A quick thought experiment – suppose there are two businesses. Business A (for ‘Awesome’) continues to execute brilliantly. Revenue and earnings are growing fast. The business is “beating and raising” every quarter. Analysts’ forward estimates are increasing, and management are praised for their exemplary execution. Everyone is positive on the business and its prospects. Business B (for ‘Broken’) was once a fast-growing business but has decelerated. It has missed analysts’ forecasts. Forward estimates are decreasing. There has been turnover in management. The narrative is decidedly and increasingly negative.

As concentrated long-term investors in fast growing businesses, these are situations we face daily. The question we perennially mull over is: where should we spend our time and energy? Should we focus on the Business A’s of the world, where the outlook is bright, or the Business B’s, shrouded in storm clouds?

If your first instinct is to say, “show me the valuation”, you indeed pass. Valuation matters in any assessment of investment merit. However, this question is deeper than valuation. It goes to the heart of what type of investor you are.

Quality at any price

Warren Buffett is famous for pivoting his investment approach from one focused on buying deeply undervalued, often struggling companies that still had a little value left to extract – the so-called discarded cigar butt – to one focused on buying great companies at fair prices. With his 60-year track record of 19.9% compound annual rate of return while at the helm of Berkshire, it’s hard to argue against this pivot. However, a great business at a fair price does not mean a great business at any price.

I am reminded of the following quote from Nick Sleep in his Nomad partnership letters when reflecting on Walmart’s phenomenal value creation over the past 5 decades.

If, in 1972, upon reading that year’s twelve-page annual report (!) an investor chose to make a purchase of shares, he could have paid over one hundred and fifty times the prevailing share price (a price to earnings ratio of over fifteen-hundred times…) and he would have still earned a ten percent return on his investment through to today.¹

The point that Sleep is trying to make here is that the best long-term compounders are perennially undervalued by the market. While I believe this to be true, I think it misses an important nuance; that the vast majority of excessively valued businesses do not generate great returns. I would suggest that the answer to the inverse question of “how many businesses trading at 1,500x P/E have gone on to generate acceptable long-term returns?” is a far more interesting one to answer. I have not done the analysis, but I suspect it’s very few.

The reason I raise this is not to pick holes in Nick Sleep’s view – anyone who knows me will tell you how influential he has been on my own thinking – rather to use it as an example to challenge some sluggish thinking that is pervasive in the world of growth investing. Let’s expand on this with a pair of case studies.

The Language of Awesome – A Duolingo Case Study

Duolingo (“DUOL”) is a widely used mobile application for language learning. Each day, almost 50m people log in to the app to learn their language of choice. Not only is Duolingo the biggest application for language learning, it is also the most engaging, with a meaningful portion of users maintaining 365+ day streaks. The business has been able to turn this level of engagement into a highly profitable and fast-growing business. On all measures, the performance of the business has been exceptional.²

The company has been public since July 2021 and has exceeded the high-end of its starting revenue guidance every year since.

The share price has followed suit, appreciating more than 5x from its initial IPO price. Today it trades at approximately 20x next twelve months (“NTM”) revenue. The quality of the business and execution is now widely acknowledged by the market. From here, to achieve our target return of 25% p.a., we would need to believe that the business can sustain 25%+ annual growth, taking revenue to >$3bn, and achieve 40% EBITDA margins over the next 5 years, all the while still holding the current multiple. I am unsure of too many businesses that have traded at 20x forward revenue for five years. A high hurdle indeed and a business priced for perfect execution.

Broken Promises: When Growth Falls Apart – A Twilio Case Study

Twilio (“TWLO”) is a cloud communications platform that enables businesses to programmatically embed messaging, voice, video, and authentication capabilities into their applications using simple APIs. Developers use Twilio’s tools to create seamless communication experiences across channels like SMS, phone calls, email, chat, and WhatsApp without needing to build or maintain telecom infrastructure.

The business went public on the NYSE in June 2016 at a share price of $15. It was initially very successful, growing users and revenue at more than 30% per annum organically from 2016 to the aftermath of COVID in 2022.³

In 2023 revenue growth decelerated rapidly to single digits as users, Average Revenue Per User (ARPU) and existing customer revenue expansion rate all flatlined. The company missed analyst estimates in both 2022 and 2023.⁴

The share price went on a round trip, increasing from the $15 IPO price to a peak of $435 in February 2021 and back down to c.$40 by late 2022. At its peak the business was valued at 27x NTM revenue. Today it is approximately 3x.

The TDM Approach

Let’s return to the original question. Should we be spending our time doing work on Business A (Duolingo) or Business B (Twilio)? Like most things in investing, there is not one right answer to this question. There are good reasons to either pursue or not pursue both businesses. The more relevant question is which business best suits the style of investor that you are.

Before exploring this deeper, let’s take a trip down TDM memory lane. Two successful early public investments for us were LogMeIn (“LOGM”) and Ellie Mae (“ELLI”), both SaaS businesses serving very different end-markets. LOGM is a provider of communication software mainly to SMBs while ELLI offers an end-to-end mortgage platform to financial institutions.

We first invested in LOGM in early 2012 at a share price of c.$35 (market cap c.$1bn). At the time the business was generating approximately $120m in annual revenue and growing at c.20%. Within months of investing, the company downgraded revenue growth guidance and became embroiled in a messy patent litigation case, triggering a c.50% decline in the share price. A second downgrade followed in early 2013. The share price remained below $20 for most of the first year of our investment, valuing the business in the order of 2x NTM revenue. We used this opportunity to significantly upsize our investment in the company, taking it to a peak weighting of c.12% of the portfolio. We ultimately exited the position in 2016 at a share price of c.$80 (c.$2.3bn market cap) following a merger approach from Citrix.      

Our investment in ELLI followed a different trajectory with a similar ending. We initiated a position in mid-2013 at a c.$25 share price (~$600m market cap). The business had approximately $150m in annual revenue growing north of 20% and was highly profitable with 30%+ EBITDA margins. The business has a variable component to revenue based on mortgage volumes which added some lumpiness to the revenue. As such it was susceptible to missing forecasts.

While the outcome was ultimately successful – we exited the position in 2019 following a takeover bid from Thoma Bravo at $99 per share – we had to endure eight 20%+ drawdowns, three 30%+ drawdowns and one 40%+ drawdown throughout our holding period, many of which were caused by ELLI missing revenue forecasts due to its volatile variable revenue. We bought shares after every one of these. At its peak, ELLI had a 15% weighting in the portfolio.

The point of these stories is not to gloat over past wins (indeed we’ve had our fair share of misses as well), but rather to illustrate an important point; we are the culmination of our past experiences. We have had our success running towards rather than away from businesses that look more like a “Business B”.

Does this mean that we only spend our time on Business B’s? The answer is no. We love following successful businesses that are executing well. At the very least we could learn something to make us better investors or help our own portfolio companies. But even more importantly, at TDM we measure ourselves in decades, not months or years. The world is unpredictable – unexpected and uncontrollable things happen. Almost every great business will have a slip up at some point. We know that the performance of even the best businesses is not linear and that there is a high probability that Business A will look like Business B at some point during our investment horizon. This is a critical point. It is our job then to work out if this is merely illusionary, momentary or a permanent degradation in business quality, and importantly, if the current price compensates us for the risk of the latter.

Both LOGM and ELLI were not perfect businesses when we invested, but they were closer to A’s than B’s. It wasn’t until they had a few slip ups that we dialed up our diligence and, once comfortable, fully sized the positions. This is the crux of how we allocate our time and energy as investors. This is who we are.

A (brief) look under the hood

At the risk of coming across as if our best days are behind us, we will give a little look under the hood of a business we recently made an investment in. In fact, despite having deployed significant capital into existing portfolio companies, it was our first new investment in over three years.

This is a business we have observed for over a decade. It is a disruptor and market leader in its space. Over this period, it has experienced tremendous growth in revenue and earnings, with revenue expanding c.20x and EBITDA c.50x, culminating in the share price expanding more than 10x.

It has consistently delivered on expectations, exceeding the high-end of its initial revenue guidance nearly every year. FY2017, FY2022 and FY2024 were the exceptions.

We watched the share price fall and the multiple de-rate following both the 2017 and 2022 downgrades. Unfortunately, we failed to act in both cases as growth quickly re-accelerated, the business returned to its “beat and raise cadence” and the share price recovered.

The 2024 miss was even more pronounced. We watched from the sidelines as the share price fell more than 50% and the multiple de-rated from a historic >10x NTM revenue to c.5x. This was our cue to accelerate work – a task which took the better part of 4 months – before we decided to initiate a position. To extend the earlier analogy, in our view this is an ‘A’ business that momentarily looks like a “B”, and with this, an opportunity to buy a great business at a fantastic price – a rare ‘fat pitch’ to swing at. Time will tell if we are correct.

There are a few takeaways from this investment and process:

1. Price matters. The fact that the business fundamentals have compounded at a much faster rate than the share price over the past decade highlights that you can clearly over-pay for a great business.
2. Even the best growth businesses will likely have one or more slip-ups in their journeys. Be patient and be prepared to act when it does happen.
3. A large share price fall is a good starting point but is not sufficient on its own to justify investment. One must still do the work to build conviction in the investment case. As noted above, this was c.4 months work for us despite having observed this business closely for more than a decade!

Are there exceptions to the rule?
 

I can think of exceptional circumstances where we are comfortable holding a true Business A. That is when we have behind-the-scenes access to the business. As investors in both private and public businesses we sit on the boards of 7 of our 11 current holdings. We speak to these management teams frequently – often daily. We play a key role in building the team, setting strategy and supporting execution. We know the ins-and-outs of these businesses.

There is also irony to this vantage point – it only deepens our inclination to pursue new investment ideas that resemble the Business B’s of the world. It is indeed this ‘inside view’ of how businesses actually operate that has forged a belief that the line between Business A and  Business B is incredibly thin, and that with the right team, execution and support (and maybe a slice of luck), a line that can be crossed. All investors recognise that when a Business B does ultimately become a business A, great returns usually follow.
 

Footnotes

1. Nomad Investment Partnership letter, 30 June 2009 ↩︎
2. FY2025e is based on Visible Alpha consensus as at 26 May 2025 ↩︎
3. Twilio acquired Segment in November 2020 which impacted comparisons in 2021 onwards. ↩︎
4. Twilio stopped providing full year guidance in 2020. As such, consensus sell-side estimates have been taken as at the beginning of the year as a representation of estimates for the year ahead ↩︎