Regardless of the short-term movements in the market and the potential for rising inflation, the major companies of the next decade will continue to be tech companies. Regardless of the economic trials and tribulations ahead, technology will continue to change the world and determine what the future looks like. These companies are often more difficult to understand and value than traditional businesses and it is critical to look beyond the basic valuation metrics and ratios traditionally used in assessing stocks. There are a few reasons for this.
Firstly, the best tech companies are not focused on profit. They are racing to solve a problem and then win their market. That means scaling fast and capturing market share. Profit comes much later. This is a counter intuitive concept for many to become comfortable with, because one of the most basic business concepts for years has simply been that good businesses make profit and bad ones don’t. The internet started to change that 25-30 years ago with companies like Amazon relentlessly reinvesting in the growth of the business above all else. From a stock perspective, the profit figure will always be low and PE ratios went out the window. What matters more is the business model and the subsequent growth in customers, subscribers and revenue.
For years Amazon was derided by stockbrokers and investors as being ridiculously expensive. One of the main reasons was the stocks very high price to earnings ratio of 1,000 (or more). For context investors would typically see 10-30 as reasonable and 30+ as higher for a growth stock. In other words, the share price was many times the profit per share. Investors were bewildered at just how expensive the stock appeared and the media loved leading with news headlines about the crazy valuations. But they simply didn’t understand the strategy that Amazon and Jeff Bezos were pursuing. I am not saying we would buy the stock at any price, but profit wasn’t Amazon’s goal back then and it’s still not.
I am fascinated by Amazon and their business model as it evolves, especially the growth of their Amazon Prime subscribers. These customers pay a subscription fee to access a range of products, services and further discounts. With the infrastructure inherent within their business model, it now enables Amazon to sell almost any product, to anyone, anywhere in the world. With the scale they now have as they grow their fee-paying subscribers, they will eventually be able to sell products at cost. That’s why they are a threat to almost every retailer in the world. In the future, you will not be able to buy products more conveniently or more cheaply than with Amazon. After taking decades to build their strategic position it makes it very difficult for traditional retailers, who need to make a profit on the goods they sell, to compete with Amazon in the future.
For Amazon, it really is about winning the whole market and gaining as many customers as possible. More importantly though and more difficult to identify is the strategy that I think will secure their dominance for the years and decades ahead. I am always very interested in the number of Amazon Prime subscribers when they release that information. The subscription fee is just the start. Eventually, they will be able to increase their subscription fee significantly and they won’t lose customers because the savings customers realise will still outweigh not having the subscription. These are the types of companies we are looking to include in our portfolios across industries.
This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you.