A key metric for each company can signal investors that their growth stories are beginning to sour.
Three of the 10 largest initial public offerings (IPOs) in U.S. history made their debuts in 2020. One of them, Snowflake (NYSE:SNOW), set the financial media ablaze with a huge first-day pop, an unlikely investor, and a valuation reminiscent of the market mania in 1999 and 2000. One stock that didn’t make the list of biggest IPOs was GoodRx (NASDAQ:GDRX), which turned the unusual combination of growth and profitability into its own big first-day gain. Both of these companies have a metric that investors can use to determine if their early growth stories will remain intact through 2021.
The financial world was already excited about Snowflake’s IPO. Then it was reported that Warren Buffett’s Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) had acquired a stake in the company — it turned out to be about $735 million of stock — and the shares more than doubled on the first day of trading. The company followed up by posting year-over-year revenue growth of 115% in its first earnings report for the quarter ended Oct. 31, 2020. Its net revenue retention rate, or sales from customers that existed at the same time last year, was 162%. Not only is the company bringing in new customers, but existing customers are spending a lot more than they were last year.
The cloud data platform company is firing on all cylinders. However, investors should keep a close eye on that last metric — the net revenue retention rate. Unlike a pure software-as-a-service (SaaS) company, Snowflake’s sales are consumption-based. This means that instead of being able to count on predictable revenue, the company relies heavily on perpetually increasing customer usage to keep growing.
It’s a reasonable assumption for now. The amount of data we all create has been doubling every two years for the past decade. However, just like Cisco‘s reliance on internet companies during the dot-com bubble — sales dropped 15% in 2002 and the stock fell 86% peak to trough — Snowflake’s growth could be wrecked if the need for more and more data wanes. No one can predict the future, but Snowflake’s valuation depends on data usage progressing as it has been. The dependence on customer growth is a risk that doesn’t seem to be appreciated by those paying 170 times sales for shares compared to an average ratio of 2.75 for the S&P 500 at the end of 2019.
GoodRx takes a very complicated system and makes it simple for users. By typing in the name of a drug, customers can find the lowest price and location for their prescription. The company uses data from pharmacy benefits managers (PBMs) to create a coupon showing the lowest prices and collects fees from those PBMs each time a coupon is used. The company has co-CEOs, one with a biology degree and technology consulting background, the other a Facebook alumnus and former CEO of a healthcare-based social network. Together, they have built the most-downloaded medical app of the last three years.
Unlike Snowflake, GoodRx is profitable. The company has posted a profit each year since 2016. On top of its profits, the company is growing. Its $388 million in 2019 revenue was 56% higher than 2018. For the first nine months of 2020, the pace has slowed a bit to $397 million, up 44% from the same period in 2019.
Perhaps the most important metric for GoodRx is its monthly active consumers. The number grew near 60% consistently for each of the six quarters leading up to 2020 only to fall off in the second quarter when doctor visits and subsequent prescriptions dropped due to the COVID-19 pandemic. By the end of September, there were 4.9 million monthly active consumers, up 29% from the same time in 2019. No one knows how many Americans, stuck in the country’s uniquely complex health system, may end up becoming regular users of GoodRx. If growth remains at the recent level, Wall Street will assume the saturation point is much lower than when the company was growing users at 60% annually. Investors should keep a close watch on this user number. If it does not reaccelerate as the pandemic wanes, expect the stock to stumble.
Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Jason Hawthorne has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares), Facebook, and Snowflake Inc and recommends the following options: short March 2021 $225 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and long January 2023 $200 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.
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