Facebook, Instagram, YouTube, LinkedIn, Twitter, Pinterest and…
Are you overwhelmed by the number of social media platforms?
Definitely for me.
As individuals, we can choose a few to spend most of our time on. But, it is a different case for businesses as customers can come from anywhere and they get to decide which are their preferred platforms to connect with businesses.
For small businesses, it would even be more challenging since they do not have a budget to hire a big team of digital marketers to manage all the social media platforms.
The Stock: Sprout Social (NASDAQ:SPT)
Enter Sprout Social (NASDAQ:SPT), a social media management Software-as-a-Service (SaaS) platform targeted at small businesses.
Marketers can now manage their accounts with Facebook, Instagram, Twitter, LinkedIn, Pinterest, YouTube, Reddit, Tripadvisor, Glassdoor and Shopify, all in one place:
Social Sprout is still a relatively young company founded in 2010 with a revenue of $189m in 2Q2021. That’s less than a billion in a Financial Year.
Currently, Sprout Social has a 3-5% penetration rate in a $50b Total Addressable Market (TAM), still a long way to grow and capture the market share.
Social Sprout’s Growth
Grow, it does. Sprout Social achieved a 42% growth in its 2Q2021 revenue compared to a year ago. This is above the median revenue growth rate of 29% for B2B SaaS stocks (according to Public Comps).
Moreover, it has achieved breakeven on its operating profits and a positive free cash flow. That is an important milestone as we know many young SaaS companies lose money for a long time to capture market share. Having positive free cash flow means they can sustain their operations without the need to raise serious money.
Social Sprout’s valuation and why most investors may miss it
In terms of valuation, Sprout Social isn’t the cheapest SaaS you can buy.
It is trading at an EV/Forward Revenue of 35x, higher than the B2B SaaS median of 12x. Even for high growth (>40% revenue growth) SaaS, a fair EV/Forward Revenue would be around 27x according to Public Comps. Sprout Social is expensive by either approach.
But I still invested in it.
Why?
Because I am using a momentum strategy that cares less about the valuation but more about the strength of its upward trend.
It was one of the top-ranking stocks by momentum and the buy signal came when it was trading near its historical high since its IPO in 2019. Momentum trading always feels counter-intuitive because you are ‘forced’ to buy high and not low. You would be thinking ‘so high already‘ in your head and feeling ‘later it comes down how‘ in your heart.
Instead of listening to the voice in my head, I just obediently followed the rules and bought it at $91.59. And Social Sprout’s price went up to $136.41, returning 49% in 2 months. Momentum does indeed exists in the short term.
I believe that momentum trading is best done in a rule-based manner because it is so counter-intuitive and our human biases will always undermine it if we have to make judgement calls.
What is expensive or high can go even higher, sometimes to our bewilderment.
Another advantage is that we don’t need to look at the fundamentals of the businesses too much as we will be using a simple screen for high-quality stocks like this. And we just rank them by momentum to determine the trending stocks to buy.
Basically we just want to buy high-quality stocks that are going up. I call it the Quality Momentum Trading (QMT) system.