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Spurning Wall Street’s Valuation Status Quo

Steve Symington discusses his flexible, long-term oriented approach to valuating businesses.

December 22, 2020

Valuation is obviously an important part of determining the potential for any stock to beat the broader market’s returns. So it’s no coincidence that recognizing “valuation matters” is one of the core principles that guides our methodology here at 7investing.

But we also approach valuation quite a bit differently than most other stock-picking services, spurning the “12-month price target” approach that Wall Street has popularized in favor of presenting a more evergreen, big-picture view of the potential longer-term returns for becoming a shareholder of any given business. In reading the rest of my colleagues’ takes on the same topic published today, you’ll notice we each implement a slightly different approach in how we individually form that big-picture view of the companies we research.

I personally favor (but don’t strictly adhere to) a top-down approach to investing and valuation —  first looking for sustainable macro trends, sectors, and/or industry tailwinds that are likely to usher in significant positive change, then drilling down further into the specific companies I believe will benefit most from those tailwinds. And I generally want to see businesses that are early in their respective growth stories, with comparatively small market capitalizations relative to the size of the industries they’re working to disrupt or create.

And you won’t find me citing the same tired metrics to value every stock — a topic our colleagues Austin Lieberman and Matt Cochrane covered in some detail in one of our earliest 7investing podcasts back in April.  Each business is unique and deserves to be valued as such.

Rather, it depends on the business and its specific operations, whether we’re talking about insurance-centric financial holding companies (where price-to-book values are often, but not always, cited as a nice round valuation measure), real estate investment trusts (or REITS, where dividend yields and funds from operations (FFO) are important), or software-as-a-service names (where recurring revenue growth, price-to-sales ratios, and dollar-based net expansion rates (DBNER) can be useful).

As for whether the market itself is overvalued —  I’m not so sure. To be clear, I would welcome a healthy pullback with broader-market indexes trading at all-time highs. And we can perform all kinds of simplistic mathematical acrobatics to argue overvalued conditions are present today — I’ve seen various analysts cite everything from forward P/E ratios to market caps relative to GDP and the impact of treasury yield trends to that end in recent months, only to watch the market continue its relentless march higher.

Instead, as I described above, my focus will remain on finding high-quality businesses trading at reasonable valuations relative to their target addressable markets and long-term potential.

As for one “overvalued” company that I think the market is consistently underestimating: I think DocuSign (NASDAQ: DOCU) fits the bill nicely. Sure, we’re talking about a company valued at over $46 billion with its shares having more than tripled since this time last year —  even as a chorus of bearish traders called its valuation everything from “absurd” to “mind bending” along the way.

That certainly doesn’t mean DocuSign stock is impervious to pullbacks and volatility — and indeed, considering I still don’t own DOCU shares myself, I’d welcome a hefty drop to give us a chance to open a position at a lower valuation. But we’re also talking about a business that expects annualized revenue of just over $1.4 billion this year and recently capitalized on the optionality provided by new products — namely the rollout of its DocuSign Agreement Cloud suite early last year — to more than double its estimated total addressable market to $50 billion globally. Criticize its lofty valuation all you like, but I suspect that won’t be the last time DocuSign moves to expand its reach from being “just” an e-Signature company to evolve as a budding leader in the broader digital transaction management (DTM) industry.

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