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What If 2020 Was Just Tech Getting Started? (Cestrian Stocks Bulletin #38)

What If 2020 Was Just Tech Getting Started? (Cestrian Stocks Bulletin #38)
By Cestrian Capital Research, Inc • Issue #38 • View online
In which we leave our cynicism at the door, for once.

DISCLAIMER: This note is intended for US recipients only and, in particular, is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Cestrian Capital Research, Inc., its employees, agents or affiliates, including the author of this note, or related persons, may have a position in any stocks, security, or financial instrument referenced in this note. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note’s date of publication and are subject to change without notice. Companies referenced in this note or their employees or affiliates may be customers of Cestrian Capital Research, Inc. Cestrian Capital Research, Inc. values both its independence and transparency and does not believe that this presents a material potential conflict of interest or impacts the content of its research or publications.
Pass The Kool-Aid, We're Addled
As everybody knows, this whole market rally is doomed. The real economy is crack’d, asset prices are all jacked up on Fedamphetamines and thank-your-choice-of-God-you’re-still-alive endorphins, inflation is coming, or if not then deflation, and anyway one of those -flations is going to smackdown real estate and stock prices, Delta variant is running amok, infections are on the rise and all in all RUN FOR THE HILLS IT’S ALL GOING TO H*LL IN A H*NDBASKET. Right?
Well, maybe. Definitely if you read your Economics 101, we’re all doomed. For a generation or more. Because not only do you have to deal with all the above, but we will all be toiling to pay the welfare bills of those struck down by long Covid, and having to do their jobs too, because they sure will be too sick to do the work themselves. Productivity down, GDP growth down, inflation, or deflation, or stagflation or another kind of flation that nobody has invented yet. Doom!
The thing is, if Economics 101 ever was any use for predicting asset prices - anyone ever use CAPM, really??? - it probably isn’t right now, because the underlying conditions are so divorced from the 20th century backdrop in which conventional Keynesian and monetarist frameworks were formed that neither paradigm offers much explanatory power if you ask us, still less any kind of sensible policy guidance and frankly almost zero power to predict asset prices.
Born and raised fundamentalists, true believers in the dream of the Enlightenment, we find ourselves more and more turning to stock charts to light the way ahead. In a nihilistic world where there is no dominant guiding ideology, be it political or economic, where there is no consensus about how to value $x of revenue or earnings or cashflow, well, what better way to value and predict stock movements than that most postmodern of tools, the chart. Where feelings can move a stock as easily as a rational earnings reaction.
(We’ll let you into a secret. ‘Twas always thus. Rational stock analysis by any method is just an ex post facto tool to make one feel in control of the world. It’s a Renaissance garden for the modern age.)
If you read our stuff you know we have a fondness for Elliott Wave analysis. It’s easy to get all high falutin about Elliott Waves but that’s not really necessary. The basic principle is that humans get happy in 5 steps up, and sad in three steps down. Unless they are depressed, in which case they get sad in five steps down and happy in three steps up. Easy.
Apparently as an act of magick, but in fact as an act of everybody following the same spell recipes ergo creating a self-fulfilling prophesy, Elliott Waves tend to respect Fibonacci limits. Meaning that the limits of each wave tend to occur at specific Fibonacci levels. And that means that the predictive power of this stuff can be pretty good. Not every time, else it would indeed be alchemy, but more times than you would think. Sitting here at Cestrian Towers, where we mainly while away the present End Of Days drawing lines and coloring in charts, we are taken aback at how often the combination of Elliott Waves and Fib levels are on the money.
And here’s a pattern that keeps recurring as we go over the tech names we cover. It looks very much to us that the crazy-up ride that cloud names had in 2020 - specifically from March '20 to Feb '21 - might be merely Wave 1 of those Five Happy Waves. And, since Feb '21 - May '21 saw these same names mainly hammered into submission before rebounding sharply in June to achieve in some cases new all-time highs - that looks like the brief Wave 2 hangover followed by the start of the Big Ol Happy Wave, Wave 3.
This pattern can be seen at Zscaler, at Crowdstrike and others.
Here’s Zscaler ($ZS).
Slurping The Kool-Aid, One Stock At A Time
Slurping The Kool-Aid, One Stock At A Time
And now CrowdStrike ($CRWD).
Positively Waterboarded Now
Positively Waterboarded Now
Now, there are many better Elliotticians than us around town and no doubt potshots and brickbats can be hurled at the various assumptions in those projections. But the basic chart logic is sound and in particular the possibility that 2020 was just the beginning for these names is definitely, er, possible.
The question is, how can that be? Given the darkness on the edge of town right now?
The answer, we think, is the same answer to the question asked by non-tech folk which is, “why is tech always too expensive” and the 1.618 extension of that question (that such folk never ask of themselves because it would be internally embarrassing for them and cause psychological difficulties), “how come I am always wrong when I decide to not buy the best tech names because of that same dumb valuation that has kept on getting dumber these last twenty years”.
Why is tech different? It’s not different. It’s just younger. Tech is still a very, very early stage industry. If you think that the oldest pureplay software stocks (as opposed to software rolled in with hardware and services) are maybe 30-40 years into their trading lives, and you think that say railroad stocks have been trading for maybe 3-4x that time, you can see why it might be early days yet. And for some categories - particularly cybersecurity in our view - it is way early. And way early means higher rates of revenue growth. And cloud delivery means big ol cashflow margins the likes of which railroad stock owners can only dream. (If you ask railroad stock owners they will likely tell you that these newfangled high growth tech stocks all lose money lol).
You see if you take $ZS as an example and you say, that chart above constructed using Elliott garbage and Fibonacci nonsense, you know the one that says that the stock currently valued at, er, 51x TTM revenue, that stock right there can move up from the current $227 to maybe $327 within a year from now, don’t be ridiculous what are you smoking? We would say, well, the stock was at $227 or so in February this year, chart says it could reach $327 in Q2, maybe Q3 2022, that’s a >40% move up from Feb ‘21, but as the company is growing revenue at 54% p.a., that $327 would involve the revenue multiple coming down, not up. Ah, you might say. But no company can keep growing at 54% p.a. whilst also generating very positive cashflows, as $ZS does. And we might say, well, anything can happen, but $ZS’s backlog, their very large book of contracted business or 'remaining performance obligation’ in the lingo, that’s growing even faster than recognized revenue which means there is every chance that revenue growth accelerates. Which all other things being equal means the revenue multiple can move up, not down. In other words, coming back to the Age Of Reason method, fundamentals are improving and our rather fanciful price target implies a worsening of fundamental valuation, so, that’s not so racy is it?
(One day we hope to produce the Grand Unified Theory Of Everything. No, not the reconciliation of Newtonian and quantum physics. Something much more important than that. The happy-ever-after marriage of fundamental and technical analysis. We haven’t tried yet because we suspect that way lies The Beautiful Mind, but, when we get a minute, we’ll have at it).
Naturally we don’t know if $ZS or $CRWD or the many other tech names that look like 2020 was just the beginning ($NET, anyone?) will play out that way. Indeed we love a tale of doom as much as the next fearful investor. But, they might do. And that’s how we’re playing them with our own money for now. We aren’t buying much at these levels because we bought a bunch at lower levels (and flagged such opportunities in our pay services. $CRWD in the $160-180 zone just a couple months back for instance). But along the way, a pullback will come, it always does, and then? We may add a few shares to the back of the truck.
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Cestrian Capital Research, Inc - 8 July 2021.
DISCLOSURE - Cestrian Capital Research, Inc staff personal accounts hold long positions in CRWD, ZS and NET.
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