Earnings increasing & multiples expanding (Re-rate commencing)

There are two key factors at play here: i) massive YoY earnings increases and ii) a multiples expansion (aka "re-rate") -- this is the holy grail of investing -- these are the two twin turbo drivers of a multi-bagger and significant share price growth.

The theory of value is simple. Stock prices drift away from underlying values in the short term, and drift back towards underlying values in the long term. When the divergence between the price and the underlying value – Graham’s famous margin of safety – is wide enough, value investors bet on it closing. They anticipate mean reversion. This is what is starting to happen with CXZ right now -- the share price will find equilibrium with fair value, which has increased significantly post FY20 results.

A simplification of fair value is driven by the two key levers mentioned -- i) earnings (and for SaaS companies: revenue) and ii) a "multiple":

• For profitable companies: Fair value market cap = Earnings (NPAT) x Earnings Multiple (PE)
• For SaaS technology companies: Fair value market cap = revenue (ARR) x revenue multiples (PSR)

Not only has CXZ increased its earnings by 587% YoY as of the FY20 announcement 2 trading days ago, it has also been trading on an extremely low earnings multiple, which is about to go through the process of "expansion". To illustrate this, I have charted all of the top ASX SaaS companies (see below) by revenue (ARR) growth and the revenue multiple (ARR multiple). You will see that the faster the company is growing (x-axis), the higher the "multiple" (y-axis). A line trend-line approximates the pattern.


CXZ is trading on a mere 4x revenue multiple at 4c, despite similar companies trading on north of 20x revenue for the same growth rate. At 4c, CXZ trades on only 10x PE. Yet, the ASX software average is a ~41 PE. So not only has the underlying revenue and earnings increased, the multiple now also needs to catchup with the industry average. This is what is driving a re-rate on this stock.





The question is, how high will CXZ go? Well if you take fair value to be the ASX software industry median earnings multiple, a PE of 40 for CXZ would be a share price of 15 cents (40 x $3.2m NPAT / 863m SOI). If you take the median revenue multiple for a similarly growing ASX small cap SaaS stock, 15x revenue could be achieved, which is also a share price of 15 cents (15 x FY20 recurring revenue).

Personally, I'm not letting go of this gem too soon. I let go of NZS and DW8 too early (albeit still achieved multi-bagger returns thanks to a very low entry) and I have learnt from those experiences.

The current prices are soon going to look like ancient history.

Do the work. Trust the work.

T.E.P.