlwind couple of months, both in the investing world and outside it. I’m looking forward to a quieter period before Christmas. Hope everyone has a great December and holiday season! I’ll be back with the regularly scheduled post at the start of January. Until next time!