Bala, since the material on "Gorilla stocks" is part of a larger article, I excerpted the relevant portion and pasted it below. I believe Allen said he would expand on his argument about WIND's future dominance of embedded real-time computing, so perhaps that effort will address your question. BTW, there is a thread on this Gorilla concept... exchange2000.com
FOOL ON THE HILL
An Investment Opinion by Louis Corrigan
Hunting Gorillas
Since the day Microsoft (Nasdaq:MSFT - news) went public in 1986, it has probably never looked inexpensive based on standard investment criteria. And yet it's been the quintessential great investment of the last decade, with the company's market cap rising from two-thirds of a billion dollars at its IPO to $240 billion today when it trades at a price-to-earnings ratio of about 63.
The software giant is only one of many high-tech firms that trade at a P/E multiple that makes many value-oriented investors cringe. And yet, many of these companies experience long periods of accelerating gains in market share, rising margins, and eventually, the industry position to muscle into entirely new markets when growth in the core business begins to wane. In other words, conventional notions of valuation don't seem to work because they are based on ideas of competitive restraints that don't apply to high-tech the same way they do in other industries.
Microsoft might teach us, then, that some strong technology businesses get stronger over time, and this potential is often not sufficiently factored into a stock's price, lofty though it may appear. Still, it's important to determine exactly why this should be so and which cases this lesson might cover and which ones it won't. After all, every high-tech investor can reel off a string of examples where the highflyer crashed and the wreckage was not pretty. For every Microsoft, there's at least one Novell (Nasdaq:NOVL - news) . For every Cisco (Nasdaq:CSCO - news) , a Shiva (Nasdaq:SHVA - news) .
Such issues are at the core of The Gorilla Game, an instructive new book by Geoffrey A. Moore, Paul Johnson, and Tom Kippola. If you have more than a passing interest in high-tech investing, you ought to find this an indispensable and highly readable guide. It will sharpen your analytical skills by helping you conceptualize the type of market a company operates in and the concomitant competitive advantages the company may or may not have at its disposal. It also provides a conservative, risk-averse framework for buying and selling these stocks based on fundamental changes in the marketplace.
The book's value derives from a happy joining of the authors' special talents. Moore is a well-known business strategist whose earlier books, Crossing the Chasm and Inside the Tornado, have greatly influenced corporate managers throughout the high-tech sector due to the productive way they conceptualize market opportunity. Readers familiar with Moore's earlier work will recognize that these books provide the basic conceptual foundation for the new book. Added to the mix, though, are insights on how to turn Moore's framework into a full-fledged approach to technology investing. This input comes from
Johnson, a respected senior technology analyst at BancAmerica Robertson Stephens, and Kippola, a successful private investor who now works for The Chasm Group, Moore's consulting outfit.
As the name implies, a gorilla is a monster company, the undisputed master of its domain. Yet one finds gorillas in the mist only in certain jungles. For example, the authors argue that while America Online (NYSE:AOL - news) and Yahoo! (Nasdaq:YHOO - news) are obvious leaders in the burgeoning Internet space, and both have been exceptional investments, neither is gorilla material. The reason is somewhat complicated, but essentially, both operate as transaction service companies that depend on branding and the cultivation of community. The cost to the user of switching from these services to others is really little greater than the cost of switching from one favorite television show to another. We all love Seinfeld, but if it had to go head to head against ER, then most people would see that its competitive position, though incredibly strong, is hardly insurmountable.
Gorillas develop only in markets where it's possible to create such an insurmountable competitive position, such as Microsoft's on the PC desktop. These are markets where customers and suppliers would endure huge costs in switching to a competitor's product. Such high switching costs are concentrated in industries where one company succeeds in providing an open but proprietary architecture that offers a discontinuous innovation relative to what's gone before and thus creates an entirely new supply chain.
An architecture must be proprietary because the vendor needs to have control over its pricing and implementation, but it must also be open so that other companies will integrate their own value-added products with the gorilla's, creating a value chain where all the players have a stake in promoting the would-be gorilla's solution. A company like Iomega (NYSE:IOM - news) , for example, has proprietary storage solutions that distinguish it from commodity hard drive manufacturers such as Seagate (NYSE:SEG - news) . But the cost of switching from a Zip drive to a competitor's high-capacity removable storage product is
significantly lower than that of switching computer operating systems, for example, because Iomega hasn't succeeded in building a strong enough value chain around its offering and perhaps might never succeed in doing so.
A gorilla can only develop when a market moves into hypergrowth and vendors along the potential supply chain spontaneously standardize on one company's product in order to respond quickly to the demand. That standardization, in turn, fuels the customer demand. This scenario is built on the technology adoption life cycle, a relatively familiar concept where innovators try just about anything that's new. Early adopters may follow, but the market only explodes when more pragmatic customers jump on board, bringing the product to what the authors call Main Street. One reason investors continually undervalue gorillas is that the move to standardization and value chain creation that this process entails does not lead to a more mature market with increasing competition and diminishing returns. Instead, it often produces one company with increasing market share and thus a far more profitable and lengthy stay on Main Street than one might expect.
The gorilla game involves learning how to spot industries that might give rise to gorillas and to learn when to invest in these industries so as to minimize the risks but still capture a significant share of the gains. For the investor, three periods are crucial: the chasm, the bowling alley, and the tornado. The chasm represents the market after the early adopters have jumped on board but the more pragmatic buyers (the "herd") remain reluctant to commit to the new innovation and older industry players try to belittle the upstart's offerings. The bowling alley is the first step after crossing the chasm, the point when a new product penetrates whole niches of a larger market. The tornado represents the market stage when a product moves beyond these
niches, proliferating in the mainstream mass market.
A gorilla game investor gets interested when the market enters hypergrowth, such as significant sequential quarterly growth combined with 100% or more year-over-year growth. The authors recommended buying application software companies during the bowling alley phase while waiting until the tornado for companies selling enabling technology, such as an operating system. But they say an investor should buy an entire basket of stocks (usually two to four) representing all the companies with a good shot at becoming the gorilla. The goal then is to look for signs of the emerging gorilla, usually selling off the also-rans (called chimps) as they drop out of the competition. An investor should consolidate the money from those stocks into the remaining candidates until only the gorilla remains. The gorilla should then be held for the long term, until an entirely new product category seriously threatens to end its rule.
This brief sketch only begins to touch on the nature of the gorilla game, and why, for example, a great company like Dell (Nasdaq:DELL - news) is a king in a royalty game with princes and serfs but will never be a gorilla candidate. In addition to this framework, the book offers several case studies, including a snapshot current to last September on the ongoing gorilla game in the customer service software arena. It concludes with some helpful investment tools and techniques for hunting gorillas as well as a model portfolio for investing in the "tornado alley" that is the Internet. But rather than talk more now about a book that deserves extended community involvement, I'll simply suggest you take a look and join us for the discussion started by our own Mike Buckley in the new Gorilla Game message folder. Happy hunting! |
