In this episode of Industry Focus: Tech, Dylan Lewis chats with Motley Fool analyst Tim Beyers about how he analyzes stocks. Tim talks about his process for finding great companies and how he goes on to research them to find out if they make great investments.
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This video was recorded on November 13, 2020.
Dylan Lewis: It's Friday, November 13th, and we're talking about the process, building the process, and trusting the process. I'm your host Dylan Lewis, and I'm joined by longtime Fool and Lead Advisor on the Cloud Disruptors 2020 product, Tim Beyers. Tim, how's it going?
Tim Beyers: Going well, Dylan, going well. How about you?
Lewis: I can't complain, this is my favorite time of the year, I've got these burnt orange colors in Washington DC, the weather's beautiful, it's a great time to go walk outside, I'm hopping into Rock Creek Park as much as I can on the weekend these days.
Beyers: That's beautiful. I mean, it's pretty cold here in the mountains in Colorado, but it'll warm up a little bit the next few days and we'll get that beautiful Winter, but sort of Indian Summer-ish, and so, we've got the leaves but the snow hasn't come and stuck on the ground yet. If you've ever been to Colorado, you know that the snow does not stick on the ground for very long. We have one of the best Winters in the entire world I'll argue, but of course, I'm arguing for the home team here, so I've lived in Colorado for over 20 years.
Lewis: You know, I have been to Fool Colorado, I desperately want to get back and I'm excited to be able to do that at some time hopefully in 2021. Because in addition to Colorado being wonderful, you guys have some pretty cool stuff going on out there, it is a really awesome group of people and a very fun office. So, I'm crossing my fingers that I can make that happen sometime soon. In the meantime, Tim, I have to settle for virtual you, and [laughs] settle for hosting you on the show this way, which is fine by me, this is great too. And the reason I wanted to have you on is to, really, talk through the investing process that you like to use.
And folks that listen to the show, Brian Feroldi is on a lot, and what I love about having Brian on is he is someone who has a very set way of how he likes to look at businesses.
Beyers: He does, yeah.
Lewis: He's really, kind of, taken a methodical approach and honed it over time. And what's great is you can show your work when you're going through all these things. And Tim, I mean, you've been investing for quite some time, I think you are also someone who has put a lot of thought into how you look at businesses, and so I wanted to have you on to talk through how you do that and then just give people another take on what that looks like.
Beyers: Sure. So, you want to start with investing, like, where do the ideas come from?
Lewis: Yeah, I think we can go from, kind of, the initial spark of, like, this might be interesting, to how do you break that business down, and ultimately, what's the decisionmaker for you when you're deciding to put some money behind something? And so, I guess, yeah, let's start with the idea. I think there's a lot of lore to discovering companies, you know, there's this idea of sifting through spreadsheets or filters or that old wives' tale of being in line at a fast-casual restaurant and seeing the line is long and realizing, hey, this might be something, you know. So, where do the ideas come from for you?
Beyers: Yeah, it's very interesting. I hope this isn't a horribly boring answer, but there are three places, principally, and almost none of them have to do with the traditional things you might think of, like, looking at a list or doing a screen, I just really don't do that. And part of the process for me has been, I'm drawing on my experience in tech. And so, I started many years ago, like, I started my career as a sports reporter, you know, we talked about sports before we came on air here. I started as a sports reporter. I was a really terrible sports reporter, but I was a sports reporter. And then I worked in sports PR. And after a while when I got my graduate degree at Syracuse; so, you know, Go Orange! You know, I got a little exhausted with the process of just being in sports, because it was intense and it was amazing, and I'm so grateful for it, because -- and we can talk about this sometime or maybe even before the hour is over. But I had a chance twice, while I was at Syracuse, to cover NBA preseason games and I got to meet Charles Barkley and Michael Jordan.
And in the second game, I'm doing stats for the late, great Tom Mees of ESPN. And you know, it's a Chicago Bulls preseason game; I don't remember who they were playing, it might have been the Nets, which don't even ... you know, I guess the Nets is Brooklyn now? I'm not even sure, is that right? Okay. This is when they're still in New Jersey. And I'm just doing stats. And Michael Jordan comes over to the table, says "Hi!" to Mr. Mees. I'm like, wow! This is amazing.
And there were lots of great moments like that, but I got a little exhausted by it. So, when I went back to California, I started working for this tech PR firm and I got enamored instantly, I just got completely lost in it and learned everything I could about deep tech. And so now, when I start looking at deep tech stocks, I draw on that experience, and the first thing I do is talk with people, I talk with our developers, like, that's the No. 1 filter for me. Every two weeks I have this call on the books with one of our cyber security experts, this really wonderful guy named Jeff Levitt, and Jeff and I just spent an hour just talking about stuff. And he will help me dissect things that I don't see, because he's deep into the weeds.
And so, the first thing that happens when I'm looking at an idea is, somebody who has used the product or knows about the product has told me something that, sort of, sparks like, I heard something, OK, that's unusual. So, for example, people have heard me talk about Snowflake on Fool Live very often. When BG, who I've had gone on this week in tech, who's in our Data Platform team, when BG and Nicole, who are the leaders of our Data Platform team, tell me that this thing is amazing and it would be very hard for me to not use this, I get really interested.
Lewis: Yeah, there's usually good money to be made with delighted customers, I think, [laughs] that's a good investing axiom to follow.
Beyers: Big time. So, I really do start with the product, like, that's the thing in tech for me, there are many other investors who have different processes, like, Jim Gillies always starts with the proxy statement. He wants to see if leaders are aligned with investors; that's a great way to go. I always start with the product. Like, I want to know whether or not the product is a meaningful product that's going to delight customers in some way.
And sometimes, that comes, like, another thing that I'll use, I'll look for unusual stories. So, the way I found Peloton (PTON +3.19%), this is true. I don't know if I'm not proud of this or if it's just like, it's sort of just, kind of, sort of blew me away, like, I had heard about it --
Lewis: I can't wait to see where you're going with this, Tim. [laughs]
Beyers: I didn't know what it was -- I didn't really know what it was -- I had to ask people what it was. And then my wife told me a little bit more about what it was and how people really love it. And then I didn't really get serious about it until I read this article called, I Joined a Stationary Biker Gang, that was it, in The Atlantic. And the whole thesis for it was that people go crazy every year going to what's called Peloton Homecoming. Like, I knew about the bike and I knew that it was interesting, but nothing really put me over the edge on this until I learned about Peloton Homecoming. Do you know what this is?
Lewis: I don't, no. And I'm guessing a lot of our listeners don't, so [laughs] what's the 30- or 60 seconds on it?
Beyers: Peloton Homecoming, very simply, is like our FoolFest, people go to New York. And thousands and thousands of people pay to go to New York to get, like, facetime with the people that they workout with, because this is all virtual, but there are a lot of affinity groups that workout together, and they meet up at Peloton Homecoming. And they do these amazing things, it's like, you know, it's like a reunion, and it gets bigger every year. And so that told me that not only are they delighting customers, but they've actually built a community and that community is sticky, and it's independent of the product. And that gave me a lot of confidence that this business is more than what it was being depicted as.
Lewis: And so, I guess that filtering mechanism is a little bit different for how the ideas come in, but the core thing that you're looking for is the same, as your first example, when it comes to talking with the end user, where it's like, you want people that are delighted, you want rabbid users and people that are going to evangelize for this product or is this brand.
Beyers: The product matters. Yes, the product matters. And not the product itself, but people's experience with the product, this is something that Steve Jobs was really good at. And instead of the late Steve Jobs, as much, sort of, vitriol he gets for some of the ways he was just kind of cruel and some other things. Like, he didn't have universally good traits; I think we can fairly say that. But what he did understand is that what you're looking for is people's experience with the product, how people experience the product and their connection to it is an indicator of value, and so that's what I look for. I look for people's experience with the product. If they're meaningfully engaged, so like BG and Nicole tell me, this is crucial to our business, we're not looking at another data warehouse, this is the thing that we're going to use. And then I ask them the question, well, what would cause you to switch? And the answer, and this is true, from Nicole says, well, I can't really envision something that would force me to switch. And I say, OK, I'm going deeper on this one.
Lewis: [laughs] Yeah, bingo! That's what you want to hear if you're an investor. I'm sure there are some folks listening, Tim, that say, well, Tim you have a background in tech. You spend a lot of time in the space. And so, you've probably tuned some of your content-filtering, you know, the news you consume, whether it's newsletters or things you go to, to get some information. And there might be some people that are like, you know, it's awesome that you have these employees at The Fool that you can talk to that work in these spaces, I don't have access to those types of people in my everyday life. Are there any sites or forums or aggregators that you could point to and say, you know, this is a really good place, if you don't have those people, to start getting some of that information.
Beyers: Yeah. You know, if you're talking about a tech product -- let's just say we're talking about tech for a minute here -- there are a couple of things you could do, just about every one of these tech companies and tech products, they have some kind of community, so there are things you can look for. Like, you can go and join that community or you can observe it, and you can see how active it is. Like, if it's stale, like, the last message posted was three weeks ago, that tells you something, that tells you that it's not that interesting, whereas if you go to, say, one of the products that I use that I'm a big consumer of, Airtable. If you go to the Airtable community, which anybody can get into, if you take a look at that, you're going to see a boatload of messages, you're going to see a lot of messages. And what that tells you is that, even when those messages are frustrations, like, why can't you do this yet? Another way to frame, "Why can't you do this yet?" is I love your product, help me use it more, right? Like, that is --
Lewis: Tim, I think something that can sometimes get lost in the customer feedback loop or what could sound like criticism is like, I love you so much and I want you to be even better.
Beyers: I want you to be better. Yes. Why aren't you solving this problem for me yet, because I use you for so many things and I can envision, like, five other things I could do with your product, please help me do those things. When you see a customer begging for that; and you do see it, you know, you can go to some of these forums for these tech products and you'll see people saying, hey, when is this coming, when is this coming? That tells you that that company not only has customers who are interested, they have customers who want to buy more, which means they have optionality, so that community aspect can be very illuminating.
Lewis: I'm guessing Zoom is one of those businesses [laughs] so far in 2020, right, that has probably had an outpouring of folks reaching out. And just because we're, kind of, leading a lot of The Fool into this podcast episode, I'll just say, you know, you mentioned Airtable, I was in a meeting the other day where someone joked, just like, all right, we've said Airtable three times, take a drink, you know. Like, it's [laughs] basically like one of the most mentioned platforms internally at The Fool right now, and it has spread like wildfire because it's so successful.
Beyers: Yeah. And there are, admittedly, so there you go, there's my Airtable shirt. I'm not the only one, by the way, who's been an Airtable evangelist inside of The Fool. I mean, Doug Reale has been a big one, who's on our Blueprint team. Katie Carrera, who's like a power user of Airtable. And these people are growing up inside the company. When you start to see that, it is an indicator that things are going well.
So, yes, one thing you can do, if you don't have access to it, but I would also say, you know like, you could look at those communities, but I would also say, you probably have more connections than you know you do. And it could just be like asking your kid or asking an acquaintance and say, hey, do you know anybody who develops software, like, do you know any software developers? Or even just ask somebody at your work. You know, the vast majority of software developers are not working at a hi-tech company in Silicon Valley, they work in Middle America and they're either keeping software or they're developing new software for a company, it could be like a retailer. I mean, seriously, that's the vast majority of developers, do that stuff. So, you probably know them, you just haven't really engaged with them yet.
Lewis: So, Tim, with the sources that we just talked about for ideas, we've got basically, talking with folks and kind of just understanding people who have expertise, you know, what are they really focused on, what do they love. Looking for some of those unusual stories, like you mentioned with Peloton, or a product that just does something that nothing else in the marketplace can do, or addresses a need that you really need to be able to scratch.
You invest in a lot of things, we're going to keep this kind of in the techs sandbox, because this is a tech show. But when you see that, what is kind of the threshold for you being like, you know, I am going to dig deeper, and I'm going to spend -- you know, whatever that initial glance might be -- an hour, two hours, really starting to look at this business.
Beyers: Yeah, for me, it's usually pretty fast, only because I have an overdeveloped sense of this, and that's just a product of years, so for other people, you know, your mileage may vary. But the first thing I do is I use what I call the Ballmer test, which is just my silly way of saying like, does it appeal to developers? If you've never seen it, go look up, "Steve Ballmer: developers" you'll know exactly what I'm talking about, the YouTube will come up. [laughs] But Ballmer was right that developers do matter. And so, when you see developers that are, sort of, coming on board and using a tool or talking about a tool, it helps.
So, for me, like, I have access to developer, so I can verify that for us, because we use Fastly, and I can ask our developers how we use it, and I can get Dan Ceebus telling me, I can envision 10 different things we can do with this thing, it really starts to resonate with me. Independent of that, you can use this tool called GitHub. And GitHub is -- you know, you can look up how a company's product is actually rated. You know, you can look at the star ratings for some of the software libraries they'll put up there. And all of these companies, they usually put their software up on GitHub, it's a way to organize software development. And so, yeah, look for those stars, it can be very interesting.
Also, just look for stories. Honestly, you can do a Google search, and say like, you know, name your company, developers and see what pops up. If developers are talking about this, it's usually a good sign. So, that's one thing I do. If developers are interested, and sometimes in their SEC filings they'll say like, we have X many developers that use our product. All of those things are, it's a checkbox, if developers like it, I'm starting to get interested.
Another thing I'll say is that I want to look at this from the perspective of how was the company born? So, I really like to look at the origin story. We talked about product, like, product is what I lead with, right? Something, a historical pattern that I have found is that, especially in tech, when a founder is customer zero, like, they had this problem and they were determined to build a product to solve it, that's usually a really good indicator. And so, there are many companies like this, Fastly is like this, Artur Bergman, working at the Wikimedia Foundation, playing around with other content delivery networks not working for him, saying, screw it, I'm going to build my own. Builds his own, makes it better. That's a customer zero incident.
That's Fastly being founded by a CEO, now Chief Architect, who says, I'm going to be customer zero here and build something better. That was also true for MongoDB, it's also ...
Lewis: And for the folks that maybe aren't familiar with MongoDB and Fastly, Shopify is like, that is probably one of the best known and extremely [laughs] successful case studies in exactly what you're talking about there, Tim.
Beyers: Yeah, Tobi Lutke, customers zero, I'm going to build it myself, because the thing that I need does not exist. In tech, which is naturally an innovative field, when a founder comes in and is customer zero, pay attention to that.
Lewis: Yeah. I love that, because usually if that's the case, it isn't hard to find that, you know, it's going to be front-and-center in the prospectus, it's probably going to be in the About Us on the company website. Anybody who's covering it, especially if it's a lesser known company that's coming public, that's going to be in the lead of the news article about that company, that just becomes the story.
Beyers: Yeah, no doubt. And then the third thing I look for is how big of a problem is this? It can be an annoyance for a founder, but if it's not a big enough problem that it's shared widely, then that can be just a nice little hobby. But to be an investable business, it really does have to be a migraine-level problem. So, is it a shared problem, like, is the problem an annoyance for this founder, who is customer zero, and they have solved the problem that is a big problem? Like, in the case of Fastly, it clearly is a big problem. They're big sites that need to be able to dynamically update their content instantly, in microseconds, it cannot be, like, a 30-second delay, we can't have that. so, Fastly's innovations are necessary and applicable to a wide group. Same thing with MongoDB, and same thing with something like Twilio.
So, you do want to take a look at the Total Addressable Market. And last weekend I did a little bit of a deep dive on taking a look at Total Addressable Market by identifying who the ideal customer is. So, really, all this is, Dylan, is like, who's the ideal customer? How many of them are there? If there are a lot of them, you've got something. Like, in the case of Twilio, for example, you've got essentially the world's developers, because everybody is putting communications into their software; texting, email, what have you, right? So, you got tens of millions of developers; that's a pretty big market. So, yeah, I see it ...
Lewis: And Tim, you know it's funny you mentioned Twilio, I was going to mention Twilio, because you know, I think developers can be an overlooked element within the tech space. And for me, like, that company was a real turning point in understanding who needs to love a product. And part of it was that they were so open and candid about it, they were just like, [laughs] developers love us. Like, if you talked to developers, they're going to be like, yep, they give us the building blocks, they make our jobs way easier, we don't have to build this thing, we're able to integrate it. And that really changed the lens that I looked at a lot of companies with.
Beyers: Yeah, absolutely. Take a look at what the customers say about the company and be clear -- you know, very often a company will tell you who their ideal customer is, Twilio is very clear about this, they say right upfront in their SEC filings, developers are our customer, these are the people that we talk to. And you want to know that, and if a company is ambiguous, or let's do the warning sign. So, the flip side of this is to say, like, our stuff is for everybody. Run. Run away from that, because there's no such thing. You know, if you don't have a niche that you're starting with and you don't have a problem that you're solving for a very specific customer, then really you're just doing, you know, finger in the wind, that's all that is, that's a bad strategy, run from that.
Lewis: [laughs] So Tim, so far, we've spent a good chunk of the time on, kind of, the softer stuff that you need to do some reading, you need to get a feel for the business. You mentioned TAM, and I think we can briefly touch on a couple of financial elements that you tend to look for once you feel like this might be something, there might be something here. So, when you're looking at the numbers, does it start with Total Addressable Market, are you looking at the financials first? You know, where are you tending to focus your early research?
Beyers: The financials are the last thing that I look at, they quite literally are the last thing I look at. I look at customer and product, like, those two are the first two things that I look for, customer and product. Then I look at leadership and I look to see whether or not this is a customer zero company, if it's a customer zero company, I'm really interested. And one of the other patterns that I have found in tech that really resonates is a technical founder paired with a business founder. So, that's like HubSpot, you know, Brian Halligan, Dharmesh Shah, one is the CEO, one is the CTO. Shared vision, but division of responsibilities, that can be a really great combo.
That was also true, for example, at MongoDB. Now, those founders, more than 13 years later after starting the business, they've since moved on. I'm not really concerned about that, because 13 freaking years, [laughs] that's a long time to do a heavy-lift, right, but similar idea. So, I like that a lot. And then when I finally get to the financials, Dylan, I start looking at some metrics that are a little off-standard, I start looking for what I call the compounding metrics, because very often what you're seeing are things like, it's not profitable yet or, you know, revenue growth is off the charts, but they're burning cash. You know, how much money are they going to need to raise, when are they going to get profitable? Like, things like that.
So, instead, I started looking for high rates of revenue growth, but I started looking for things that give me some sense of unit economics. And unit economics meaning, for every product that they sell, say, every license, every time somebody uses the product, the more people that use it, the more profitable it becomes. Like, I want to be able to see evidence that that is going on. So, I look for things like gross profit growing faster than revenue, that's really useful. I also like to see, over a long period of time, when revenue growth is leading, let's say, R&D growth. Revenue growth leading R&D growth, that can be really useful as well, because I don't just want to see, like, good products, what I really want to see is good products that are saleable. So, if a company is spending a boatload on R&D, but revenue growth is slowing, you know, they may be throwing a lot of money at products that don't work, so I like to see that too.
And then there's this unusual statistic called the rule of 40, it's not a perfect statistic, but I like to see some improvement in this area. I don't need it to be over 40, but here's how the math works. You're taking the revenue growth rate, so as a percentage, so let's say, a company is growing 50% annually, and then I add to that the operating margins. So, revenue growth rate plus the operating margin percentage, so let's say a company is growing 50%, and its operating margin is -10%, still losing money, well, that's still 40%. So, the rule of 40 says there's enough growth there that over time we can expect this to be a cash generating company. I like to just see that, even if it's not 40, I like to just see it improving; if it's improving, I'm good. Like, I want to see signs that this company is gaining steam as it grows, if it's not, then I have to ask why.
Lewis: I love all of that. [laughs] And I think Brian and I have joked on the show before, you know, doing the prospectus breakdowns, like, it's a high growth company that's losing a ton of money because they're just shoveling money into sales and marketing. Tell me if you've heard this before, right --
Beyers: Yeah, right ...
Lewis: And just like, we see this over and over and over again. And so, I think, to be clear, we're talking about relatively early stage businesses with a lot of the criteria that you're using. This kind of goes out the window for something that has been profitable for maybe five or 10 years and is a lot firmer in its position in the market that it's going to be growing into.
Beyers: Yeah, totally. I mean, a mature business, you really wouldn't want to use the same level of diligence. You would want to be looking at profit, you want to be looking at margins and you'd really want to be looking at, like, if this was a dominant tech business, one metric, it's not a bulletproof metric, but one you could really look at, is free cash flow margin. You know, the best of these tech businesses have ridiculous free cash flow margins.
Let me give you an example; Amazon Web Services, 30% free cash flow margin. That is bananas. Meaning, $0.30 of every $1 of revenue flowing down for Amazon Web Services shows up as cash. Period. Just cash. Like, that is extraordinary.
Lewis: Yeah. And that's why they can do everything that they can do, right? They have that huge cash engine that's pushing everything forward for them.
Beyers: 100%, yep.
Lewis: And one of the other things, I think one of the threads I want to pull from what you laid out with the financials is. When you see things like gross profit growing faster than revenue or growing faster than R&D or sales and marketing spend, it kind of signals a couple of different things. One of them is that there's leverage that the company is enjoying. And it is basically being able to spread more usage over whatever fixed costs they may have in place, and that leads to a more profitable business over time. One of the other things that that can hint at is, existing users are continuing to spend and they maybe are even spending more. And so, that initial sales and marketing investment that you're making winds up really paying off down the road as you're in year two, three, four, five of your relationship with your customers.
Beyers: Yeah. And you should always ask. So, when you see those, let's take that one step further, and say like, when you see that, you may also see the company support or publish a statistic called, either dollar-based net expansion rate or dollar-based net retention rate. And if it's high, then what you're seeing is customers spending more. The difference between those two, by the way, you know, you're just comparing a cohort of customers year-over-year, and if it's greater than 100%, that means they're spending more. The greater it is over 100%, the more they're spending.
If it's an expansion rate, you're taking the same cohort of customers. You know, these 30 customers, and then these 30 customers a year later. If it's a retention rate, it's all the customers that started a year ago and then the customers that remained. So, it could be like there were 60 customers here and now there are 55 left, but we're counting everything from that 60, including when those others dropped off, everything that dropped off, and then we're just comparing it to a year later, and is it higher? So, that retention rate includes churn.
Lewis: Yeah, we often say on the show, retention rate is the good one. [laughs] You know, expansion rate is helpful, but if retention looks good, then that's even better, because it's a little bit more of a complete number.
Beyers: It is, it's absolutely right. And then the other thing you may find is, you know, if you're seeing these efficiencies, that a company may have introduced new products. Like, as part of that R&D spend, there are new products that have come out and now they're selling those new products and it's gaining efficiency. This is why we like optionality so much, that's why you hear us talking about optionality all the time. When a company is making new products and then rolling them out and then you see this divergence, revenues growing faster than, say, sales and marketing spend, they're gaining some efficiency here. That's the beauty of innovation. You know, you found something else you could do for your customer, you solve that problem, the customer spends more, margins increase. That's good.
Lewis: And I think what we should, kind of, remind people of, is we talked about TAM before, TAM is not necessarily a static number, you know, it's not established once and then that is the TAM. If you start realizing that there are adjacent markets that you can work in, that TAM could become bigger over time.
Beyers: For sure. You know, Total Addressable Market is not necessarily useful to say, like, wow! This company says its TAM is $80 billion and its revenue is only $200 million right now, it's going to get to $80 billion in revenue some day! No, don't think about it like that. But do think about it in terms of how is that company behaving. If it has a large market and that TAM has historically been growing, and it's serving its ideal customers with more stuff, and it's growing the amount of business it does with those customers over time, and its TAM is growing, then this company is probably very healthy, it may be expensive, but it's probably very healthy and has more runway than even the street expects.
Lewis: So far, when we've been talking numbers, Tim, we talk TAM and I think we wound up hitting cash flow and the income statement. Before we leave numbers, is there anything on the balance sheet that you really tend to focus on with the first glance at a business?
Beyers: Yeah, I want to see if they're not yet cash flow positive, you know, what's the burn rate? So, if they are burning cash, how much are they burning and how much do they have in the bank after you subtract all of their lease obligations and bank debt, how much do they have and how long could they support this cash burn? So, let's say they have $200 million in cash and $100 million in debt and leases, that's $100 million of excess cash. If they're only burning $10 million of cash a year; that's 10 years of runway. That's fine. But if it's $70 million that they're burning, I may not want to invest here, because they're going to have to go back to the well real soon, and the terms on that may not be great.
Lewis: Yeah. And as an investor that puts you in a spot where they're either going to be taking on more debt or you're going to get diluted as a shareholder.
Beyers: You're going to get diluted, and you really don't know. And here's the thing that I ask in that situation is, why is the cash burn so high? Like, what is it they're trying to achieve, and is it worth it? And that's a good question to ask. Like, every time you're looking at a business where there's some unknown, asking, what is it this company is trying to achieve and is it worth it? That's a really useful question to be asking yourself ...
Lewis: And other people, [laughs] it is, and that's the beauty of it, you can simply throw that question out there. And, you know, some management teams are responsive, and would be happy to answer those questions.
Tim, I mean, you've been in tech for such a long time, directly and as an analyst. And I'm guessing, at this point, there is not a lot that is going to get past you, but I'm curious --
Beyers: Oh, you'd be surprised. [laughs]
Lewis: [laughs] I'm curious if you still have those moments of, you know, I don't get it, or is this too hard. And like, what do you do when that's what you're, kind of, facing?
Beyers: Well, the beauty of the stock market is that -- I mean, I'm stealing from Warren Buffett here, but you know, you can just keep the bat on your shoulder, man, you do not have to swing at every pitch. And that's the beauty of it. So, if I don't get it, and this happens to me all the time, I don't get it, then I don't swing. And I can give you a clear example of this. You know, when there is a company that is assembled from a lot of different parts, particularly a lot of old tech, like, I am just -- we talked before we came on air, about whether or not I'm superstitious, so I'm not really superstitious, but I'll tell you, I'm really suspicious of a company that rebrands, has a lot of old tech and is layering new tech on top of it. That kind of gives me the heebie-jeebies, and sometimes unfairly so.
Like, I have immediately taken out, and said nope, I don't want any part of that. And I've done that. The most recent time I did that was with Dynatrace (DT +0.31%). So, that ticker is DT. This is a company that does application performance management. So, essentially looking at how your infrastructure is performing; it's a Datadog competitor, and I really like Datadog. And so, I have been admittedly dismissive of this company, because it's founded back in, like, 2004. Then was formed and sort of bulked up after purchase in private equity, I believe. There is an older company called Compuware that brought it in and then brought it all together, and then it was a private equity firm came in, a good private equity firm, Thoma Bravo, came, brought it in, put some more money into it. And then spins it out. I'm like, God! I don't know, I don't know, man! This just feels like you're putting a lot of stuff together. And they promised they rebuilt everything from the ground-up, but really, did they? And so, I just got instantly suspicious of it.
But you could argue, if you look since IPO and over the past year, Dynatrace has beaten the market. Now, it's not beaten the market by as many companies that I chose to focus on, but it's still beaten the market. So, that was some unfair, arguably, suspicion on my part. But, yeah, every time that comes up, Dylan, and I'm thinking like, this is too hard, my response is, I'm not touching that one. I may come back to it, but I'm not touching it right now.
Lewis: Yeah, I think complicated leadership history or complicated corporate history, where it's been taken private, brought public again, it's changed hands a couple of times, usually if [laughs] someone likes something, they're going to hold onto it. And so, that's kind of a red flag for me as well.
Beyers: Yes. Yeah, absolutely. So, I have so far been wrong on Dynatrace, and I may prove to be wrong for the duration of this company. Because so far, they are winning, they're doing fine. They get reasonably good ratings from industry analysts like Gartner. So, is my skepticism warranted? I haven't gone back and reevaluated, but at least in terms of stock market performance, the answer is no, my skepticism was not warranted so far. Maybe later on I'll be proven right, I don't know.
Lewis: [laughs] And that's the beauty of this, we get to keep scoring the whole time.
Beyers: We get to keep scoring; yes, exactly.
Lewis: [laughs] And that's the fun of it. And we -- I think, one of the things I love about being at The Fool is we have that transparency. One. And what we do allows for that transparency. You know, I did a show last week where I was like, I was dead wrong about Upwork versus DocuSign, thankfully, I bought them both, [laughs] and, you know, wound up benefiting from the multi-bagger returns that DocuSign has enjoyed, but I was dead wrong about Upwork. And that's going to happen, you're not going to be right all the time, you're going to be wrong sometimes.
Beyers: No, you're going to be wrong a lot. So, if I could just, kind of, if you're going to distil the process that I use, I recognize that it is not the Brian Feroldi process where it's like a deep checklist, and I'm just checking boxes. I don't do that. And that's primarily because I am relying a lot on my experience. But I can tell you, I start with the product and the customer. I look for the ideal customer and I look for the appeal of the product, is there a real connection to the product. And if the founder or even the CEO or the team, if there is a customer zero mentality there, if those three things, if I can check the box on those three things, there's a clear product here that really has a big customer base and that customer base is obviously growing, they have an attachment to it, because there's a clear need. That really excites me. And sometimes I get that from developers, sometimes I get that from articles. But if I can identify that, that's the first thing I look for.
And then, you know, customer enthusiasm wrapped around that, so I can tell that there's a big problem here, it's a meaty problem and a lot of people have it, then I'm really interested. And if there's a customer zero mentality here, so that I know that there's going to be more building, more improving, like there's a lot of investment that's going to grow this company over time, I'm interested. But I get to the financials at the end of the process. I'm really looking at, is this a migraine-level problem? Are customers really excited, and I can identify who those customers are? And you know, is this a killer product? Like, that's what I want to know; that's what I want to know.
Lewis: I think I know the answer to this, but is there a point where valuation factors in?
Beyers: There is. Like, in the case of Snowflake, which is a company that I love, but there's no way I can justify that valuation, because the amount of growth required is, you know, so massive that I'm just not willing to make a big bet on it. So, for me, a company like that, I might even want to own, like, one share, but that's it, and then I'm kind of waiting to see, because, you know, I can be patient, the market is always going to give you more opportunities. So, yeah, my valuation exercises, Dylan, are working back to see what's the required revenue growth or cash flow yield for some of these companies. So, if I can justify the revenue growth that's required, given the present valuation, then I'm interested. And I have a little bit of a model to do that, it's not the same thing as a discounted cash flow analysis, but it's kind of close. And that's how I look at it. But it's the end of the process.
It's more important for me to see that this is a company that actually has rabid customers and has a market that it can grow over a long period of time, because the products are clearly needed. Because this is the thing with tech, right, there are a lot of faker products, in tech in particular. You know, boy! You want to have a drinking game, play buzzword bingo on any kind of tech. [laughs] You will not survive the night. [laughs]
Lewis: [laughs] To make sure we didn't miss anything, Tim, we have the focus on the product, the users, leadership team, the founding story, financials and valuation wind up coming in there at the end; is there anything that we missed in that process where you're ultimately saying, like, yep, this is something I want to put some money behind?
Beyers: Incentives. I mean, incentives do matter. So, when I see how a company and a leadership team measures itself, and if it is consistent with what we want as investors, that is usually a nice proof point. If it's really off-kilter, then I get a little bit concerned. It's something I check; it's definitely something I check. It's not the first thing I check, but I do want to know how the incentives line up.
Lewis: Yeah. I mean, a company with warped incentives can provide shareholder returns, I am less convinced it will happen consistently.
Beyers: Yeah, I think that's right; I think that's a great way to put it.
Lewis: Yeah. Well, Tim, thank you so much for talking through this with me.
Beyers: Yeah, absolutely.
Lewis: I think that this is a very good option B., not to say that Brian Feroldi is the A. choice, but another, a multiple-choice approach to --
Beyers: I'll give him the A. choice. Can we just say, like, if you can do it and you have a very clearly defined checklist for yourself that the amount of stress that takes off of you mentally I think is worth its weight in gold. So, I give a strong +1 to a great checklist, and both Brians have great checklists.
Lewis: Yeah, Brian Stoffel being the other Brian, who has been on the show before. But, yeah, we're trying to give something to everyone here. Some people like the clear framework, other people like the thought exercises that I think you tend to go through with your approach. And you know, I know in Brian's case it's like, I have the framework, so that I can blame the framework, you know. [laughs] You create these systems, so that there are times where it just doesn't work, it doesn't come together and you can at least, kind of, dissociate from it a little bit. [laughs]
Beyers: Yes. And in my case, I have nobody to blame but myself here, because if I am making erroneous judgments or my filter is wrong -- this is why I talk to a lot of people though, I mean, I don't want to make it seem like I just make snap judgments here, I tend to talk to a lot of people. Like, before I made a bigger bet on Fastly, I wanted to talk to a lot of different analysts and developers about it, because it is really complex, and I needed to know more. And as I've gone deeper and I've learned more, it has confirmed for me. But this is not a short process, [laughs] it was not a short process with Fastly at all.
Lewis: That's actually my immediate question in hearing you say that is, if you were to ballpark this whole thing that we've just run through in real time, what does it look like, is it days, weeks, months?
Beyers: It's usually a couple of weeks to get to a place where I feel very confident, but -- and this is the big but -- if it's really complicated and I feel like I'm in the right ballpark, then I will take extra time. So, like, with Fastly I really felt like I needed to take extra time, you know, with Arista Networks, I feel like I needed to take extra time, because these are deeply complicated businesses. But generally, you know, like Peloton, a couple of weeks.
Lewis: Well, Tim, I think I speak for our members and our listeners when I say I am happy that you put in that extra time, because you are an awesome source of investing ideas, and as we found out today processes as well.
Beyers: I appreciate that. I probably get way more credit than I deserve here, but I'll take it and I'll take it humbly. Thank you.
Lewis: Yeah, thanks again for joining me, Tim.
Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say, "Hey!" shoot us an email at [email protected]. In fact, if you have a really awesome checklist or approach to investing, we want to hear about it, maybe we can do a listener-focused show at some point. We're always looking for ideas, always looking for different ways to look at companies. You can always get us on Twitter as well @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes or wherever you get your podcasts.
As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear.
Thanks to Tim Sparks for all his work behind the glass today, and thank you for listening. Until next time, Fool on!
