I sometimes write notes to myself about my thoughts on investing. This one is of particular interest to a number of stocks we discuss on this board (AMZN, SHOP, HDP, SPLK, SWKS, AAPL) so I thought I’d share it with you. Keep in mind this is more in the nature of a personal journal of what is going through my head and not any sort of advice or firm investment philosophy on my part. And may even be completely wrong! Let me know if you have any comments or questions!
It occurs to me, the stocks I own which are hardest to evaluate are all in some way involved in a new market created by the internet. Here are my "crayon illustration” (à la Peter Lynch) level descriptions my investments with the largest exposure to a new market (past or present):
Amazon (AMZN): Amazon has been at the forefront of the movement towards online retail sales ever since the company’s creation, then branching out into other internet related products opportunistically. Most notably cloud computing (AWS).
New Market: Online Retail Sales, Cloud Computing, and more
Shopify (SHOP): Shopify is involved in the same new market of online retail sales, but instead of providing the sale itself, Shopify provides simple tools which permit anyone to easily setup an elegant online storefront.
New Market: Creation of online storefronts
Hortonworks (HDP): Companies such as Google are collecting data at a rate never before seen in human history. Hortonworks helps turn this pile of data into something accessible by corporations.
New Market: Big Data
Splunk (SPLK): Marketing is a central tenant of capitalism and the internet has made it possible to capture unprecedented amounts of marketing statistics. Splunk helps companies analyze this mountain of marketing data. No surprise that they have links to Hortonworks!
New Market: Big Data (Marketing)
Historical Perspective: Amazon vs Shopify
Amazon is of particular interest here because it offers a historical perspective. Amazon has confounded analysts since I began tracking the company and comments by others indicate this is nothing new. Amazon has been met by doubt and predictions of future doom and gloom at every turn yet the stock price continues to rise. Most notable among the doubters are themes such as “this can’t last,” “too good to be true” and “overvalued." Yet among those doubters there is no consistent reason for the forecast of doom and gloom.
In this way, Shopify looks eerily similar to the Amazon story: Doubt persists without a consistent reason between doubters and investors are happy to be along for the ride. The primary difference is that Amazon began its entrance into a new more than twenty years ago while Shopify is still relatively new to it’s market.
Hortonworks and Splunk are both at the forefront of a brand new market, Big Data, and as such are of immediate interest.
Implications of New Markets
Assuming any of this is correct, what are the implications of a company involved with a new market?
Companies are easily misunderstood. The implications of a new product in a new market are not going to be easily understood by anyone. Sometimes excitement at something new will trump reason (Smartphones, 3-D Printing). Other times the implications (or scope) of the new product(s) may not be easily misunderstood and potential ignored (Online Retail Sales, Big Data).
Marketing expenses may be higher in order to capture market share within an expanding market. This is particularly important for a business with a subscription model where any new business brings recurring revenue each subsequent quarter. This permits a company to potentially grow at the rate of the expanding market.
High initial R&D expenses may occur as an entirely new technology is being developed, followed by a reduction to a sustainable level.
Early adoption comes with the benefit of brand name recognition (creating your own market for a service nobody knew they needed) but at a significant risk of someone coming along later and learning from your mistakes, thus producing a better product. (Is SHOP a case in point for this?)
Significant risk that the new market may look like a great idea yet disappear as “just a fad” (Yahoo style one-stop portals?) or be superseded by a more advanced version of the same market (AOL with dial-up internet vs broadband internet?).
The Profitability Paradox: Caused by the new market?
Amazon shows a bit of a paradox: The company continues to grow and shows very little profit yet the price continues to rise. Perhaps the reason is that it is still expanding into its new market(s)? If online retail sales and cloud computing reach a stable market level, will higher earnings be observed because high levels of growth through spending are no longer possible?
It is tempting to look at industries from the industrial revolution (Ford, for example) except that it seems the internet has drastically changed the nature of investing. Is there a “new market" which has reached the saturation point in the past two decades?
Is it useful to look at the rate of growth of these companies compared to the rate of growth of their respective markets? Are Smartphones a possibility for this? I have encountered comments that smartphone use in the world is approaching a point where market growth is slowing down and investors should look to upgrade cycles rather than market expansion.
Along For The Ride: Skyworks, etc.
A notable point worth further consideration is that there will inevitably be companies which are along for the ride. Skyworks (SWKS) is a perfect example. Skyworks is produces analog semiconductor chips which is a long established market yet they are a supplier for companies targeting two new markets, Smartphones and IoT Devices. This spreads out the “new market” risk but comes with other risks such as Skyworks’ overly high dependence on Apple. From an investment point of view, these companies are intriguing because they create boring products everybody uses but nobody thinks about. More likely to be undervalued than a company providing a product targeting the new market directly.
Keep an extra close eye on these types of stocks! They could just as easily be overhyped as misunderstood and there may be no telling which is which ahead of time. Perhaps 3-D printing is an interesting case study in this? 3-D printing was recently an exciting new market and is still expanding in some very interesting directions but has yet to yield the hoped for results. All too often little more than a fun toy. Will 3-D printing eventually fade away? Or was the excitement simply premature and more time is needed to fully develop its potential? Or is it approaching a stable point of “market saturation”?