Figuring Out Portfolio Fit

Thinking through buys and sells when weighing new information.

Earnings season can always feel a little fast and furious. As recent results have rolled in, I’ve received multiple messages asking how I use these updates to compare current holdings like say ZM or OKTA against watch listers like ETSY or SNOW. Basically, how do I decide who stays and who goes after seeing new reports? Well, that’s a very good question.

Almost all investors must manage an ongoing competition between the back of their portfolio and top of their watch list. That shouldn’t be a surprise considering these companies are often very similar in performance and execution. It is also not surprising something like a major announcement or earnings report can tip the scales from one to another. But when running a concentrated portfolio, it’s rarely as simple as just adding a new position. Likewise, the fact I generally hold little to no cash means I’m often forced to sell something to make room. Given this dilemma, what’s a guy to do?

Rather than try to compile a hypothetical checklist, I thought it might be easier to walk through a real-life example. Below is a post I wrote elsewhere back in October detailing my reasoning for exiting Fastly and entering Peloton. Neither stock has really lit the world on fire since, so that shows how much I know. 😏 However, that’s not the point. The point is to illustrate how I compared the businesses in trying to best manage my portfolio for the long term.

My original inspiration was this statement:

“Long FSLY, for now as I’m still undecided on what to do.” - fellow poster Griz

My response (please remember this was posted in October, so it was written in the context of market conditions at that time):

I believe this statement perfectly reflects the lingering FSLY discomfort in most of these posts. Fastly threw us a curve last week with the announcement lowering its guide for the upcoming quarter. The story has clearly changed even if opinions differ on exactly how much. It seems most of us have landed somewhere on the hold/trim/sell spectrum (any buyers here?). Ultimately, hindsight will make it clear what we should have done. It always does.

Rather than rehash the announcement itself, I thought it might be worthwhile to outline the thought process the led to my decision to sell. First, my initial thoughts on the news can be found here. Second, I agree 110% with every point made here.

I tend to group my holdings by conviction level. As noted in the first post linked above, my conviction level on FSLY changed. I might not know the exact level yet, but I am sure it is lower. The question becomes do I have enough information to act on it?


First, let’s take a look at why Fastly was in my portfolio in the first place:

• Thesis Before the New Info – FSLY has an intriguing new product in beta. As I am waiting for that to hopefully kick in, the company is supporting itself with a core business at mid-to-high 50’s growth (using the prior guide with a reasonable beat and not last Q's 62%). I know FSLY has lower enterprise customer growth and some customer concentration, but the company seems to be managing it so far. Besides, the Signal Sciences acquisition should help here. The prior CEO moved to CTO, which seems to better fit his skill set. The new guy is green but seems OK otherwise. FSLY has a pretty attractive thesis.

OK. Where does that stand now?

• Thesis After the New Info – FSLY has an intriguing new product in beta. As I am waiting for that to hopefully kick in, the company is now supporting itself with a core business at low-to-mid 40’s growth (using the new guide with a lesser beat). That’s a big drop off. The low enterprise customer growth and customer concentration might be more of a concern than I thought. If nothing else, it puts more pressure on Signal Sciences contributing immediately. Fixing this misstep will be handled by a new CEO backed by a former CEO who prefers the technical weeds instead. This isn’t a terrible thesis, but it is one with considerably more risk.

My portfolio entering that fateful day looked like this based on allocation size:

ZM
CRWD
DDOG
FSLY
NET
DOCU
OKTA
TWLO
PTON (top watch list name)

The second my FSLY conviction changes it becomes time to reassess its spot in my portfolio. This is the same process I used in June when my Fastly conviction rose high enough to bump Slack from my portfolio. In today’s case:

• FSLY vs NET – This comparison has been beaten to death, and they were close for me with Fastly being a step ahead coming into this comparison. NET recently followed its Birthday Week with Zero Trust Week. Between the two events, Cloudflare released somewhere in the neighborhood of 74 million new products and enhancements (give or take, of course). Meanwhile, FSLY shot itself in the foot and was surprisingly quiet with damage control. So, NET > FSLY.
  
  

• FSLY vs DOCU – DocuSign is trending strongly upward with next quarter almost certainly delivering 50%+ growth and favorable profitability metrics. Meanwhile, FSLY shot itself in the foot and was surprisingly quiet with damage control. So, DOCU > FSLY.
  
  

• FSLY vs OKTA/TWLO – Okta and Twilio are both mid-to-high 40’s grower with higher run rates than Fastly, more stable profitability profiles and MUCH more established leaders. I previously liked FSLY’s growth prospects better, but that advantage is no longer certain. In fact, TWLO just pulled off a big acquisition the market loved and might put itself back in the 50%+ organic growth category next quarter (hmm, I may need to revisit TWLO). Besides, have I mentioned that FSLY shot itself in the foot and was surprisingly quiet with damage control? So, OKTA/TWLO > FSLY.
  
  

That puts Fastly’s conviction level at the bottom of my portfolio and forces a showdown with Peloton.

• FSLY vs PTON – Peloton just posted a year of 99.6% growth with strongly positive EBITDA and cash flow. It estimates 99.9% growth this year (which will almost certainly be beaten) along with a stronger EBITDA margin. I fully acknowledge PTON selling consumer-based widgets makes it a bit tougher to follow and likely a lot more fickle than a software company. However, it also has an impressive subscription component growing 100% at close to a $500M run rate. FSLY is…well…something much more uncertain than it was before. So, PTON > FSLY.
  
  
  

Staying disciplined to how I am trying to run my portfolio, I have a decision to make right here. This reassessment just earned PTON a spot in my portfolio. Notice this development by itself is not just a FSLY decision but involves PTON as well. PTON just cleared my inclusion bar. That would not have been the case if FSLY had stopped higher up. Now the question becomes whether I want to hold myself to eight positions or increase to nine by say swapping some FSLY into PTON. After thinking about it, I decided to stick with eight. Once I make that decision, FSLY automatically exits my portfolio. It doesn’t matter whether I’ve got FSLY’s new market status exactly right. All I need to know is I no longer have enough conviction to own it in my 8-stock portfolio. Nothing personal Fastly, and I’ll gladly watch you from afar. That being said, don’t let the door hit you in the ass on the way out.

To be fair, this all happened very quickly during the first 30 minutes or so after market close Wednesday (note: October 14, 2020). I sold after hours immediately upon making the decision, giving me ~9% cash. Conveniently enough I had just finished my PTON breakdown, so I already felt good about its spot at the top of my watch list. I also implicitly trust much of the work done by others I know on PTON’s behalf (isn’t crowdsourcing great?). My initial comfort-level blink puts PTON in the 5-6% allocation range. With PTON sitting at all-time highs, I was admittedly hesitant to bite off a 5%+ chunk all at once. Knowing I would double check my due diligence over the weekend, I entered limit orders Thursday at 3%, 5%, 7% and 9% below the high just in case I could grab some a little cheaper. The first hit Friday, so I now have a 1.6% position to start. The other orders remain intact heading into Monday. I plan on filling out the position over the next day or two even if I end up buying a little higher. The remaining cash most likely finds its way into some combo of DOCU, TWLO and potentially another name or two.

I know this post trends more toward portfolio management than analyzing an individual company, but I do believe it is relevant to the FSLY topic at hand. I hope it helps. I know it helped me to write it out.

Thanks for reading.