Holding Steady On SoundThinking

It’s been about 15 months since I took a small ($3500) position in Shot Spotter Inc, now called SoundThinking, Inc. (NASDAQ:SSTI), and in that time, my investment has lost about 21% against a gain of about 1% for the S&P 500. It’s been about 4 months since I decided to not take what was at that time a 35% return on the stock, deciding to neither sell nor add, and the shares are down about 42% since then, having suffered particularly after the company lowered revenue guidance by about 2%. There’s an obvious lesson there about “buy and hold”, but that’s for another article. Today I want to decide whether or not it makes sense to buy more at this cheaper price, hold, or consider my $700 loss to be a painful reminder about why we want to consider selling winners, no matter what the consensus “let ‘em run” attitude is. I’ll make that determination by looking at the most recent financial results, and by looking at the valuation of the stock as a thing very much distinct from the business.

I’m busy, you’re busy, we’re all busy. Given that, I want to save as much of your time as possible by giving you the gist of my thinking about a given stock in a single, easily digested “thesis paragraph.” This should save you some of that much needed time that seems to matter so much. You’re welcome. While I’m not going to sell my SoundThinking position, I’m not going to add to it, at least until we have some more clarity about the rest of the year. While I think the market overreacted to the company announcing that revenue would be about 2% lower this year, I’m in a “show me” kind of mood where this business is concerned. The CFO has claimed that the uptick in various expenses like Sales & Marketing, R&D, and so on won’t be repeated next quarter. I’m going to confirm that before adding to my position. Additionally, it should also be pointed out that the shares are cheap by some measures and expensive by others. Given that I’m in the mood to preserve capital, I’ll take no action at the moment.

Financial Snapshot

I don’t think there’s any way to sugarcoat it. The financial performance this quarter was not ideal, especially when compared to the same period a year ago. Revenue was down by about 3%, and operating expenses were up by just under 5%, which is not a great combination, obviously. Net income swung from a positive $387 thousand last year to a loss of $1.79 million this year, because, in the teeth of slowing sales, Sales and Marketing, and G&A expenses were up by 4.9% and 7.6%, respectively. An investor could take some comfort in the fact that comparisons to last year are challenging, given that 2022 was an excellent year that saw net income higher by about $4.6 million from the year ago period. That hope fades, though, when we compare the most recent period to the same span of time in 2019. Although revenue in 2023 was up by about 115%, net income was lower by about $1.4 million. This is why I write that there’s no way to sugarcoat the income statement performance here.

Before moving off of the income statement, I want to point out that on the most recent conference call, the CFO stated that the company added significantly to Sales & Marketing, R&D, and G&A in the first quarter, and won’t need to add a significant amount to those for the remainder of the year. This is a claim that I’m going to be returning to next quarter to not only forecast profitability here, but also management credibility.

The capital structure remains relatively strong, given that cash represents about 9.6% of total liabilities. Please note that this is a pretty significant deterioration. In 2020, cash of $28.67 million represented about 109% of total liabilities. Thus, I don’t think there’s a bankruptcy risk here, though I acknowledge that the trend is moving very much in the wrong direction here.

In spite of all of the above, I’m willing to add to my position if the valuation is reasonable.

The Stock

If you're a regular, you may already know what I’m going to write, but that won’t stop me from writing it anyway. I consider the stock and the business to be very different things. SoundThinking sells data services to law enforcement. The stock that we buy and sell is a slip of virtual paper that gets traded around by a crowd that drives the shares up and down based on gut reactions. For instance, the company lowered guidance by 2%, and the stock crumbled on the news. A rational person might call that a bit of an overreaction. Additionally, a stock may be bid up in price simply because the crowd’s feeling buoyant about equities as a group. Additionally, the stock may be affected by the change in interest rates.

In my experience, the only way to profitably trade stocks is by spotting discrepancies between expectations and subsequent reality. If the market is unreasonably optimistic, you avoid the stock, and if the market is overly pessimistic, you buy. Additionally, another way of writing "overly pessimistic" is "cheap." I like cheap shares because they have that great combination of lower risk and higher potential reward. They're lower risk because much of the bad news has already been "priced in." To use this stock as an example, the market price for SoundThinking dropped precipitously when the company lowered guidance. The proverbial horse has already left the proverbial stables. So, the person who bought the day after the price collapse has a very different risk profile from the person who bought the day before it. Additionally, cheap shares are potentially greater reward because a small bit of good news has the potential to send the shares skyward.

I measure the relative cheapness of shares in a few ways, ranging from the simple to the more complex. On the simple side, I like to look at the ratio of price to some measure of economic value, like earnings, sales, book value, and the like. I want to see the company trading at a discount to both the overall market and its own history. In my previous missives on this name, I hung on in spite of the fact that the price to sales ratio had climbed to 6.2 from the 5.3 that I had originally bought at. Today that figure looks like this:

The shares are now about 38% cheaper than they were when I took my initial speculative position here. Additionally, they seem to be trading near all-time lows. It seems the market has become very pessimistic here, which I like to see.

I previously suggested stock investing is about trying to spot the discrepancies between expectations and subsequent reality. In my view, you want to get out when the crowd becomes too optimistic about the future, and you want to buy when the crowd is down in the dumps. Being a bit of a math nerd, I want to try to quantify expectations as much as possible, and to do that I turn to the works of Stephen Penman and/or Mauboussin and Rappaport. The former wrote a great book called "Accounting for Value" and the latter pair recently updated their classic "Expectations Investing." Both of these books consider the stock price itself to be a great source of information, and the former in particular helps investors with some of the arithmetic necessary to work out what the market is currently "thinking" about the future of a given business. This involves a bit of high school algebra, where the "g" (growth) variable is isolated in a standard finance formula. Using this methodology, we can work out that the market seems to be assuming that earnings will grow at a rate of about 10.5% in perpetuity, which is fairly optimistic in my view. This suggests there may be further downside from current levels.

Given that I’m in the mood to retain capital, I’ll neither add to nor sell my stake in SoundThinking at the moment. I will reassess after the next quarterly results, to see if the CFO’s claims of cost containment turn out to be accurate.