1 Timothy Chapter 2 verses 5-6 state, "For there is one God and one mediator between God and mankind, the man Christ Jesus, who gave himself as a ransom for all people. This has now been witnessed to at the proper time."
As a Christian I think of today's themes - inclusiveness, equity, peace, among others and I find it ironic that Jesus Christ has already completed them and continues to offer them to everyone each day. The Bible is clear that there is one God and Jesus Christ is the only path to Him. This is not exclusive as God has created every person in history and for the future, and most importantly, God's desire is for none to perish and for all to have everlasting life. It is each person's choice as to whether they will accept or reject Him.
Sometimes I feel like investing is much more complicated than this, but I always need to remind myself that it is straight forward for the most part, and just like with the decision to accept Jesus Christ, emotions and selfish tendencies often get in the way. The Bible is the key and guide as it is God's word, having tools and parameters to counter today's emotional triggers and pressures for investing is also key.
I will admit that I was eagerly optimistic for UiPath, Inc. (PATH) as the company was preparing to go through the IPO process. My convictions were typical, focused on Revenue growth through addressable market opportunities, and Cash Flow inflection potential. Fast forward to today, and PATH just reported its first complete fiscal year as a public company and is coming up on one year after IPOing.
The "path" for PATH has been pretty rough throughout the company's initial IPO year, with the SP closing at an all-time low after the earnings report earlier today. While I'll focus on PATH briefly, PATH's debacle should challenge investors to consider valuations holistically as there are many inconsistencies within markets today. This is atypical, and largely stems from political and generational impacts, and the future of power and control will be shifting.
PATH's results were not terrible, and not great. They came fairly close to my expectations on Revenue, but saw a reversion back to negative Cash Flow performance, which I was not expecting. The reversion for Cash Flow is not materially concerning, but still an indication that PATH has farther to go before clearly illustrating a clear ROI per the business model.
PATH finished its fiscal year trading 19 times EV/Revenue with no multiple for OCF/Share as Cash Flow was negative. During 2021, PATH traded north of 50 times EV/Revenue, and after today's slaughter, is at a 10 times EV/Revenue multiple. The company remains in a very strong financial position with Net Cash at $1.9 billion. However, guidance for fiscal year 2023 was lower than my initial expectations, suggesting quicker deceleration than anticipated.
After digesting the results, I've updated my mid-term financial model accordingly. I had previously been expecting the company to see Revenue growth north of 30% annualized even towards 35% to justify investing in the $50-65 range. This has been reduced to 25% assuming slower growth the next couple of fiscal years, with acceleration occurring thereafter.
I've adjusted my OCF Margin expectations towards 15% over the mid-term, which still will show exponential Cash Flow inflection. Regardless at 15 times EV/Revenue and 80 times OCF/Share, investors could expect to see an annualized investment potential return towards 15% from today's SP at around $21.50.
I did purchase PATH on IPO day and averaged my cost basis to just below $57 last year. However, as the company reported its results, I became concerned regarding Revenue growth and Cash Flow inflection levels versus my cost basis and potential annualized investment return rate over the mid-term. I liquidated the entire position at just over $47 per share in late-November. In order for PATH to become a compelling investment again, my opinion is that it will need to drop towards the mid-teens. As Cash Flow inflection is less clear at the moment, I likely would not be a buyer at this level still.
Getting valuation right is a tough endeavor. Over the short-term, the stock market is highly inaccurate with its pricing as it deals with a slew of variables that impact volatility. Today, this is generally associated with the pandemic, inflation, and war/other geopolitical tensions. Politics continues to exacerbate problems versus find solutions placing further pressure. Longer-term, once consistency has been achieved, the market can more clearly value businesses based on sustainable expectations. For aggressive growth plays, volatility is the norm during early stages.
Ways to determine valuation range generally from explicit historical comparison, relative/peer valuation, discounted cash-flow, DCF, models, etc. I prefer to use a combination, accounting for historical and relative/peers directly, and a projected EV/Revenue and OCF/Share multiple over time rather than discounting back to today's price through a DCF.
Projecting out five years or more is more art than science (although science is always preferred), and I don't see any benefit either way for DCF or estimated multiples, based on inputs/assumptions for the future. The simple truth is that whether today or sometime tomorrow, every company will have an EV/Revenue and OCF/Share multiple. Time will tell as to my accuracy.
Two examples of explicit historical valuation (an argument for future multiple assessment versus DCF) are Amazon, Inc. (AMZN) and MercadoLibre, Inc. (MELI).
Over the past fifteen years, including 2022 performance-to-date, AMZN's average EV/Revenue multiple stood at 2.55 times (red line). The first seven years, the multiple was below this level, while the past eight including 2022 it has been above - 2016 being the near-recession anomaly. It should also be noted that in 2008, the Great Recession had impacted AMZN to a substantially discounted level.
We can also clearly see the peak valuation pandemic bubble during 2020 where AMZN traded 55% greater than the average. Interestingly AMZN has witnessed EV/Revenue multiple expansion well beyond pre-pandemic levels, a core concern moving forward and justification for projecting EV/Revenue back towards the average, or at a minimum a more modest premium towards 3 times. If the laws of growing scale lead to contracting multiples, which most would concur with, then AMZN has broken this trend substantially.
I always place stronger valuation prioritization on OCF/Share and the representation above for AMZN is a much more cleaner relationship with respect to sustained valuation, exception being the past two years post-pandemic, and coming out of the Great Recession.
Similar to the EV/Revenue valuation multiple, OCF/Share has substantially broken the norm with the caveat being that seemingly, 2020 was justified based on Cash Flow. This was masked though as AMZN's Cash Flow performance was severely inflated, a consistent occurrence across certain growth areas, notably, e-commerce.
MELI has a very nice sustainable EV/Revenue valuation with a clear extreme multiple expansion during the pandemic and similar to AMZN, discounted level coming out of the Great Recession.
MELI has actually displayed a much more justified pattern of scaling substantially and witnessing contracting multiples, although since 2013, the OCF/Share multiple has been much more stable. In any case, we can clearly see that MELI is not trading a premium as compared to AMZN through the pandemic, although the company has witnessed a similar inflated Cash Flow margin during 2020. The challenge with MELI is that the company has witnessed a much more volatile OCF Margin prior to the pandemic since its accelerated Revenue expansion post-2016.
Comparing AMZN (red circle below) amongst relative/peer companies isn't so easy as AMZN has strong e-commerce and technology businesses. AMZN also is one of the few trillion dollar EV companies as well. I am building a Competitors List database and I decided to combine the best of both worlds with Large Capitalization companies including Mega Caps ($200 billion EV or higher), and Technology-based companies per the list below:
Apple, Inc. (AAPL) - EV $2.8 trillion
Microsoft Corporation (MSFT) - EV $2.2 trillion
Alphabet, Inc. (GOOG) - EV $1.7 trillion
AMZN - EV $1.6 trillion
NVIDIA, Inc. (NVDA) - EV $674 billion
Meta Platforms, Inc. (FB) - EV $550 billion
Visa, Inc. (V) - EV $427 billion
Mastercard Incorporated (MA) - EV $355 billion
The Walt Disney Company (DIS) - EV $285 billion
Costco Wholesale Corporation (COST) - EV $250 billion
Cisco Systems, Inc. (CSCO) - EV $222 billion
Adobe, Inc. (ADBE) - EV $214 billion
Looking at these relative/peer companies, only COST has a lower EV/Revenue multiple based on the current and two-year estimate. From this perspective, AMZN is valued relatively well amongst its peers. suggesting a sustained valuation proposition for the future.
When using the same companies and comparing OCF/Share AMZN (red circle) comes in much higher for current multiple comparison and in the middle of the pack for the two-year estimate. As I stated before, I place a stronger emphasis on Cash Flow, so this is a red flag in my book.
Setting Valuation Expectations
Growth is never perfectly linear, but AMZN is a challenger to buck this trend irrespective of macro-economic cycles. That being said, as the company is definitely overvalued from a historical perspective, and arguably overvalued based on relative/peer comparison (especially as Mega Caps are collectively overvalued), I am taking a more cautious approach for mid-term valuation multiples - 3 times EV/Revenue and 25 times OCF/share. In this scenario, AMZN's potential annualized investment return is 10%. I tend to place more of the "science" into my Revenue segment and margin assumptions over time as this snapshot reflects the high-level output, while I continue to track historical and relative/peer trends to inform/update valuation expectations.
Pandemic Bubble Valuations
For me, while a company like AMZN is overvalued today, a 10-15% return while being overvalued is still a solid area for investors to be in. What I'm more concerned about are companies that are still trading at peak-pandemic valuation levels.
Upon reviewing EVs from $16 to $75 billion within the Competitors List, the following companies stand out with extreme EV/Revenue multiples:
Cloudflare, Inc. (NET) - EV $38 billion
Snowflake, Inc. (SNOW) - EV $64 billion
Datadog, Inc. (DDOG) - EV $47 billion
CrowdStrike Holdings, Inc. (CRWD) - EV $47 billion
Atlassian, Inc. (TEAM) - EV $74 billion
These five companies have current EV/Revenue multiples from 30 to nearly 60 times, and two-year estimate multiples from 16 to 30 times. While some have witnessed strong Cash Flow inflection, not all are Cash Flow positive. Those that are, are still estimated to trade with OCF/Share multiples around 100 times, with some even beyond this level. I can find aggressive growth companies meeting and/or exceeding expected performance for most of these companies over the mid-term with extremely discounted valuation multiples. There's a lot to unpack with respect to addressable markets, competition, etc., but there is no way to justify these multiples after the market has been decimated the past few months. These are examples that I believe will see a similar "path" of SP declines forthcoming.
A core question after going through the pandemic for investors to be thinking about is where valuation will fall over the mid-term. I'm still building a lot of data to exponentially increase the Competitors List to measure against my portfolio, but my sense is that there are four general categories for various growth types for EV/Revenue multiples over time:
Highest growth - 10-15 times EV/Revenue
Strong growth - 6-10 times EV/Revenue
Modest/sustained growth - 3-6 times EV/Revenue
Slowest growth - 0.5-3 times EV/Revenue
For OCF/Share I see it as follows:
Highest growth - 50-75 times OCF/Share
Strong growth - 30-50 times OCF/Share
Modest/sustained growth - 15-30 times OCF/Share
Slowest growth - Less than 15 times OCF/Share
The key is to find severely discounted miss-pricings of which there are some big ones at the moment. One example that I continue to promote is Roku, Inc. (ROKU), trading 5 times EV/Revenue and 75 times OCF/Share. ROKU is a great example of a company that will continue to thrive regardless of economic cycle. The current supply chain issues are a headwind, but more so for much larger companies across many industries. The supply chain issues today necessitate a stronger U.S. administration that unfortunately doesn't exist to restructure supply chains at a much broader scale. Regardless, ROKU will return towards an EV/Revenue multiple in the 10-15 range and continue to see Cash Flow inflection over the mid-term sustaining the EV/Revenue multiple.
For overvalued companies like the five listed above, investors are going to have a rude awakening, even if Revenue growth rates continue to win. It's always easy to look back in hindsight, but PATH should be a lesson for overvalued companies today. Unfortunately for investors, there are still many more than one would think.