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Direct to consumer and the data explosion

December 22, 2021

Above is a chart of an ETF, QQQ3, which has been a long time favourite on Quentinvest. I am showing it for two reasons. First, it looks generally positive which is a good sign for the stock market as a whole. Secondly, because I am recommending buying this ETF along with three other leveraged ETFs, which capture the performance of the US stock market.

There are still plenty of alarming charts around but also plenty of good ones and so many companies are doing so well and are so confident on their prospects that it would take an extraordinary reversal of fortune to blow them off course.

One complication is that Covid and the endless stream of new variants affects companies in different ways including those in the technology sector. A further complication is that so many shares have risen so much in the last few years that profit-takers, understandably, have itchy trigger fingers.

Last but not least is the whole issue of valuations. One of the shares I mention below and which was featured in the last Quentinvest alert is Snowflake. The fundamentals are breathtaking but so is the valuation at around 100 times sales. The great 20th century value investor, George Graham, would have been stunned but then how often do you come across a company which is on track to grow sales nearly 12 times between effectively 2019 and 2023 (its year end is 31 January 2024), so 12 times in four years.

Not only that but the TAM (total addressable market) being addressed by the company and very much accessible in this technology-driven globalised world is massive. So massive that CEO, Frank Slootman, says he believes that at some point growth could reach a tipping point and become meteoric, whatever that might mean for a company already growing this fast.

How can anyone put a meaningful value on Snowflake? All you can say is that the company is incredibly exciting and the valuation is eye-poppingly high. As I noted in my alert, Berkshire Hathaway is a major shareholder so they must be believers.

As an investment holding shares in Snowflake is like being a passenger in a Formula One racing car being driven by Lewis Hamilton. If you think that might be fun Snowflake is a perfect investment for you.

All the foregoing is to attempt to explain why there is a lot of toing-and-froing going on in the market. My feeling now though is that my worst fears will not be realised but it is still a time to proceed with caution. The underlying fundamentals are just too strong. I read the latest reports from company after company and I just think – wow! Against that background it seems unlikely that shares will totally collapse though some are being severely punished.

Just to clarify a point on the figure for times recommended. QV for ETFs is being effectively merged with QV for Shares so I am adding to the recommendations made in QV for ETFs the recommendations made in QV for Shares. This means that, in total, QQQ3 has been alerted 26 times since the first alert, four years ago, in October 2017. As you can see it has done very well and no reason to suppose it is anywhere near finished yet.

So ETFs to buy.

Wisdomtree Nasdaq 100 3x leveraged. QQQ3. Buy @ $226.5. Times recommended: 26 First recommended: $31.50 Last recommended: $231.40. Lowest recommended: $30.50

Direxion Daily S&P 500 3x leveraged. SPXL. Buy @ $133. Times recommended: 2. First recommended: $87. Last recommended: $116.5 (Note that there is another similar leveraged S&P 500 ETF which has also been recommended in QV for ETFs – Wisdomtree S&P 500 300. 3USL. Times recommended: 11. First recommended: $572.25. Last recommended: $1777. Lowest recommended: $432)

Direxion Semiconductor Bull 3x leveraged SOXL. Buy @ $61.50. Times recommended: 15 First recommended: $11.33 Last recommended: $52.43. Lowest recommended: $7.86

Direxion Technology Bull 3x leveraged TECL. Buy @ $79.5. Times recommended: 7. First recommended: $24.75. Last recommended: $72.47 Lowest recommended: $22.20

The four ETFs above are all leveraged ETFs. They can be terrifyingly volatile but if you wait for the next buy signal after a period of volatility that becomes an opportunity, not a threat. These are the ones I prefer because I like the action – Formula One rather than Morris Minor.

IG will not allow you to buy the above ETFs on a leveraged account so I buy them in my share account which means I will never be forced to sell in periods of volatility. Just in the latest period of volatility QQQ3 fell 21pc in a matter of weeks even though that looks just a blip on a long-term chart.

If you don’t want volatility there are three ETFs which will move in the same direction as the above group but without the leverage.

QQQ Buy @ $389 (Nasdaq 100)

SOXX Buy @ $525 (Semiconductors)

SPY Buy @ $463 (S&P 500)

If you want even more leverage you could buy these last three ETFs as CFDs and get up to five times leverage. I don’t do that because I think it is very important with ETFs that you are never forced to sell. They are classic win in the end investments.

Nine shares for the data explosion

One of the phenomena of the age, especially in a Covid environment, is the shift to selling direct to the consumer (D2C). Below is a quick definition of what D2C is all about.

Direct-to-Consumer (D2C) in the manufacturing sector is a phenomenon of the digital age and specifically of this century. By the start of the 2000s, the sales structures in B2B [business to business] were clearly defined: Manufacturers produced their goods, sold them to a network made up of intermediaries or wholesale dealers, who in turn supplied to smaller dealers locally or to the end users. At the turn of the millennium, more and more companies focused on establishing online shops and therefore on an accompanying online sales strategy also.

Influenced by increasingly strong international competition with digital customer experience strategies, the demands on B2B companies increased. This especially applied to customer focus and personalization. With more and more companies establishing direct and personal interactions with consumers, “Direct-to-Consumer” as a new form of sales was born.”

I guess it is a bit but like Farm Shops. Why go through all those intermediaries when you can grow the stuff and sell it direct to the final consumer for a lower price but a higher profit. It works for Jeremy Clarkson and seemingly increasingly for the rest of the world. My daughter lives within easy walking distance of a string of giant supermarkets but she still gets stuff delivered.

In order to make the best use of direct to consumer and many other things in a technology driven world data has become key and is being generated at a staggering pace. One quote I saw suggested that as much data had been generated in the last two years as in all the rest of history. The mind boggles at what is going to be happening a decade from now.

The problem is that other investors have picked up on this opportunity and stocks which are key players in the data market, like Snowflake, are on super-demanding valuations. I have just been reading a piece about three ‘extremely overvalued’ stocks and the three were Snowflake, MongoDB and Cloudflare, which are all key players in the data space, growing very fast and making great play of the opportunities that lie ahead.

Companies are struggling to make use of all this data. A recent article in Forbes about the data explosion noted :- “On average, companies only use a fraction of the data they collect and store.”

The article went on to say.

“In fact, only 1pc of the world’s data is currently being analysed, while at the same time 100pc of the data is costing companies for storage.”

It concluded.

“Yet for businesses that can create and execute on a data strategy, there are significant opportunities for new revenue and business models, competitive advantage, and customer development and growth. To achieve this, the IDC predicts that “over the next three to five years, companies will have to commit to digital transformation on a massive scale.”

This article was written before 2020 but looks every bit as timely right now and explains why investors are so excited about shares in the companies which are helping the world to treat data as an opportunity rather than a cost.

The ones I have particularly identified as playing key roles in this process are:

Cloudflare NET. Buy @ $144

Confluent CFLT Buy @ $69.3 (new entry)

Datadog. DDOG Buy @ $180

Factset Research Systems. FDS. Buy @ $467

MongoDB. MDB. Buy @ $545

Morningstar. MORN. Buy @ $336

Snowflake. SNOW. Buy @ $359

Synopsys. SNPS. Buy @ $361

Yougov. YOU. Buy @ 1380p

ZoomInfo Technologies. ZI. Buy @ $65 (not to be confused with Zoom Video Communications)

There are differences here. Cloudflare, Confluent, Datadog, MongoDB, Snowflake and Synopsys are more at the infrastructure end helping companies and organisations deal with the data they are accumulating or need to access. Factset, Morningstar, Yougov and ZoomInfo are data providers supplying key data that companies need in order to operate more effectively. What they have in common is that their businesses are all about data.

The one that may be the least familiar to Quentinvest subscribers is Morningstar which only recently joined the QV for Shares portfolio although it has already been recommended four times starting at $246 in April 2021. Morningstar provides financial data on things like ETFs but it has an exciting something new which is really starting to power the shares higher in the form of PitchBook, a company which it acquired in 2016. Pitchbook specialises in providing data on unquoted companies, mergers and acquisitions, private equity and venture capital.

Launched in 2007, PitchBook is still led by founder, John Gabbert and is growing very rapidly. In Q3 2021 Morningstar sales grew 20.1pc to $428.9m of which 18.6pc was organic growth. PitchBook revenues grew 47.2pc while another recently acquired business, SustainAnalytics, grew sales 46pc from a small base to $19.8m. I have not been able to find the quote again but Pitchbook has recently been described as being a rival to Bloomberg and growing explosively.

At the time of the acquisition in October 2016 Pitchbook was described as follows:

“The company’s PitchBook Platform and best-in-class user interface make it easy for clients to access data, discover new connections, and conduct research on potential investment opportunities in the private capital markets. The PitchBook Platform covers data on companies, financials, general partners, limited partners, investment funds, and service providers. PitchBook has approximately 600 team members located in Seattle, New York, London, Ukraine, and India. PitchBook’s client count has more than tripled over the past three years (to more than 1,800), and sales bookings have grown by a compound annual growth rate of more than 70pc for the five years ended Dec. 31, 2015. Based in Seattle, PitchBook had $31.1m in revenue for the trailing 12 months ended June 30, 2016.

If we assume it is compounding at 50pc a year sales would be around $350m (just my guess) now against group revenue for all Morningstar running at around $1.5bn.

I also love the ambition at Morningstar. This is CEO, Kunal Kapoor, at the 2021 agm.

And we are particularly excited about the fact that even though they have become meaningful parts of our business, the addressable market opportunities available to us are still so meaningful. When Jason and I talk about Morningstar and our growth trajectory, we don’t wake up and say, how do we get to be a $2bn company. We wake up and talk about how do we become three times our size, five times our size. And one of the reasons we can do that is primarily because the addressable market available to us across different parts of our business remains so meaningful and so attractive, whether you are looking at our licensing business, our assets under management businesses, or our credit ratings business, which is just beginning on its wonderful journey, I believe, to really change the way credit ratings are impacted and used across the world. We have a really unique and wonderful proposition in this part of our business.”

Confluent is a new entry to the QV portfolio and also a recent issue so their shares are likely to be particularly volatile. They have already ranged between $37 and $95 in just seven months trading as a public company. The company describes itself as “creating the foundational platform for data in motion”.

The business is storming ahead.

I’m pleased to say our third quarter results exceeded our expectation and our guidance on all metrics. The outperformance we’ve seen is a result of great product market fit, the secular tailwinds driving the adoption of data in motion and cloud, and a lot of hard work by our team. I’ll get into these drivers in a moment. But first, let me touch on the numbers.

Revenue in the third quarter totaled $102.6m. This is significant for two reasons. First, this is our first quarter ever achieving over $100m in quarterly revenue, and we’ve managed to hit this milestone in less than seven years. And second, revenue growth of 67pc year-over-year represents a further acceleration from the growth we saw last quarter. Growth in Confluent Cloud revenue also accelerated coming in at 245pc year-over-year, well outpacing the growth of the overall business.”

In their first report as a public company CEO and co-founder, Jay Kreps, explained why he thought Confluent was doing so well. His explanation serves for others in the group.

“I think the underlying macro change that is driving Confluent’s success is that virtually all businesses are becoming defined end-to-end in software. It isn’t just that there are more software applications, but increasingly they are the core activities of the business. The production and distribution of goods and services and interactions with customers are driven by software. To do this, these software systems must connect end-to-end to the different parts of the business and operate in real time as the business executes out in the real world.

This transformation is really being driven by customer demand. In today’s world, consumers expect the best digital experiences from the organizations that they interact with. These experiences go beyond simply a user interface or app, but touch everything from logistics to operations to back-end processes that together create a customer experience. At the core of all the software that drives this is data. Data management has traditionally been about storage that is data at rest.

Databases have long been the mainstay of data management, and storage is exactly what they’re built to do. They help you safely store your data and look up or process the right bits as you need it. But now the explosion of software and data means that there are more databases, applications, analytics, platforms and SaaS layers. And increasingly, all of these systems need to work together in real-time to help operate the business. It isn’t enough anymore to have all these systems existing as disconnected storage silos. They all have to integrate in real-time.

Confluent’s role is extending support in the infrastructure layer to cover the other half of data management, the management of data in motion that databases have traditionally ignored. This problem is very different from the world of data at rest. It isn’t about storing piles of data for individual disconnected applications. Data in motion requires a platform that helps support the real-time flow and processing of data between applications as it is generated to help drive the operations of the business.

This new platform forms a key component of the emerging next-gen data architecture which we think over time will be a requirement for every company. By using data in this way, companies can make it far easier to tap into data from any part of the company and operate on it in real-time. The streams of data both trigger custom applications to take action, as well as enabling real-time processing and enrichment of the data and integration into other data systems.

Data in motion makes it possible to do this in a decoupled way because of the publish/subscribe nature of the usage. Any part of the business can publish the real-time stream of data about its own operation, and any other part of the business can choose to tap into that stream to react or process it.

Our goal is to make processing real-time data streams as easy and ubiquitous as the infrastructure around storage and batch processing. Our product strategy is laser focused on this goal. To do this, we’re building around three key pillars; being cloud native, being a complete offering for data in motion, and being everywhere. These three pillars represent key aspects of making this new paradigm the new default standard, as well as key aspects of differentiation that separate us from competitors. We think this differentiation is key to our success in driving Confluent’s high growth and, in particular, is the driving factor behind the outsized growth of our cloud offering.”

I think we all know that I am not a value investor. It is not just in the stock market. I like everything I buy to be reassuringly expensive. When I first moved from outer London to central London I was told to expect to pay twice as much for half the space and that did not put me off one bit. Fortunately I bought in the country as well because recently that has been where the money is going. I have a property near Brockenhurst in the New Forest where, according to the Sunday Times, prices have risen so much it should be near the blue end of the Monopoly board. Again though the property I own was expensive when I bought it. It works. Now I am told it is worth 10 times what I paid (after considerable refurbishment). Expensive is just a moment in time.

All the shares featured above are expensive. Snowflake is up there with the most expensive shares I have ever seen. It reminds me of the early days of Tesla, which looked ludicrously overpriced as it flirted with bankruptcy but has recently been bumping around a trillion dollar valuation. Data is everywhere now. If I want to market my publications I need data. The success of any campaign will not be determined by the quality of the marketing but by the quality of the data.

Similarly when I write my publications I need data from people like Factset and Morningstar. I consume it by the bucketload. Data is becoming the essential raw material powering the global economy, the 21st century equivalent of fossil fuel energy. So all these data specialists have a huge opportunity. They are like the energy stocks that became so gigantic in the middle years of the 20th century.

Direct to consumer, the new engine of global commerce, runs on data. It is yet another step from the real world into a virtual world where something you cannot touch matters more than the physical stuff. We saw it decades ago when Microsoft demonstrated that its software was far more valuable than the hardware on which IBM bet the ranch. That trend just continues as we talk about things like the Metaverse which is sort of a data construct.

In order to succeed in this world we are on a huge learning curve. How to collect the stuff [data]; how to store it. how to analyse it; how to share it; with whom to share it; how to make it secure; how to profit from it and on and on. Companies and organisations are not going to be able to do this for themselves. They won’t have the people, the focus or the time so they will turn to specialists – data kings like the companies above.

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