This is a weekly blog post dedicated to talking about current events in the world of innovative companies and how they fit into powerful long-term themes. I also share a few random thoughts that came up in the week. My goal is to make this topical, thought provoking, and insightful.
When improvements are bad….?
(Theme: Massive Disruption in Software; Software Eats the World) What Happened?
Paycom, a provider of Human Capital Management (HCM) software as a service (SaaS), recently reported disappointing earnings. They’ve been working on a new version of their software to enhance features, attracting customers with payroll services and online HR access, including mobile. However, they reported a revenue growth slowdown for the completed quarter and future guidance, causing their high multiple stock to plummet by roughly 40% in a day.
The reason behind this drop was the new software version’s success in eliminating payroll errors, leading to a significant decline in service revenue as there were fewer issues to correct.
The company essentially eliminated a revenue stream through innovation. Chad Richison, the company’s CEO emphasized that this change benefits customers and, in the long run, will benefit Paycom. Chad enjoys a very good reputation, and it was the company’s decision to invest in improving the product with an eye on the long term. It brings to mind the story about how Jeff Bezos decided to develop the Kindle, which would obsolete Amazon’s main business at the time, selling books over the Internet.
This serves as a wake-up call for the SaaS industry, especially as we enter the AI Era. Rapid changes in software, making tasks faster and cheaper, can leave companies that do not invest and innovate lagging way behind. The best companies in the software industry generally have the highest valuation multiples. When there is a slowdown in growth or any uncertainty, high-multiple stocks can suffer greatly. In this space, the ones to own might seem expensive now, but they’ll likely grow
fast enough to appear cheap in hindsight. We believe that there will be many stories like this one as the pace of innovation continues to run at a dizzying pace.
Time will tell if this was a good thing for Paycom in the long term, but we anticipate that many companies will be facing the same challenges in the coming year. This could mean increasing levels of business and stock price volatility as investors sort through the pace of change.
The economy may be slowing, but Cloud hosting is still growing….
(Theme: Total Migration to the Cloud; AI is a massive disruptive force)
The major cloud hosting players (Google, Amazon’s AWS, Microsoft’s Azure) posted strong results, with Azure leading the way. Key takeaways: Cloud migration is still growing robustly, and we’re early in this shift. Amazon’s CEO, Andy Jassy, sees cloud’s future potential, predicting a reversal in the IT spend equation within a decade.
There’s also a trend of cost-consciousness due to economic uncertainty among customers. Nevertheless, all these companies remain optimistic about the future of cloud hosting.
In a nutshell, these cloud providers are well-positioned in the Data Era. They have market leadership, top talent, scale advantages, financial strength, and a strong focus on Generative AI, meeting customer demand and benefiting semiconductor suppliers.
During my recent visit to Florence to see my daughter, we had a conversation about human behavior and dealing with others’ expectations, especially in our younger years when we’re sensitive to perceptions. The main takeaway I could offer was the power of “acceptance.” I, too, struggle with this, so it’s a good reminder for me.
Living consciously means recognizing the superpower of accepting things as they are in the present moment, rather than wishing for change or making excuses. We discussed the importance of accepting that we do our best and that sometimes things don’t go as planned. It’s also crucial to acknowledge that not everyone sees things the same way.
As an investor, adapting to change is vital. The recent earnings period has witnessed significant shifts, particularly on the downside. While we don’t have to like such results, we must accept that change has occurred.
Truly Great Doesn’t Come Around Often
Legendary Indiana University basketball coach Bobby Knight passed away last week. He was a complex figure and one of the greatest coaches of his time. After his passing, ESPN commentator Jay Bilas shared a story about Knight’s basketball insight.
In 1984, following his coaching of Michael Jordan in the U.S. Olympic team’s gold medal win, Portland’s GM, Stu Inman, sought Knight’s advice for the NBA draft. Knight recommended selecting Jordan, calling him the best player he’d ever seen. Inman mentioned having Clyde Drexler and needing a center. Knight’s response: “Then play Jordan at center.”
Jordan became the NBA Rookie of the Year for the Chicago Bulls, leading them to six championships and earning the title of the greatest player ever. Portland chose a center with an unremarkable career.
This story offers some investment insights. First, seeking advice from smart people can be valuable. Second, being open to that advice matters. Third, extraordinary results often require unconventional thinking. Lastly, truly exceptional players (or companies) are rare, so staying open-minded is key to spotting them.
I am an investor and entrepreneur, having started two investment companies. I am the Founder and CIO of Arrowside Capital, based in Boston. I have more than 30 years of experience in the investment business, investing in mostly small and mid- sized companies, all geared toward innovation and growth. The blog is named The Zen Innovation Investor because I believe it is so important to remain calm and focused during the rapid pace of change in the world today. I am keeping a view of the long term while also keeping abreast of developments in the world of innovative companies. I view this as a place to sharpen my thinking and provide some insights that are thought provoking.
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