Left Brain Thinking: Growth Investing with Ryan Reeves, CEO of Investing City

Hello everyone and welcome to Left Brain Thinking. We're here joined by Ryan Reeves of Investing City. He's the CEO and founder over there, and, uh, thank you for joining us. This is our first time having a guest, so Ryan has graciously agreed to be our first guest on the show, and you can look forward to seeing plenty of, uh, more guests as we, uh, continue with this format. So Ryan, welcome.

Thank you, I'm honored to be the first one.

Thanks so much, Ryan. Before we get started, we've got a little bit to read from, uh, compliance here. The opinions expressed by our guests are not endorsed by Left Brain and may not reflect the views expressed by other clients or investors. Depending on the facts and circumstances, public commentary made directly by a client about their own experience with or endorsement of an investment advisor, their personal investments, or their approval of Left Brain is considered a testimonial. Testimonials are based on unique experiences from current clients or private fund investors and are not representative of all client experiences. Testimonials are unsolicited and no cash or non-cash compensation is provided. Well, with that out of the way, Ryan, We'll just jump right in. I want to learn a little bit more about your background. I know you and I have talked a couple of times on your podcast and really enjoyed the conversation. There's a lot of the reason why I wanted to have you on first. So I guess the first question is, what drew you into the investing business? And we'll start from there.

Sure. So I— it was kind of a random thing, but in the 5th grade, I actually had a teacher who had like a little afterschool program where she brought in her husband to talk to us about the stock market. And you could show up if you wanted to, or not. And for some reason I showed up and we had this little stock picking competition. And, you know, usually people do this when they're seniors in high school, but for some reason we did this in the 5th grade. And I thought it was really fascinating that you could just kind of observe the world around you, you know, figure out what kind of restaurant you liked as a kid or different media. And video games, and you could actually make money by investing in those same companies of the products and services that you use. And I thought this was a really fascinating thing. And I also just have kind of a lifelong passion for puzzles. And I very much view the market as a big puzzle that you can try to figure out. And there's just so many dynamics that it's really just, you can endlessly learn whether it's psychology, economics, business, there's just so many things that investing provides in terms of you can just go so deep. And so all those aspects kind of led me to investing and I've kind of just stuck with it ever since.

[Speaker:ROBERT_LEONARD] I kind of agree with how you got into it. It's a little similar to my story. And once this investing thing gets a hold of you, Um, never really lets go, does it? Um, do you remember what your first stock was that you picked, uh, back in the 5th grade?

Sure, so it was Corning Glassware.

Um, GLW, right?

Yes, exactly. I, I remember reading an article that was talking about how Corning was gonna, uh, be the, the main provider of Gorilla Glass in the new iPhones, and this must have been What year was this? This was probably, you know, 2008 and iPhone was launched in 2007. So, I mean, honestly, I wish I would've just picked Apple and just held on. I just read this article that was kind of random and I was like, oh wow, that's cool. And I didn't even think to choose Apple, which would've been the much, much better choice. But, you know, surprisingly, I just got lucky on this first pick and over the next 3 years, the stock doubled. And I was like, wow, you know, I doubled my tiny little amount of money, but if this was bigger, you know, um, that could actually made a big difference. So, I think it's kind of interesting. You hear different stories where some people get lucky on their first pick and it really sucks them in. Some people do really poorly on their first pick and then they like go even deeper. Like, what did I do wrong? So it's kind of just interesting, the different personalities. And I kind of wonder sometimes if it didn't work out, would I, would I still be interested in it? I think so, but it's kind of funny to think about.

Yeah, it is funny. Just kind of a binary situation like that. It could have gone a different way and you could be in a completely different situation. It's really interesting. I wouldn't beat yourself too much up about Apple. I don't think in 2008 it wasn't as obvious Apple was going to just destroy everything like it did. But yeah, also a good learning experience, right?

Totally. Yeah, I think. And it is interesting. I mean, sometimes We try to get too cute with it where we're trying to find the picks and shovel player to this big revolution. And sometimes the revolution is kind of staring us in the face. And so I've kind of been thinking about that lately where I think the really the best long-term winners are a little more obvious than we think, but we try to get too much in the weeds of little details. So it's just a thought I've been having lately.

[Speaker:IAN_CASSEL] Yeah, around here we say a lot of the time investing's really simple. It's not easy, but it's simple. And a lot of the times we do outthink ourselves or overthink ourselves. And there are a lot of considerations too. A lot of times we're looking to diversify portfolios and it takes us away from concentrating in some of the best ideas. And obviously, as advisors here, we have a lot of different factors that go into how we make decisions. But sometimes the simplest thought is the one that's going to be the right one. So That's a really good lesson to take from that, I think. Well, other than the 5th grade, kind of what else in your background, you know, drove you this direction here?

Sure. I just think business is such a force in the world. I mean, anybody who has a job in some context, if they're— even if you're in a nonprofit, like business is just the exchange between value between products and services, just serving your fellow man. And I think that studying different business models and just figuring out what sort of models work really well and what sort of things don't work really well. Kind of goes back to that puzzle solving thing. So yeah, I think business is such a force for good and just being able to figure out what are the businesses that are delivering the most value to customers is a really interesting intellectual exercise. I mean, Warren Buffett has that quote that if like the better investor you become, the better business person, the better business person, the better investor. And yeah, I think that that's pretty true. And I just have kind of always had a fascination with business.

I think that's a great point. I think, you know, and the way the stock market is covered and the way people are introduced to it, you sometimes don't even realize that it's about a business underneath. And, um, and we'll talk a little bit more about your philosophy and kind of the way we see things too, is the fundamentals are generally going to win out in the end, and the best businesses tend to be the best investments. And, um, you know, as long-term investors, it's, uh, important to keep sight of that, you know, again really simple concept. But from day to day, that's the challenge, is tuning out all the noise of price and sticking to those fundamentals. So, and that's something we're really dealing with in the last few months, I would say, more acutely than, you know, any time, at least in recent memory.

Totally. Yeah, I think that that is a really important point to bring up. I mean, last few months have been, you know, very difficult for companies that are growing fast. And, you know, you hear all this talk about regime changes and narrative is shifting, you know, growth stocks, just nobody wants to own them. But if you look at the fundamentals, a lot of these companies are still just trucking along. And so it's kind of interesting how Mr. Market can sour very quickly on companies, even though the results have really not changed that much. And I think that the way I like to describe it is, so I was a basketball player all growing up. And one thing that you would— coaches would tell you is when you're playing defense, you should stare at the opponent's waistline because the waistline actually doesn't move as much as the ball. If you're staring at the ball, the ball's moving all around and you can really get distracted and the person can just go right by you because you think the ball's over here and then it just changes so quickly, but the waist, you can't move the waist that fast. It's— and I view that similarly in investing. The business results is really like staring at the waistline and the stock price is like the ball where it's going all over the place. And so if you can focus on what's most important, just keeping that offensive player in front of you, so to speak, then it really helps you just kind of keep your mind straight. And when everybody's losing their mind, you can go back to what are the things that I can control, which is focusing on the business and making sure that growth is good, margins are good, everything's headed in the right direction, the industry dynamics. These are the things that we can focus on. We can't control what other people are doing by buying and selling the stock, but if you know why you hold something and you can have a long enough time horizon and just focus on what matters, I'm focusing on that opponent's waistline, then it really helps.

Ryan, I really love that analogy. I usually hate analogies, but, uh, I thought that one hit, um, pretty well actually. Um, okay, well, you touched a little bit on your philosophy of investing, and I want to dig a little bit more deeply into that. Um, you know, how did you come to this philosophy of growth as an investor, why do you prefer growth? And yeah, let's start there and then we can dig in from there.

Sure. So when I started investing, the first place you stumble is Warren Buffett. Everybody, it's like the first thing that you kind of find. And so I started reading all of his letters and I was like, "Wow, this stuff is a little bit over my head, but obviously he knows what he's doing. He's like the richest investor ever." And so that was my first foray into investing, low PE stocks, very value investor sort of mindset. And I thought it was very interesting. I thought that it was super fun just to learn about different businesses, but when I got introduced to more of a growth style investing, something clicked. I think that I've always kind of had a fascination with technology too, and different industry trends and Whenever I would read letters from venture capitalists, that was where like my passion seemed to lie. Like I really enjoyed Warren Buffett, but there was just something a little more interesting to me. And I think that an important thing is to kind of follow your curiosity, because if you're really curious about something, then you're going to learn about it, you know, so easily, so deeply. Versus if you're kind of forcing yourself to do something, then, you know, it's just a little bit tougher. And if the thing is that investing, there's so many people that love investing that if you're forcing yourself to do something, there's hundreds of people out there that will do it on the weekends for free because they just enjoy it. And that's just a, that's just a huge advantage for them versus you. But if you really follow, um, you what's naturally really interesting to you, then I think it just makes it a little bit easier. And so I got first introduced to growth investing from The Motley Fool actually, and Rule Breakers. It was the Rule Breakers newsletter that when I was, you know, like 12 and a half, I asked for a Rule Breakers subscription. And I thought it was so interesting. Like David Gardner in particular had held Amazon, you know, since the right, like basically IPO day and Netflix and, you know, these companies had compounded like 40% for 20 years. And if you do that, you get a very, very large number. And so I thought that that was just crazy that you could make that much money by holding on these companies that grow and grow and grow. And just the dynamic of being able to hold a company a long time, get to know it super well, really attracted me. And so, yeah, that was, I started out And the thing is growth and value are two sides of the same coin. I think that this dichotomy is often pretty silly. It's pretty much just everybody's trying to find value. It just looks differently. I mean, growth investors are basically betting that the multiple compression will be smaller than growth and value investors are betting that the multiple expansion will be faster than any. And then there's, you know, obviously middle grounds where people are looking for both multiple expansion and growth to, you know, be really good. There's, there's different camps, but there's really 3 legs of investing, right? There's, um, growth, uh, the quality of that growth, the durability of it, and then the valuation. Um, quality is bit— you can also think about that as kind of like margins. I mean, a very high quality business will be— have very high margins. And those are kind of like the 3 composition return, growth, margins, and valuation. Obviously, if you have like a more mature company, there's capital allocation, dividends, share buybacks, that sort of thing. But you can really break it down to those three legs of the stool: growth, margins, and valuation. And essentially, value investors are betting a little bit more on the multiple where, you know, you have a depressed multiple and it kind of gets back in line with what you think is reasonable. Growth investors are, are, they kind of know that the multiple is high, but, and they're willing to let that compress, but they think the growth will be more durable than other people think. And so there's just different ways to do it and there's not necessarily a right or wrong way, obviously. The market kind of goes in cycles, but I just really was attracted to the fact that these companies, you know, they're growing very fast. Oftentimes they are just providing tons of value. And if you think about like, if a company is growing at 100% and the multiple, you know, compresses a little bit, you can get some serious returns versus— there's just different ways to do it. And I think that I was a little bit more attracted to growth investing, and that's not necessarily the right or wrong thing, but I I was just really curious about it and the types of companies that are generally growing really fast fascinated me.

Well, Ryan, you covered a lot of ground there. I thought a lot of it was interesting. So a couple of things. I agree with what you're saying on value and growth. Here we've been doing a little bit more value investing lately, and you start to see that those divisions do break down in a way. Some of the value companies we're looking at, They have decent growth. Then I look at companies like Apple, Microsoft, Amazon. If you're really committed to value versus growth, where do you put those? Because they're growing pretty rapidly for value, but they're not like your traditional growth company. So I think it's really a good point that you make that it is a bit of a silly distinction. I guess one question that came up for me, and you mentioned, of course, the three growth margins and valuation. Is there a point where valuation gets too rich for, for you?

Totally. I think that there's, there's an interesting tension here because oftentimes it is the wrong decision to sell when it, when a stock gets too expensive. And that's because, um, companies that are really high quality will tend to get overvalued because they're going to just knock it out of the park and people are going to over-extrapolate and the valuation is going to get really rich. Um, but the thing is, um, you have to be correct on two things to get this right. So you have to be correct on that the stock is overvalued, and I think that that is probably the easier one. But then the harder one is being able to, uh, get back into that stock if you really think it's a long-term winner. Being able to ride the ups and downs is important, and being able to time it— okay, I'm out of the stock, and pay capital gains tax or whatever, which really, you know, hits you. Even if, you know, this could be a 10-bagger and paying the capital gains tax on that can be, you know, really quite a hit. And so selling to pay the capital gains tax and then, you know, being able to time it perfectly. So maybe you, like, let's say the stock is, you think it's very overvalued at $100 and you sell it and then pay X dollars per share in capital gains and the stock goes down to $80. And okay, is that the right price? Is $70 the right price? Like basically how much of a pullback do you need for it to be worth it? And you can run the numbers based on capital gains and how, you know, you know, reasonably valued you think the stock is, but I've just seen time and time again when I've tried that to time it perfectly, I inevitably miss out. Whether I just forget about the stock, you know, when you sell it, it's just hard to kind of monitor a stock and keep tabs on it. And so, I mean, it's, uh, I've just seen time and time again for myself that I usually, you know, have sold stock and it's done really, really well afterwards. Because I mean, ideally, if you are investing in good businesses, you want to see those stocks go up after you sell them. Like if you sold a company and then every single one of them just crashed after you sold it, then you'd probably have to question your stock picking ability. So when stocks actually keep going up after you sell them, it's really tough, but I think a little encouragement is that, hey, maybe you actually know a little bit of what you're doing and that this business is actually good. And so it's not all bad when you sell a stock that continues to go up, but there's big lessons in there. But to answer your question, yes, I think companies, the way that I I think about valuation is looking 5 years out. What do I think reasonable earnings will be 5 years out? And then what do I think is a reasonable valuation multiple? And if even with very aggressive assumptions and the forward return is not that great, then yes, I think it makes sense to sell based on all of your opportunity costs. And, you know, there's tons— I'm not saying that my model will be right, But, you know, if I have very aggressive assumptions and I can only get like a 5% CAGR over the next 5 years, then it probably makes sense to sell, even if there's some serious capital gains. But, you know, I say this, but time and time again, I'm like, well, this company could always do better than even my assumptions. And so I kind of talk myself out of it. And there's really this tension here because valuation is a tricky thing. It's not very black and white. It's kind of like a spectrum. Of possibilities. And when valuations are higher, then you're, um, you, you basically have to believe more things. You have to be more certain about the future. And so if you have a valuation that is very high and the future of that company is, is very uncertain, then I think it does make sense to sell. Like, I, I don't, um, I'm not, uh, under the camp of never sell, but I, I think that I, I really understand where they're coming from because the very best companies get overvalued tons of times, and if you're not able to hold them through that, you'll definitely miss out on big winners. So there's this tension, and I think it's a really interesting question.

[Speaker:TREY_LOCKERBIE] Yeah, you put your finger on kind of the challenge here is, and again, it all goes back to the long-term thinking versus that short-term noise, because I think valuation is we're talking about a snapshot in time, right? And it can take you away from thinking about what's going on in the long term. And yeah, that's— and the other thing I wanted to pull out of there was, you know, you talked about you got to make a couple of good decisions if you sell, right? Whereas I guess holding on is a decision in itself. But I think in investing, almost every decision is a difficult one. So the fewer decisions we can make, the better we're going to be. In the end. And that's why we like long-term investing. And then you also brought up the other point, which is taxes is another factor in that whole process. So yeah, it's again, it's simple, but it's difficult. And in the moment, these decisions are hard and we can't lie to ourselves and say they aren't. We look around and Like you mentioned, oh, why didn't I just buy Apple and just hold on to that? Well, there's a lot goes into that decision. So, um, and it always looks so much easier in the— on the back end. So, um, let's talk a little bit more about your decision-making process and kind of your stock choice, uh, picking process. You know, talk about a couple of the, the inputs to that and, and how you think about Um, why would I choose Stock A over Stock B?

Sure. So I would say the, the main thing I'm looking for is really fast underlying intrinsic value growth. And all that really means is that revenue is growing fast and margins are expanding. Um, and so that's, that's really like the two key variables that I'm looking for to get me interested. And once I'm interested, then I go through a full process of really investigating the company, whether that's looking at all the competitors, reading their 10-Ks if they're public companies, looking at industry reports, poring over the management team, understanding company culture, maybe talking to some employees, like all the typical business analysis stuff. But the first things that get me interested is, you know, is this company growing very fast? Like not just, you know, like 20%, but ideally very fast. I mean, honestly, one of the slowest growing companies in my portfolio is growing 54%. And so these companies, that's the slowest one by a good margin actually. So these companies are not just growing a little bit, they're growing very fast. And the reason why I'm looking for such fast growth is because it's not easy to do that as a company. I mean, obviously you can sell, Dollar bills for 90 cents. And that's what we'll talk about next. But, uh, these companies that are growing, you know, 100%, they, uh, are providing a service, uh, or product that a lot of people want. And that the demand for that product shows that there's something interesting about this company, whether it's a better product, better distribution system. Um, and, and nearly all of the companies are organic growth. They're not just buying this growth through acquisitions. And in order to grow a company, you know, at a several hundred million dollars over 100% is just not an easy task. And these entrepreneurs, I mean, for you to double your business when you're well over $100 million, some of these companies are well into the billions of dollars of revenue. For you to keep doubling is just a mind-blowing feat of managerial skill or industry tailwind or whatever. But there's usually some reason why these companies are growing 100%. And the second part of this is, Like I said, you can sell dollar bills for 90 cents. You can, you can have a very unsustainable business model, you know, just giving away free money basically. But if your margins are expanding and you have, you know, very positive incremental margins, um, then there, there's something there. Because if you— the way that I think about it is revenue kind of shows the demand for that product and margins kind of show the execution of your business. And if you have demand and execution, that directly leads to really, uh, high long-term earnings. And earnings are essentially what we're trying to get at as investors, because if you kind of break down the, the three legs, right, growth, margins, and valuation— growth and margins equals earnings. So it's really earnings and valuation multiple. Um, and so you're just kind of breaking it into the two components because oftentimes these companies don't even have, uh, you know, positive earnings. And that's because they're reinvesting so much back into the business because they see a huge market opportunity and they're trying to get to scale so that they can have, you know, economies of scale or network effects or all of these different things that kind of create longer-term moats. They're trying to get to that point. Obviously the downside is that if there's big tailwinds, you know, you can have a lot of competition. And so if your margins are just going more and more negative and you're just losing more and more money, but you're still growing, then there's a problem there. It's, it's not like, um, I just give them a free pass. And so I'm looking for the companies that are growing really fast, but they're showing some sort of operating leverage. You know, it might be negative 40% margins to negative 20%. And I would actually look, you know, favorably at that because the incremental margins on that, basically the added dollar of revenue on the, um, improved margin could actually be like 30% margins. And so If you extrapolate that out, it looks much more positive than the past. And so if you look on a unit economic basis, it's much more important. And so those are really the two things that get me interested. And then I'll go through and basically try to disqualify the company. You know, if there's tons of red flags in management's past, then, you know, I'll be kicked— it'll be kicked out even if the growth and margins are really exceptional. And so basically that's what I'm looking for. The growth and margins get it on the table, and then I'm trying to do my very best to disqualify it. And if I can't disqualify it, then usually it ends up in the portfolio. And I run a very concentrated portfolio, like 8 companies. And so I'm looking for the very best of the best and trying to concentrate as much as I can on those. Wow.

Okay. I like a lot of that. It sounds like, you know, something what we look for is acceleration in fundamentals and That's kind of like what you're saying with the margins. You're looking for that second derivative more so than anything else. And I think that's a good tell when you're trying to look 5, 10 years down the line. That's a good way to do it, as good a way as any. And I guess the last question I'd ask you before we move on and talk about a couple of ideas is what's your sell discipline? Like what makes you want to exit a stock?

Sure. So if the growth and the margins are no longer exceptional and I have other companies that are doing much, much better, then there's an opportunity cost. And so opportunity cost is definitely one. And then obviously if kind of the thesis is broken, if growth is decelerating a ton way faster than I thought and competition is coming in, or they're just not executing, Um, and then, you know, that, so basically the, the feat, my thesis is broken or there's opportunity costs and, you know, valuation is, is kind of a trailing third. If it ever gets insanely overvalued, I don't mind, um, cutting it, but mainly it's, um, you know, growth is basically, I, my trajectory for the company is, is much different than the present reality. And if that's the case, then I don't mind moving on to greener pastures. And then I'm always, always have like a big watch list where companies, you know, are vying for the top spots. I kind of view it a little bit like managing, kind of going back to basketball, managing a basketball team where you want to have the best players on the floor as much as you can. And, you know, if companies aren't performing, it's my money and the company's They basically have to fight for my money. I don't have to do anything. It's kind of Warren Buffett talks about the baseball analogy. You don't have to swing all the time. And these companies have to deserve my hard-earned dollars. And I just try to keep really high standards. And yeah, that kind of leads to selling sometimes.

Sure. If we're talking about stocks or your dating life, I don't know.

Well, I'm married, so.

Well, you know, back in the day.

I'm kidding.

Okay. I guess I have one more question before we get into stock ideas, but how have you approached the last year or so? It's been kind of a bear market in growth. Does that change the way that you approach things or does it make you more convicted?

Yeah, it's a really timely question. I mean, I've just been trying to do a lot of self-reflection and where did I go wrong sort of thing. And what I don't want to do is kind of have my head in the clouds and say everything's, you know, great, and I, you know, double down even when, you know, I'm clearly wrong. And sometimes in investing, it's even hard to know when you're wrong in the short term. I mean, I've been through so many pullbacks, you know, over the years, and it's easy to get discouraged and, you know, kind of think, you know, I was wrong, I should have sold at the top, you know, it's obvious, you you know, in hindsight, but it's never really obvious in the present. I think we can easily fool ourselves into thinking that it was obvious and it very, very rarely is. But I also don't want to, you know, go on the other side of just changing my mind too quickly. And so there's this big— there's a big balance here. But I mean, I honestly just am focusing on the fundamentals. If these companies fundamentals aren't really changing, then, you know, I feel pretty good about the long-term trajectory. I play very little attention to macro stuff. I mean, the narratives can change in macro so quickly, and there's just so many variables that, you know, that can work for some people. But what I was saying at the beginning is you have to kind of follow what you're curious about, and business is much more interesting to me, and I don't mind studying it. Some people, you know, macro is right up their alley. And so I really think it depends on what you're interested in. So, I mean, if you're really just interested in the art of making money and you can just, you know, go through sector to sector, then all the power to you. I think I need to grow in that a little bit, honestly, but I'm just fascinated by the fastest growing businesses and try to learn as much as I possibly can about them. So This hasn't really changed any of my outlook, but I am trying to do some self-reflection and, you know, where did I go wrong? Did I go wrong even? And, you know, you can anchor so heavily to the recent past.

Yep.

But it's important to just look out, you know, 5 years, where are these companies going to be? And how do those compare to my opportunity costs? And if I, if I can't find, you know, any reasonably valued Growing businesses, if I'm looking 5 years out, then, you know, I probably have to look somewhere else. And so it's kind of this constant evolution. But, you know, I don't feel that, you know, I am just putting my head in the sand and like, okay, I haven't done anything wrong. You know, there's just a lot that I've been thinking about. So it's a timely question. I don't have like a necessarily, okay, this is a firm answer. I've just been trying to learn as much as I can every single day. And Let the results take care of themselves.

Yeah, I think we're all kind of doing a little bit of soul searching, Ryan, at this time in the market cycle. Maybe we should just go on a 6-month vacation and come back and see how things are. I don't know. But yeah, it's challenging to want to stick to what your philosophy is, and I really applaud you for that. So let's put a little bit of theory into practice and talk about a couple of stocks that you like and the thought behind it. So I'll throw it out to you. What's the first stock you're looking at?

Sure. So one of my longer-term holdings is a company called Datadog, and they have really carved out a super strong leadership position in what you could call cloud monitoring. So if you are an IT person and you're trying to monitor your tech stack, you would have Datadog software that would monitor, you know, okay, server's down here, you can automatically see where that is. You know, network performance is not as good as we thought. And you're basically, all of these monitoring aspects are trying to make applications run as seamlessly as possible. And they're kind of a software that helps you diagnose each of those things super seamlessly. And the company has grown at, uh, basically like a 75% CAGR for the last 4 years, um, which is just top tier. I mean, free cash flow margins, um, this past quarter were 33%, for the year 24%. So, uh, I mean, 75% growth for 4 years gets you, uh, quite a bit of difference. Basically, revenue, um, in 2017 was like $100 million this past year, only 4 years later was a billion. So 10x revenue in 4 years, and free cash flow during that period has gone from 6 to 251. Um, so I mean, the, the growth in, in earnings has been, um, a bit crazy, honestly. I mean, from 6 to, to 250, it's like a basically a 50x increase, right? in free cash flow over that time. And it started from a small base, but I mean, just the sheer growth in earnings has been fantastic. And it's founder-led management, which is something that I haven't mentioned, but pretty much all of the companies in my portfolio are founder-led. And I think that it's not an absolutely necessary ingredient, but I've just found time and time again, these founders talk about their businesses differently. It's like, they're, they're babies. I mean, these are things that they eat, sleep, and breathe. They think about in the shower versus a professional management. It's kind of just a job. Like, sure, there's professional managers that absolutely love these businesses and, and they just do amazing things. I mean, there's so many examples like, um, Nadella at Microsoft. I mean, Tim Cook has done an amazing job at Apple. Like there's so many examples of, uh, not necessarily founders, but they've absolutely crushed it. But I think that founder-led companies, there's just something a little bit different where, um, I mean, they have a ton of skin in the game. I mean, this is the thing that their livelihood is based on, and it just provides a little extra oomph that I, I, it can't be modeled, but I, I just, um, the way that you hear, you know, these founders talk about their businesses is just different. I mean, it usually ends up in very positive characteristics like long-term thinking and and all these things that, you know, short-term managers, if they're trying to do like their 5-year tenure that their stock options really depend on, they're going to make, you know, maybe short-term business decisions. And so I think it's really about alignment. Datadog has two, you know, co-founders that have been with the business. Obviously they created it. And what happened was they used to work together at an old company and they just found time and time again, like they wish they had a way to make diagnosing problems in their tech stack much more efficient. And so they left that company, started Datadog. Um, they're two French guys and they're highly incentivized and very underrated. Like they're not flashy. You won't see them, you know, all over the COVID of Fortune or whatever, but they just execute time and time again. And one thing that really caught my eye, um, when Datadog IPO'd was, you know, all you see, all these companies burning cash, um, just incinerating cash in order to get market share and Datadog. They raised very little money and they burned only like $20 million of cash to get like throughout the whole process of going public. Like it was very, very efficient company. And you look at their sales and marketing payback, they just do things very efficiently while still maintaining growth. And so that really caught my eye and the company has just continued to perform quarter and quarter, quarter and quarter. I mean, this past quarter they grew 83% off of a little bit of a a soft comp because what happened basically with COVID is some of their customers didn't expand as much as they're planning. And so they saw a little bit of a dip, like from Q1 2020 to Q2, growth went from 87% to 68%. So it dropped a little bit, but management was saying, okay, people are kind of freaking out about COVID and the business is, you know, back, back, um, back to where it was before. Like they said that by Q2 and, um, They're definitely true to the word and growth is back up to 83%. And so being able to focus on what is management saying and what is the longer-term outlook and how does the reality corroborate that, I think is really important. And Datadog has just proved quarter after quarter that it's a top-tier business.

It's really amazing how much management really matters. You know, I first got into this business, I don't think I looked at it quite as much or Like you said, there are professional managers out there and they can do a great job, but there is something a bit different. One of my favorite companies is Nvidia, and Jensen Huang is probably one of the better founder-led CEOs you'll find anywhere in the world. Yeah, like you said, it's not just a business to them, it's their life's work. They're committed to solving a problem or problems, not necessarily maximizing the dollar. In a perverted way, it seems like that actually makes you make more money. I think it's a really interesting dynamic. I guess one question for me on Datadog, and you didn't really touch on this much, but in terms of competitive dynamics, How do you look at competitive dynamics? And in this particular case, uh, how does it look?

Sure. So what's kind of interesting is when the company first IPO'd, that was the biggest question I had. I mean, there's lots of monitoring companies out there. Um, I mean, even just to name a few: Dynatrace, Splunk, Sumo Logic. Um, there's, there's lots of companies out there that are, that are doing fairly similar things. I mean, New Relic is one that had done really well for a long time. But if you just look at the numbers, I mean, Datadog's growing 83%, New Relic just grew like 10%, Dynatrace is, is more in the, you know, high 20s. Splunk is kind of going through a business model transition and growth isn't— I mean, it's growing pretty fast, their cloud business. And so it's something to watch, but fortunately all these companies are public. And so you can look at all the numbers, look at you know, who's gaining market share, who's losing it. And it just seemed very clear to me that Datadog was absolutely eating the lunch of New Relic. And if you just look at the numbers, look at the commentary, I mean, look at industry reports, it just seemed pretty clear by the numbers. And that's a great thing when their competitors are public. I mean, it scares me a little bit more when, like, you know, it's a really good competitor, but it's private and you don't exactly know how growth is trending. And so that's something to watch. But if all the competitors are public, I mean, the thing is what scares me about Datadog in the longer term is there's lots of startups that are, you know, going after the space and it's just something you have to monitor. I mean, if growth slows down and they start talking about competitive pressure, then, you know, maybe it's time to move on after, you know, 4 years or, I mean, I would be totally fine holding a stock for 5 years, even 3 years. And I mean, even 2 years and the company just says, okay, uh, you know, based on, you know, we're looking just a little bit more competitive pressure in the market. And usually companies won't telegraph it that much, but if you see growth slowing down a little bit and, um, you're hearing about companies, I mean, I stay on top of competitors. Like, uh, I try to always know what's going on even in the private markets and And so, yeah, it's something that you have to pay attention to. The way that I see it is if a company has more competition, that just means you have to spend more time on it, not necessarily that it's uninvestible. It just means that you have to be a little bit more nimble. Like that's quite honestly it. That's not necessarily that you have to have a shorter-term mindset, but you have to be, you know, more in the loop of the competitive dynamics. And if you're not and you stick your head in the clouds and say, okay, I'm never going to sell this stock. Then, you know, you, you will get hurt sometimes. Um, and so it's kind of going in without a naive mindset of, um, you know, data like cloud monitoring software. It does not have as big of a moat as, you know, pool distribution or, um, you know, like all of these things, uh, these big moaty companies like Visa or FICO, like there's, there's these companies with big moats. You have to kind of go into it saying, This company is growing their moat. They don't necessarily have a big established moat yet, and therefore I have to spend more time in these areas trying to understand where things are changing. It's not the Buffett mindset of find a franchise, hold it forever. Some businesses are like that, but I think you have to not be naive with the type of business that you're investing in.

Trey Lockerbie I hear a lot of Buffett stuff in what you say, I think, but It's just applied slightly differently, if that makes sense. Even if we're growth investors, there's a lot of value to be taken from a value investor like Buffett. Obviously, what he's done has been successful, but yeah, again, the distinction is a little bit more fuzzy than a lot of people would have you believe. And then also, Best of breed, it's kind of a cliché at this point in a way, but it really is a big thing. Owning the best company, it's the easiest way to make money in a given field. So you feel good about the field Datadog's in and there's tailwinds for that business. And then on top of that, you think you've got the best business in that sector. I think there's a lesson in that. For sure.

Yeah, I think it's kind of interesting because the best businesses, they can kind of become overvalued to a point where it's actually, it can be like, it might not make them the best investments. And, but what usually ends up happening is even though it's overvalued, the dynamics from them being the winner usually outweigh any overvaluation, whether that means they can hire the best people. Which is such a big, important thing that I don't think investors think that much about. I mean, if you think about a company, it's just a collection of people that are creating a product or service, and nobody wants to work for the loser. I mean, you see this time and time again from salespeople where they're, you know, selling a— I don't, you know, I don't want to name names, but they're selling a product that they're just losing out to the competitors time and time again. And this is their livelihood, right? Why were they going to stay at this company when they could be making way more money at a competitor? And so once the company loses all their best salespeople to the competitor, it just increases the length between first and second even more. You know, the best engineers want to work at the company that is impacting the most customers, you know, has the biggest vision. And so attracting the type of people I think is a really underrated aspect of the leader. And it just, you know, the best people will create even better products and, you know, have better sales playbooks. And, you know, there's just so many things that the leader actually, you know, whether the leader is in the press more and so customers are more comfortable with it. And so it's easier, you know, it's easier to make a sale. I think there's just so many dynamics that aren't quite thought through a lot that the leader has an advantage in, but Then again, you can always talk like out of both sides of your mouth with investing, but because, you know, let's say the company is super, super overvalued and everyone knows it's a leader, and maybe the second in command, you know, isn't that much farther behind and they still have a great company culture, that can actually be theoretically a better stock. And so there's always different aspects. It's not always black and white, but oftentimes you find that the leaders, you know, tend to outperform. I would say that it's not a hard and fast rule, but it's a general rule of thumb.

Right. And then, you know, as your stock goes higher, the cheaper cost of capital as well when you need to raise more money. So another tailwind. Okay. Well, we'll just talk about one more stock before we wrap up and yeah, this is another kind of newer public company. Yeah. Tell us a little bit more about it.

Sure. So this is a newer position in the Investing City portfolio, which Investing City portfolio is just my personal portfolio, basically all my net worth, and invest in these companies. It's, it's not like a model portfolio, but this is a newer one and it's Sentinel One. And so what's, what's interesting is I've, uh, I had held CrowdStrike for years, basically since its IPO, and I really loved that business. I thought the management team was fantastic. George Kurtz Absolute killer. I mean, just always executed quarter, like, after quarter. And, you know, so this is a cybersecurity company. So SentinelOne is a direct competitor to CrowdStrike. No getting around that. They both started in EDR, endpoint detection and response. And the thing is that SentinelOne has pioneered a little bit of what's called XDR. Automatic detention and response. And it's basically that, you know, you have all of your, your laptops and your phones. And, um, you know, back in the day there was like Norton Antivirus, and you could think of that as being, uh, software that would keep, you know, hackers out of your phone and your desktop. And CrowdStrike and SentinelOne are basically that for enterprise version, where they're protecting customers laptops and phones and all the devices. But what's interesting is they can now provide cloud workloads, and that is a huge area of growth for both of these businesses where you can, you can protect your data in the cloud versus just, you know, like, uh, your, your laptop and your phone. Obviously those are important, but as the world has moved more remote, obviously cloud is, is just this huge, huge, um, has this huge tailwind. And XDR is a little bit more automated. So, uh, EDR, you have the software that's running in the background, and there's a little bit more of a human involvement with CrowdStrike where, uh, you know, okay, we have this alert over here and we send it to our team, um, security operations center, and they're looking into it and, um, able to patch it super quickly. Versus SentinelOne is a little bit more automated. And the thing is, CrowdStrike is pushing aggressively into this. It's not like they're just leaving it alone. Um, but what's, what's interesting about SentinelOne is that it's basically how I think about it is it's kind of like CrowdStrike, but 3 years ago, if you look at the numbers, it's very similar. I mean, if you, you can look at it quarter by quarter, I mean, um, in the last quarter, uh, SentinelOne put up $66 million of revenue and CrowdStrike just about 3 years ago, um, put up right around that same number. Um, if you— it's basically almost to the quarter. I mean, 3 years ago and 1 quarter ago, CrowdStrike put up $66 million in revenue, and around that time CrowdStrike was growing, um, in the low 100%. Um, and SentinelOne is growing 119%, so it's just a tiny bit better. Um, margins are still very negative for both companies at this point in time, um, but If SentinelOne can even like remotely execute similarly to CrowdStrike, which is not an easy task, then the stock will do very, very well. Um, just because they're at an earlier stage in their life cycle, they can— they have a very interesting strategy with partner resellers. Um, but I just want to be clear, kind of with Datadog, this company has clear competition. CrowdStrike is one of the best companies around. I mean, they have 30% free cash flow margins, still growing 60%. Um, but I just see in terms of upside where Sentinel One could, could really shine. It makes it more risky because, you know, earlier stage of the life cycle, they're still burning cash. But I mean, just one data point that I want to point out is, um, with Sentinel One, uh, last year in Q4, uh, their free cash flow margin was -87%. Absolutely terrible. This latest quarter, it was -11%. So going from -87 to -11 is a huge improvement while growing 120% year over year. And so that's kind of like textbook example of what I'm looking for, where revenues is growing still incredibly fast, but there's that operating leverage, especially in the free cash flow line. So I think it's an interesting company. There's still, you know, more risk because it's earlier stage, but the numbers and the management team, founder-led company out of Israel, And they're just crushing it. They just acquired a company called Ativo Networks that is going to add to their growth. I mean, the thing is they guided for 81% annual growth next year. So I think they could come in at over 100% next year. So companies that are growing over 100% for 3 years in a row is just not a sight you see too often.

And you're getting me excited about these growth metrics again. Okay, well, I guess, uh, we'll, we'll kind of wrap up. I got one question for you on SentinelOne, and I guess it's a little bit more like a portfolio construction question. And, you know, talk a little bit about your decision to choose SentinelOne, you know, remove CrowdStrike, add SentinelOne. And, you know, do you— how do you construct your portfolio? Are you always looking to have the most high growth in there, or do you try to mix it up a bit and a couple more mature companies that are still 30%, 40% growers and have more of the SentinelOne on the other side of it? Or yeah, just tell us more about how that works on your side.

Ian Formigle Yeah, that's a great question. So it was not an easy decision to just basically switch out CrowdStrike for SentinelOne. And honestly, so far it's been the wrong decision. CrowdStrike has held up stronger because has that free cash flow. Um, but basically as I was doing a deep dive comparing these companies, uh, it just seemed like SentinelOne had much more upside. Um, so they were superior on basically every growth metric. I mean, CrowdStrike had dropped down from more of like an 80% grower to a 60% grower while SentinelOne was actually accelerating into the 120%. Um, and so it was just a different different stage of company, and I definitely prefer earlier stage companies with lower market caps, and they just generally seem to have higher upside, but also there's the higher risk, and so portfolio construction is very important. Yeah, it can be tricky. You know, if you have the fast— if you basically did a screen and just try to find the fastest growing businesses out there and just weighted those the highest, You could have a very terrible portfolio because there's so many different aspects. I mean, it's quality of management, you know, direction of the moat, how is the industry faring? Do they have huge competitors? Is it a one-off thing? You know, maybe they bought a company and there's a huge increase in their growth, but it's, you know, not sustainable at all. There's just so many factors. Maybe it's like a drug was approved and they have this big one-time spike and then You know, it will fall off the cliff. Or with Zoom during the pandemic, you know, you knew it wasn't going to be 300% forever. Like everybody and their mother was buying Zoom and, you know, literally the product Zoom. And so it really just got gobbled up market share so quickly that 300% growth was just not sustainable. And so it's really about like the durability of growth in terms of portfolio construction, but that can be tricky because you're basically weighting upside and conviction. That's kind of how I think about portfolio construction. And conviction, you can sort of think of it as downside, like how confident am I in the company that it's going to continue to go up and not down. And then upside is, you know, I'm looking at, you know, all these metrics and everything looks really great, low market cap, you know, huge TAM, all this stuff, and not paying as much attention to the downside. And the portfolio construction is really a meshing of those two things. And, you know, it can be difficult to get right. But generally, the riskier the company and the lower growth durability I think it has, it should have a lower starting allocation. And if it deserves a higher one, you know, it keeps going up, the stock price, then I have no problem just letting it become a bigger part of the portfolio. Yeah, but I think that durability of growth is an important thing to think about with portfolio construction.

And then do you do a lot of rebalancing or do you just kind of let things grow to whatever they do and, and leave it at that?

Yeah, it's a good question. So I generally, uh, leave it, but if a company, you know, has an absolutely stellar run, like, uh, last year, uh, a big winner was Upstart and it just became a too big of a percentage of my portfolio and I trimmed it a little bit. And I have general rules where I don't love if a company becomes greater than 30% of the portfolio. And that, to some people, that'd be like crazy. What, 30%? But if it, if it grows in it, I wouldn't have an at-cost position of 30%, if that makes sense. So, um, basically it has to grow into that. And I try to keep at-cost positions around 15%. And so if that means if you have $100, you're buying $15 of stock at cost, um, versus if you bought it for $5 out of that $100, and then it grew to become 15%, um, that's different. And I, I just think that companies that prove themselves can, I can deserve more, uh, space in the portfolio. And it kind of has to be commensurate with, you know, business performance. If the stock is going crazy for no reason, if it's like a GameStop scenario where, you know, there's just like outside factors that create that performance, then I'm happy to trim. But Generally, those companies that are going up and up, their business performance is the reason why.

Trey Lockerbie That's all really interesting to understand the way you put the portfolio together and manage it. It can become pretty challenging with some of these growth companies can grow rapidly and take over in a portfolio. So it's definitely something to keep in mind if you are a growth investor just getting started. This is definitely a consideration you have to think of. Well, Ryan, I have enjoyed this conversation. We could probably go for a couple more hours. I'd love to hear more of your thoughts, but I think we'll wrap it up here. We'll leave it open to you. Where can folks find you and your research?

[Speaker:RYAN_CHAPLIN] Sure. Thanks so much for having me on, but people can find me at investingcity.org and on Twitter. I'm pretty active on Twitter, @investing_city. Feel free to DM me, Yeah, I try to stay on top of that. And you can check out our research subscription at investingcity.org where all transparent portfolio and the Slack group with hundreds of members and databases that I record every little metric in, just this kind of the tagline is save time and boost returns. And so that's what we are in service of.

Great. Everybody check out Ryan over there at investingcity.org. We'll put all the details in the show notes here. Well, thank Ryan for being with us. Really appreciated all his insights. And we'll thank you for joining us and look again for us next time.

Thanks so much, Brian.