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Author: TMFFuz Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 8764  
Subject: Re: Screening for Hypergrowth Date: 6/14/2000 5:15 PM
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Fools,

With regard to how one might view the highs versus the lows, I have included what I think is an excellent investment strategy used by IPS funds. I am pretty much convinced after viewing their site that they follow the same underlying principles of the GG (not explicitly however). Number 8 below responds to the question of price ranges.

1. Focus. There are too many companies in too many industries to cover them all. In fact, investors should avoid most industry sectors. They display narrow and unpredictable profit margins, low growth rates, zero sum economics, little control over prices and profit margins and intense, cut-throat competition (metals, restaurants, retail of almost any kind, autos, chemicals, transportation - I could go on, but you get the idea). Why on earth would an investor want to own stock in these industries? Especially when other sectors offer predictable, high profit margins, control over prices, rapid growth and insensitivity to economic cycles.
Focus on disruptive technologies, as defined by Clayton Christensen. These are areas where a new technology is getting ready to overthrow the established companies in its sector. The steam engine was a disruptive technology. So was the printing press, agriculture, the electric motor, internal combustion engines, the telephone and computers. You must always ask yourself, what new technology and company is getting ready to trash what I own. Focus on the new, the disruptive, the stealth developments that the established companies do not understand the market or use for. That's often where enormous value is added.

2. Market share rules. In an industry with a new or immature technology, the learning curve all but mandates that the company with the largest market share will develop a natural monopoly. Only a major miscalculation by management (Apple, for example), or another new technology (CDMA vs. TDMA), can change its fundamentals. As Mike Maubousson of Credit Suisse First Boston has pointed out, new companies with earning assets based on information and intellectual capital behave according to power law functions. Simply put, companies that get ahead tend to not only stay ahead, but to get farther ahead. If a competitor becomes cheap because it is losing market share, history tells us not to wait around to see if it can regain it. In the past, comebacks of this type have been rare, and it's unwise to bet money on its happening.

3. Some business models are inherently superior. Generally speaking, the higher the proportion of a company's earning assets is contributed by intellectual capital, and the less capital intensive it is, the higher its quality of earnings is. It's also easier for such companies to make rapid changes required by new developments. While both Microsoft <http://www.microsoft.com/> and Intel <http://www.intel.com/> are great companies, Intel must invest billions of dollars a year in new plant and equipment for semiconductor manufacture. Microsoft, in contrast, has only a fraction of the massive sunk costs of Intel, which is why Bill Gates has been able to admit mistakes in his estimation of their markets, and change Microsoft's direction to keep and expand its lead.

Another inherently superior business model is based on time-to-payback. The reason Intel is so successful in spite of the capital intensive nature of its business is that microprocessors dramatically decrease the time-to-payback of everything from balancing a checkbook to designing a new jet aircraft. It is worth almost anything for an accountant or a corporate financial officer to not have to recalculate every spreadsheet scenario or tax change implication manually on ledger sheets. Another example is PointCast <http://www.pointcast.com/> - its success is two-fold: it reduces the information gathering effort by the user; and its price (it's free) dramatically reduces its time-to-payback, since the payback is to zero cost, time spent learning how to use it is close to zero, and user time spent actually performing its task is zero, since it is completely automated.

4. Products are where the rubber meets the road. You must understand a company's product line, its market dynamics, and the company's self image. We are in a new, high tech world. Increasingly, hot new products undergoing rapid and growing acceptance in immature, rapidly expanding markets cannot be judged by the historical norms of traditional analysis. They either simply don't apply, or must be supplemented. The expanding uses to which a new product can be put are overwhelmingly more important, since these new uses increase the product's importance and value, and produce earnings that are invisible and unpredictable in the present.

5. Don't worry about price and volatility, worry about whether you are in the right sectors. I don't mean pay anything for a company - price is relevant. What I do mean is that in the fastest growing industries, putting in limit orders to save eighths will often ensure you never own the best companies. Putting in stop loss orders will ensure you pull up your flowers and leave the weeds, since most of the best, fastest growing companies are volatile. You should hold your companies unless the fundamentals of their business begin to deteriorate, and ignore temporary price targets. In the companies of the future, these price targets will nearly always prove to have been far too conservative. If your goal is a 50% price appreciation, you will never own the company whose value increases ten times.

6. Use Management only for specifics. The abundance and accessability of brilliant thinking and research on the Internet today makes the need for management input in your decision making all but obsolete. We use management only when we need something specific, like the number of employees or the amount of goodwill amortization last year. We do not use management inputs for qualitative decision making inputs. If there are problems, you will be the last person they will tell, their focus is often narrow, and their world view is different, while yours should be global. Try the products yourself, or talk to people who use them. Do your own work.

7. Guilder's Laws of the Telecosm and Microcosm tilt the playing field toward individuals and away from institutions. With Gutenberg's invention of the printing press during the early years of the Enlightenment, the absolute power of the Catholic Church over individuals was broken forever. More of the information in the world was accessible to individuals than ever before. While the playing field still wasn't level, it was certainly better, in that it gave more power to the individual. With the information revolution, and the rapid pace of change it has created, individuals now have available to them as much information (power!) as institutions, and the ability to make use of it rapidly, without the difficulties large organizations have in adapting to rapid change, let alone dictating the direction.

8. Bide your time when buying. You can afford to ignore IPOs. In the first place, you will almost never have access to the good ones. They are sold out far in advance to institutional investors and a few very wealthy individuals. But normal, annual volatility will almost always give you an excellent buying opportunity if you are patient. The historical, annual high & low prices in the Value Line Investment Survey <http://www.valueline.com/> show that, over the last decade or more, nearly every company you own has dropped in price 40% or more during the course of a calendar year. This reflects normal annual volatility for all except the safest, highest dividend companies in mature industries, and even those have typically dropped 25% or more in price during the course of a year.

9. Don't focus on just one company you absolutely have to own. Have a stable full, and buy whatever drops into your lap. I've can't count the number of companies I've missed buying that have turned into great companies. I still don't own many of them. If I had kept cash until I could buy them for what I thought they were worth, we would be in sorry shape today. As far as I can tell, not owning them hasn't hurt our performance, and I've bought some companies that turned out to have done better than the ones I missed, and that I probably would not have purchased otherwise.

10. Gates' Law. In the short term, potential returns tend to be overestimated. In the long term, people underestimate the potential of new technologies. This has been pointed out by Bill Gates, and is responsible for many investors becoming disappointed over time frames that used to matter more, like one to three years. If you are convinced of the value and direction of a new technology, expect results to take longer than they used to, and the potential value over the next three to five years to overwhelm your predictions.

11. Learn to recognize extremes of market sentiment. I don't care what the academics and Nobel laureates say, public records of the Federal Reserve, as well as economic history, show that at the most important times, such as major turning points in the economy, and especially during periods of revolutionary technological change in civilizations, the financial markets are not efficient, the experts are overwhelmingly wrong, and the masses are almost always right. There is a large, really good shopping center in my end of town with a superior mix of businesses. It's my favorite economic indicator. I judge the economy's health by how easy it is to get a parking space there in the evenings or on weekends. In 1994, I could go any time and get a parking space right up front. Over the space of a few weeks near the end of 1994, I suddenly couldn't find a parking space at all, never mind up front. Look for Clues. This is often why average citizens are ahead of the Fed or government economists. They are living the recoveries, recessions and bear markets, and such clues are immediately obvious. Although not everyone is consciously aware of them, they still act on them. High level bureaucrats who are on the tax dole are often too insulated from these effects, and blind to the near term signals.

12. Understand the source of a company's value. Value creation is increasingly external. GAAP accounting practices, and the essential corrections to distortions of GAAP that are performed by Economic Value Added (EVATM) analysis <bookstore.html>, are only useful when assets can be measured using the limited tools of the old industrial economy, which haven't changed since the 1930s. Increasingly we must be able to understand other, intangible sources of value. We have not yet devised measurement systems for them, but you must understand them at least qualitatively. For example, it is increasingly essential to understand a company not just in terms of its products, customers and suppliers, but also in terms of its ecosystem. It is analogous to trying to understand the value of a spider in a forest ecosystem. It is impossible if we only look at the spider in isolation. We must also look at the effect the spider's existence has on the ecosystem as a whole, what specific relationships the spider has developed with other life forms, and how they affect different parts of the ecosystem.

Goodnight,
John Del Vecchio
Investment Research Fool
The Motley Fool
http://www.fool.com
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