VALUATION
Especially now that the Nasdaq has tanked significantly from its high, interest was expressed in a text version of my presentation at San Diego about valuation. The following is in the least a representative paraphrase and at times is a verbatim transcript.
Keep in mind that the date of the presentation was March 7, 2000. The closing value of the Naz the previous day was 4905. Today it closed 25% lower at 3645.
Having seen my presentation on video tape, I think the people who see this text instead of the video get the better value. Remind me that no matter how much I like Uncle Frank, Lindy and all you folks that I should never do a presentation on four hours' sleep. But I don't mind telling you that especially in light of the market decline that has taken place since Lindy and Frank were kind enough to give me the microphone, I'm really, really proud of the content.
I hope it helps you keep things in perspective.
--Mike Buckley
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We recently learned from a post by Geoff Moore on his listserv that stocks do indeed get overvalued. That statement by him validates that it's reasonable that we concern ourselves with valuation.
The manuals tells us that the market traditionally has undervalued Gorillas. Based on that, some of us have concluded that any time is a good time to buy a Gorilla. Even so, those people can pose the question of whether it is a better time to buy this Gorilla instead of that Gorilla, or this Gorilla candidate instead of that Gorilla candidate.
The Nasdaq went up 85% last year. As of a week ago it was up about 130% annualized already this year. Are some of these stocks overvalued? On December 28 (if I've got the date right) when Qualcomm was $200, was it overvalued? It's legitimate that we pose these questions to ourselves.
It's a good thing that the flight out here is so long because I used the time to finally read Clayton Christensen's Innovator's Dilemma. It fits perfectly with Gorilla-Game thinking. It is an absolute "must read," exactly as those who have been telling us that for a long time.
In his book, Christensen explains that he studied a nearly 20-year period of the disk drive industry. (What he called "sustaining innovations" we would call continuous innovations.)
If you're a business manager for your company, you want to project the market opportunity for your product. It is remarkable to see how accurate the business managers of that industry were at predicting the market value of the sustaining innovations. It is equally remarkable to see how inaccurate they were at predicting discontinuous innovations. Those are the innovations we regularly invest in.
Examples: In the first four years the 5 1/4" floppy disks were on the market, businesses shipped 250 drives for every 100 drives that were projected. Similarly in the case of 3 1/2" disks, 150 drives were shipped for every 100 that were projected. However, in the case of the 1.8" disk, only 20 were shipped for every 100 that were projected. It's on the upside and the downside that it's nearly impossible to predict the value of a discontinuous innovation.
So how are we to value our stocks?
Let's consider the example of Gordon Moore, no slouch, the co-founder and Chairman of Intel and the Moore of Moore's Law. Do you remember when IBM introduced their first PC and at the same time standardized on the 8088 processor? Moore told Christensen that, at Intel, they thought that was a small design win. In retrospect, they had no idea how to predict the value of their discontinuous innovation.
After all the success of the 8088 processor, you'd think they would have learned how to make better projections. As the next-generation 80286 processor came to be, Intel's managers listed the top 50 markets they thought the product would address. They didn't include the personal computer market in that top 50!
So how are we supposed to value the discontinuous innovations if those guys can't? For the moment, to make things simpler, forget the impact of the Internet. Truly, how are we supposed to know how CDMA will be used 5, 10 or 15 years from now? In the case of Siebel Systems, does Tom Siebel really know how sales force automation and customer service software are going to be used 5 and 10 years from now? (Okay, okay. Larry Ellison does! :) Does the CEO of Gemstar really know how interactive programming guides are going to be used? The list goes on and on. The same for CREE and light-emitting diodes. Even Chaz (Mr. Rambus) admits that he doesn't know where next-generation memory will be in five years.
Earlier I suggested that we forget about the Internet. Now add the unknown impact of the Net back into the list of all those unknown answers to the questions. How in the world are we supposed to value these companies?
I have no idea. As much as we try to value them, there's a certain point after addressing all the questions that I decide it's not possible to value them.
If we can't value them, how do you protect yourself?
I have two solutions. For me (and you should feel free to disagree with me because we embrace friendly disagreement in this forum), my first solution is to diversify among industries. [At this point in the video, with a huge grin on my face I made it clear that I couldn't look at Lindy as I said that. ] If you blow your pick on one industry, the other four or five industries might prop up your portfolio.
My second solution is to diversify among enabling and applications technologies, giving more weight to the enablers because the owners of enabling technologies have far more power than the owners of applications technologies. For that reason, I would never invest as much in a Siebel Systems as I would a Qualcomm.
Actually, a third thing I look at is market opportunity. I've never invested in Remedy because its current market is only about $500 million, small in comparison to Qualcomm's market.
So ...
If you're going to use an approach that is different from the "proper" Gorilla Game, at least do what Lindy does -- look for the lock. If you're going to invest in an enabling technology before the start of the tornado, look for the lock that makes the tornado seem inevitable.
Don't vary too much from the Game. As Frank said earlier in his presentation, we're looking for a low-risk/high-reward scenario. The more we vary from the Game, the more risk we bring to the equation. |
