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US stock market takes a rest whilst UK stars are simmering

September 24, 2020

The US stock market is taking a well-earned rest. If I pick a star stock at random we can see what is happening. Docusign invented and dominates the market for e-signatures and is building on that to lead the market for all types of online agreements. This is a great business and they are gung-ho on prospects.

Based on forecasts Docusign is forecast to grow sales from $519m for the year to 31 January 2018 to $2,270m for the year to 31 January 2023. This is what CEO, Dan Springer, had to say about business when the company reported its Q2 2021 results on 4 September.

“I spoke last quarter about how so many of them [our 5,000 plus employees around the world] faced a sudden need to transition to remote work when the pandemic first hit. Today, that need has evolved from initial crisis response to business necessity. And because agreements are central to doing business, the need to agree electronically and remotely has never been stronger. This is causing greater adoption of our offerings, something we believe will persist beyond the crisis.

Because in our experience, it’s very rare to see anyone go back to paper once they’ve gone digital. The upshot of all this is that DocuSign is becoming an increasingly essential cloud software platform for organizations of all types and sizes, a fact that is well reflected in our Q2 results. Billings grew 61pc year over year to $406m, and revenue grew 45pc to $342m. We added more than 88,000 new customers, bringing our total to nearly 750,000 worldwide.”

It is obvious the business is going very well and has a huge opportunity. The problem is the share price. In September 2019 Docusign shares traded as low as $45. A year later they reached a peak of $290.23. This valued the whole enterprise at over $50bn; that’s a punchy valuation for a business looking for sales of $2.27bn in three years time when it is expected that it will still be making losses.

Docusign is a wonderful business, a wonderful share to have in your portfolio but even wonderful shares cannot climb to the stars all the time. The shares are currently $189, down a third from the peak reached earlier in the month.

This doesn’t mean it is game over or that the business has lost its star appeal. Docusign looks as exciting as ever and will surely be a much bigger business a decade from now but it became overbought and vulnerable to the profit-taking that has been taking place.

Repeat that across the stock market and you have an obvious explanation for why the Nasdaq 100 has suddenly dropped by 12.7pc in 11 days.

I don’t know what is going to happen next but the big picture remains as positive as ever. The world is in the middle of a massive technology revolution. Change is coming at an accelerating rate and the whole process has been given a further boost by Covid-19 and the associated lockdowns. The secular bull market will resume once the reaction has run its course. There is no way to put preciste numbers on all this but the big picture is that the ladders (the periods when share prices are rising) are longer and bigger than the snakes (when share prices are falling).

Choosing by eye is not very precise but I have identified around 73 periods of falling prices since the Nasdaq 100 index was created in the middle 1980s; that is a little over two a year. So far, on every single occasion, the index has gone on to reach new peaks. The odds are strongly in favour of the bulls, making buy and hold seem an obvious strategy and suggesting that it is always right to buy well-chosen shares on the dips.

This does not mean that portfolios are zero maintenance. Most of the shares that should be in your portfolio in 2020 are in companies that didn’t exist in 1985 so you do need to keep refreshing your portfolio, adding the exciting new businesses featured each month in ‘Great Charts’ articles and selling shares in companies whose past looks more exciting than their future.

As noted below many of these decisions are obvious. Many technology shares have exciting futures, whereas for bricks and mortar companies, traditional banks, fossil fuel cars and other industries it is more a battle for survival, which, if you are wise, you will leave them to fight without your money being on the line.

Ask yourself with any share whether you would want to buy the whole business. If the answer is no, stay away.

The sum of ladders less snakes has taken the Nasdaq 100 up roughly 10-fold since 2009 and 100-fold since 1985. It makes sense to have a portfolio full of the most exciting businesses, which make up this index. Alternatively you could buy QQQ, an ETF, which broadly tracks the index. Buy some of those every month and you are almost sure to do well.

I spend my working life looking for exciting shares to buy. I judge exciting shares partly by the ‘obvious’ rule as in – it’s obvious that Amazon is an exciting business. It is equally obvious that General Motors isn’t; that is why Amazon shares have risen around 300 times since 1997, when the business floated, while, over the same period, shares in General Motors have not done so well. There are no figures going back to 1986, probably because at some point between 1986 and 2010 the company went bust and needed to be rescued. Since 2010, when the shares were refloated they have dropped modestly.

Investment is not rocket science. Indeed, it is the attempt to make it rocket science that causes most of the problems. Use your common sense, buy the future, not the past and you should do well.

I have a rule that backs up my common sense selections. I look for shares that are 3G (great growth, great chart, great story) with a bit of magic and ideally something new going on, which can be the catalyst to take the shares higher.

Magic is usually easy to spot. Does Amazon have magic as a business? Of course, it does. This doesn’t mean you have to love everything about the company; few things are perfect but it is special in ways you cannot always reduce to a formula; that’s magic and there are many businesses out there which have this indefinable magic quality. Many of the ones I feature in Chart Breakout have it; ideally it would be all of them but I am not perfect either.

An important characteristic of an exciting business is ‘something new’. Indeed, you could argue that without something new a share really does not have a reason to go higher. Everything that is not new should already be in the price.

Amazon is an innovative business with an endless parade of ‘something news’ but some are more important than others and one in particular was a game changer for the business.

Back in the day individuals and businesses bought software in packages, loaded it onto their computers and then bought more packages when they needed to upgrade. Amazon never operated like that; when you bought stuff on Amazon you were always using the latest software, which they updated for you. We now call this process cloud computing; software supported by data centres which do everything for you, often including storing the data and where the software is always the latest version. It didn’t happen by accident. It was something Amazon did for themselves and somewhere along the line they realised (a) that it was something everybody should do and (b) that Amazon could help them do it and charge for the privilege.

It is another take on SaaS, software as a service. Instead of spending a fortune on hardware, software and engineers, which you need some of the time but which often stand idle, you pay for usage. It is cheaper, better and vastly more efficient. No wonder cloud computing has taken the world by storm.

Amazon launched its new business, Amazon Web Services (AWS), in March 2006 and it grew like topsy as we can see from a fairly recent description.

 “Amazon markets AWS to subscribers as a way of obtaining large scale computing capacity more quickly and cheaply than building an actual physical server farm. All services are billed based on usage, but each service measures usage in varying ways. As of 2017, AWS owns a dominant 34pc of all cloud (IaaS – infrastructure as a service, PaaS – platform as a service) while the next three competitors Microsoft, Google, and IBM have 11pc, 8pc and 6pc respectively according to Synergy Group.”

In the latest quarter, Q2 2020, AWS delivered operating income of $3.36bn. This was up 58pc year on year and compares with operating income for the whole Amazon group of $5.8bn. Amazon first revealed the results from AWS as a separate business in April 2015. The shares were around $400 when the world became aware of this important ‘something new’ happening at Amazon. Since then the shares have been as high as $3,500 plus.

Buying a share when a big ‘something new’ starts happening can be very profitable.

There are many other examples of the effect of ‘something new’. A now iconic example was a business supplying DVDs online, which in January 2007 launched a video on demand (video streaming) business. It did this four months after the launch of Amazon Video on Demand but it still did rather well, especially after February 2013, when the company launched House of Cards, its first original content.

I am sure you realised immediately that the company is Netflix. Since it launched video streaming the shares have risen from $4.50 to $470 having been as high as $575 before the whole market boiled over. The bottom line is that when an already exciting company like Amazon or Netflix does a hugely important ‘something new’ it is important for investors to pay attention.

Another reason why technology shares have been such strong performers in the new millennium is that their whole business model is about coming up with ‘something new’.

Zoom Video Communications has been a stunning performer during the Covid-19 lockdown because with nobody going into work video conferencing and the company’s customer base have exploded. The company has reported two successive quarters of growth in the hundreds of per cent, which have been described as maybe the greatest quarters in the history of the enterprise software industry.

But it is not just booming demand which is driving the growth. Zoom Video is bringing forward some important innovations and is using its rapidly increasing resources to make a massive investment in r&d, which promises more dramatic breakthroughs in the future.

The most important recent innovation is the Zoom phone. “Zoom Phone is a simple and straightforward cloud-calling solution designed for Zoom users who want to set up quick calls without video. If you don’t need the in-depth meetings you would usually turn to Zoom for; you can launch a quick VoIP call instead, using the same tools that you already know and love.”

Zoom founder, Eric Yuan, who is a remarkable individual, believes that video is moving to the heart of the communications experience and he is building what he calls UCaaS (unified communications as a service) around video. The Zoom phone is part of this process and gives him something extra to sell to existing clients and a more attractive and comprehensive package for new ones.

There are two other interesting things happening at Zoom which could also be described as ‘something news’. The group is offering packages with hardware built in so everything a business needs can be bought on subscription. In effect this means that instead of having to take risky decisions about which communications equipment to buy in a fast-changing world you can rent it from service providers reducing both risk and upfront cost.

The group is also seeing incredible growth outside America. “Our combined APAC [Asia Pacific] and EMEA [Europe, Middle East and Africa] revenue [for Q2 2021] accelerated to 629pc growth year over year and represented approximately 31pc of revenue. We will continue to invest in international expansion to capitalize on our brand awareness and the increased global opportunity.”

Zoom is on its way to becoming a global unified communications as a service (UCaaS) giant and it is a business built squarely around relentless innovation and Eric Yuan’s determination to make his customers happy.

I will have more to say about this in future issues but I am increasingly thinking of subscribers aiming to build their own 100-share portfolios, rather like the outperforming Nasdaq 100 but with QL-chosen shares instead. I think such a portfolio could (a) beat even the Nasdaq 100 and (b) be relatively easy to maintain.

One characteristic of the shares in the portfolio could be what I call a rising red line. This is a longish dated moving average, which I colour in red on the charts at which I look. As long as it is rising no sales should be made. If it is clearly falling it is time to step aside.

Last but not least I have been looking at another example of a star-performing share, the cloud security business, Crowdstrike. The company is growing at an incredible rate with one key metric, annual recurring revenue (ARR) growing from $59m in 2017 to $791m at the end of Q2 2021. It is an annualised figure so it keeps rising as the company keeps growing.

The number of customers is up from 1242 at 31 January 2018 to 7230 at 31 July 2020. International sales have grown from $19.5m for 2017-18 to $130m for the year to 31 January 2020 with around $240m likely for the current fiscal year.

The something new at Crowdstrike is that on the basic platform the company keeps adding new modules. At the time of the float in June 2019 it had around 10 modules. As it adds to these modules it grows the total addressable market. It also sells more modules to each customer. Latest figures for Q2 2021 show 57pc of customers with at least four modules and 39pc with at least five.

This means the company is rapidly growing customer numbers and also the amount of revenue it receives from each customer. No wonder it is becoming bigger at such a rate.

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