2 minute read / Feb 7, 2022 /
If You Had $10k to Invest, Which Stock Would You Buy?
If I gave you $10,000 to invest in one company today among the following four software businesses, which would you pick?
| Company | Growth Rate | ARR | Multiple (ARR/EV) |
|---|---|---|---|
| 1 | 100% | 100 | 50x |
| 2 | 125% | 950 | 25x |
| 3 | 71% | 2800 | 20x |
| 4 | 65% | 2960 | 10.5x |
The first company is a $100m ARR business growing at 100%, trading at 50x ARR, a $5b enterprise value. The fourth company grows 65% on $7b in ARR, implying a $29b EV.
Which investment will generate the greatest return? This is the question facing late-stage software investors today.
Some might choose company 1: the high-flyer with the richest multiple. Others might choose Company 2. Company 2 compounds revenue at 83% the rate of company 1, but at half the price. Value-oriented investors may opt for company 4. The revenue trajectory mirrors company 3 at one-half the price.
So who are these businesses?
The first company isn’t a company but a composite of where the private markets traded at the end of 2021. Company 2 is Bill.com, Company 3 is Shopify, and Company 4 is Twilio.
Two valuation kinks pop out from the table. The first lies between company 1 and company 2. Should a company growing 13% slower at smaller ARR than another fetch twice the multiple? The second discontinuity is between companies 3 and 4 who chart nearly identical growth rates but whose multiples differ by 79%.
The rapid halving of software multiples has disjointed the valuations between public and private companies, and between growth and value companies.
Venture investing clocked more than $329b invested last year, up 10x since 2010. Of that $329b, $253b (77%) originated from the wallets of non-traditional investors: hedge funds, crossovers, private equity, sovereign wealth, and mutual funds.
If these late-stage investors shift focus to public markets seeking investments valued at lower multiples resulting from the discontinuity, capital might fly from the venture market.
Nine digits of hot money rushed into venture in the last two years, doubling prices. The next few quarters may reveal what happens when these funds surge elsewhere.
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Notes:
- this post compares multiples across four companies which have different markets, business models, and margin structures. I chose them to be illustrative of a broader point rather than an expansive market view.
- I hold positions in Shopify and Twilio.