RPO is now more important than ever

Musings: This business metric gives us the best sneak peek into the company's revenue pipeline

As we head into another earnings season starting mid-July, I am gathering my thoughts about the key business metrics that I want to focus on. I have a tried and tested process for analyzing earnings reports.

And I score each of my holdings and a few others using my Beachman scoring method. Look for a future post on further enhancements I am making to the scoring algorithm. I am already using them to analyze and pick stocks for my comeback portfolio.

And at the end of each earnings season, I compare the updated scores with past scores looking for new leaders and fallen heroes...checking how each stock has fared over time and making necessary adjustments to my holdings.

This Q2 earnings season is going to be critical to the success of our portfolios.

Probably the most important quarterly report of 2022.

In Q1, we did not receive dependable forward guidance from many of our favorite companies. I heard a lot of hemming and hawing on the earnings calls. There was uncertainty in the air…with a war raging in Europe, with the FOMC starting to raise interest rates, with China still in COVID lockdowns, with inflation rising around the world, with soaring energy prices threatening a global recession etc.

Some of these companies have secular tailwinds behind their backs and customers are still buying. However, any talk about a product being "mission critical" needs to be taken with a grain of salt. If your customers are retailers, banks, small businesses, home builders, crypto exchanges (of course), social media platforms, content streamers, news organizations etc, they are all hurting. Their CFOs are likely considering budget cuts and technology projects are a huge target.

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I believe that we will receive more concrete guidance from most businesses in the Q2 earnings reports. But there will still be some lingering doubt, especially for companies that are closely tied to the consumer or small business. And therein lies the challenge for us, investors.

How can we get a better measure of the future revenue pipeline for our favorite SaaS companies?

The answer is RPO and it is in the 10q and 10k reports that publicly-held businesses file with the SEC.

RPO = Remaining performance obligations. This is a leading indicator of a company’s future revenues. RPO is the total of all the $s that current clients have contractually agreed to spend with the company in the future. These are signed contracts and they tell you what the revenue pipeline is going to look like. We (investors) are not given insight into the duration of the contracts, but sometimes the company will indicate the timing of when these revenues will hit the books. As the sales team signs on new clients or extends the contracts of existing clients, they add $s to the RPO total.

Sure, you can analyze deferred revenues or ARR or billings or backlog. ARR is an extrapolation of the annualized revenue run rate and can be misleading. Deferred revenues, billings and backlog are a subset of RPO and don’t tell the whole story. And yes, contracts can be cancelled by clients for a variety of reasons, however in reality, this does not happen often prior to expiration.

If I want to get as close to shadowing the sales team when they meet clients, make their best pitch to win the business and actually secure the client's signature on the dotted line, RPO is the business metric that I want to measure and track.

I will be paying close attention to the following:

• RPO YoY growth rate

• RPO QoQ growth rate

• New RPO generated by the sales and marketing spend

• Average new RPO contracted with each new customer

For each of these metrics, I will be looking at the %rates, actual $ numbers and the trend over 4-6 quarters. Moreover, I am not shy about using RPO as a tie-breaker between companies, all else being equal.

Most growth investors look at the same handful of metrics…revenues ($), revenue growth, gross margins, customer growth and DBNRR. These are included in the earnings press releases and are easily referenced. It takes a bit more effort to dig up the SEC filing on the company's investor relations' website and search for the updated RPO figures. This additional work is well worth it, especially when it comes to making an informed investing decision.