Valuing an Emergent Tech Growth Stock like Pushpay, page-2

Jogo

Whilst I can see the merit of your approach in drawing comparisons between ‘similar’ high growth tech stocks, the result centres on a ‘current relative valuation’ but uses the ruling SP which invariably has the future baked in. The extent to which the future is baked in would vary considerably from stock to stock based on their growth prospects.

For many of these Software Companies that spend years showing impressive growth but no profits, there seems to be a common reason, that being that they spend a very high (almost disproportionate) percentage of Revenue on Product Development. Whilst this stimulates competitive advantages and resultant growth, it comes at a cost to the income statement. Ever heard it said of XRO that if they turned off the Development tap for a year, they would instantly be profitable. IMO this is common to many of these type of Companies.

With this in mind, I tend to extrapolate the Revenue growth into the future, using past and recent trajectories (current momentum). Then I look at the current Development costs expressed as a percentage of Revenue. Then based on the interpretation of the Company strategy and Management Reviews, I scale back the % of Development spend using the same timeline as the growth trajectory.

This yields two positives for Revenue. The first is where let’s say the Company reports FY revenue of $100 m and Development Costs of $35 m ( so 35%). Future Rev growth YR 1 is 40%. So next FY Rev est. $140m. Development Costs maintained at $35m ( so now 25%). What impact on Income statement / profitability. Then repeat for a further 4 years, either maintaining the annual Dev spend at $35 m or scaling back according to the narrative (as appropriate). Normally as the scale improves, the operating leverage becomes a lot clearer. This exercise quite often reveals that ‘what looks like being ridiculously expensive today’ still has potential of further appreciating.

The second scenario is where a Company has spent $ x on Development for a number of years and reach that point where they have essentially have completed the product development. Here the reduced spend drops straight to the bottomline. The compounding impact of this over say 5 years of high growth can really ignite a surge in the SP, often simply based on conventional earnings multiples.

I always run a benchmark case where the Development Cost normalises at 15% ( covering minor refinements / maintenance ). Normally works for me in terms of a longer term price target.

Welcome thoughts from others. Interesting topic.

Rokewa