To:Don Mosher who wrote (48061)
From: John Shannon Friday, Oct 19, 2001 12:02 PM
View Replies (1) | Respond to of 48103
Don - that was a great post.
And it exposes what I think is the Achilles heel of the Gorilla Game. Which is that one can reliably harvest disproportionate gains merely by systemic identification of Gorillas.
There are three factors which determine the price of any stock:
(a) time value of money
(b) estimated future profits
(c) future-risk
As you so clearly set forth, the Gorilla's dual advantage acts to increase future profits and reduce future-risk.
In the pleasant world of homogeneous behavior, one can apply Vanilla rules of thumb to an existing business and ballpark future profits; then apply a Vanilla estimate of future-risk; then discount to present value. Which for a given company will result in a Vanilla valuation.
Without question, if one applies Vanilla criteria to the evaluation of a Gorilla then yes it will be undervalued. And before a Gorilla is identifiable amongst the other shiny pebbles, it is hard to argue that it deserves anything but Vanilla valuation. And so, when it emerges and attracts proper Gorilla stature... we see disproportionate investment gains.
Very true. And a very seductive conclusion follows: all we have to do is identify the Gorilla while the market is switching from Vanilla to Gorilla.
And Moore offered up a method. A checklist and a process. Which he called the Gorilla Game.
The flaw however is that it is only reliably practicable in hindsight. It is not as valuable in advance as we might want it to be. Or more to the point as it needs to be in order to be successful.
I am not disputing that an investment in a zygotic Gorilla should deliver above average returns. No, such an investment should attract stellar returns.
I am disputing the thesis that we can reliably identify these zygotes before the rest of the market. Or that once they are identifiable as deserving of non-Vanilla pricing that the market will get it wrong and we will get it right. That would make us consistently smarter than the market. This is quite appealing from an ego perspective. But the difference between a Fool and a Genius is that each believe they are the other.
Can we identify Gorillas early enough? So far, this thread hasn't had too spectacular a track record. Individuals perhaps. But the thread as a collective has not.
Are we immune to false positives? Well, the composition of the GKI changes considerably from year to year. Which is hard to rationalize against the thesis of "long term sustainable competitive advantage".
And even if we are graced with heads the size of a planet and we can consistently beat the market... what happens if a bunch of dummies thinks they are just as smart and in aggregate they incorrectly practice the Gorilla Game on everything that smells tech? What if they bid the price up on everything from small and shiny to large and silver backed, and we are forced to pay unfair and high prices?
Or what if company management, venture capitalists, evangelistic technophile cheerleaders and the vast marketing arm of Wall Street conspire to fabricate legions of impressive and realistic Gorilla costumes and proceed to drape them on anything that moves?
Yikes.
What I am saying is that when repeated often enough and by enough people, the practice of Gorilla Gaming should attract enough spectacular failures so that in the end one's net returns turn out to be average!!!
Because the market is a very efficient machine. The cynic in me would say it is very efficient at moving capital from less sticky pockets to more sticky pockets. But its greatest efficiency is the balancing of risk and reward. Any mechanical method (e.g. checklist of characteristics) of securing a favorable risk/reward imbalance is not sustainable. Indeed, the market will rapidly adjust so that the degree of risk is appropriate for the returns.
And Moore's book has been out for a few years now. It's not exactly a secret.
What this means is that by now we should expect that Gorilla Gamers who are attempting to attract disproportionate rewards also face disproportionate risks.
For example, the "it's undervalued" thesis has nothing but the thesis to hold it together; offering no impedance to upwards price drift and an overvaluation spiral. People are willing to pay more for something that is seen as undervalued. If the price that the market quotes is "under valued", then the market price has a tendency to rise until such time as the value is fair. Which is to say, until such time as the assertion of de-facto overvaluation is no longer held to be true.
The theory of risk allows eToys to have been priced above its fair value of zero. But what justification is there for Cisco? The myth of "it's undervalued" acts to exacerbate its own falsehood.
Alternatively stated, we should expect an inflection point of proportionate returns that lies precisely at the moment the Gorilla is identifiable as such. Earlier purchases will attract greater returns, later purchases will attract lesser returns. A purchase at the inflection point should yield real returns at the rate that the market applied at the time to discount future-risk.
This has implications worth pondering in periods when the market is using a higher-than-normal rate of future-risk. An investment in a Gorilla that emerges in such a period *should* deliver higher-than-normal real rates of return! And vice versa.
Indeed, one of the characteristics of the Bubble was the expectation of substantial gain, even from dubious enterprise. Or, lower than average "future risk". No wonder that emerging Gorillas purchased during the bubble are likely to deliver lower than average rates of return. Established gorillas purchased in this interval are likely to fare even worse.
Silver lining: as long as the future looks dim, then in a kind of perverse kind of way, we should expect any Gorillas that emerge today to attract above average rates of return!
John. |
