The Investment Perspective – December 2021

“Neither the investing method nor the fundamentals of the business are right or wrong because the mood of the market is favourable or unfavourable toward the “stock”. That is because when you really think about it, “stocks” (shares) are all about the financials and the trading price, the share price… the cash up value. What matters more is the economics of the business” 

Peter Flannery

Innovation, Disruption, Success… Failure

Key Points:

• Why one promising investment failed.

• Tesla or Volkswagen?

• Paypal or Square?

We live in a world awash with innovation. This is particularly the case in the area of technology. 

I believe we have a long way to go, and there is massive innovation ahead. On a more mundane level, we also live in a world awash with liquidity. That’s when even the flimsiest of ideas can look good. 

The above infographic provides some information on a company called Zillow.

Zillow is a good example of an innovative business that showed promise and was generating a serious amount of turnover.

The business model was based around algorithms that inexpensively and efficiently provided information on properties around market valuations. For example, instead of property developers and buyers having to locate a valuer and pay their fees for a manual valuation, the algorithms developed by Zillow provided market-based valuations in real-time for a much lower cost. 

The business model showed plenty of promise, and cashflows grew. 

In “hip stock market parlance”, Zillow was considered to be one of the new breed of innovative disrupters. Indeed, it was almost ‘a rite of passage’ if you said you invested in Zillow.  One reason, of course, being that the share price grew strongly for a period of time. 

So what went wrong?

I am simplifying it. However, in simple terms, the algorithms were unable to keep up with unexpected changes in property valuations that change due to sudden market shifts beyond a certain level.

In other words, small adjustments in property prices were easily predictable and what the model was generally based on.

Larger unexpected changes in prices proved challenging for the algorithms, and eventually, Zillow the business capitulated and decided to close down that part of their business.

Pity because the idea was smart and appeared to be getting traction. In the end, though, despite what looked like a great business model, an increase in cashflows and a fast-rising share price, we did not have a quality sustainable business. 

A pity actually because, as I say, it was looking good but proved unsustainable.

The point here is that it’s sometimes difficult to distinguish between sustainable long-term success and one that only looks good but ultimately will fail.

Oh, by the way, I watched this company for about three years but didn’t invest or recommend to clients. The main reasons were that I was looking to see how sustainable the business model might be and how reliable the algorithms would be overtime throughout different environments and market cycles.  

At the same time, as you can see from the chart above, the trading price grew strongly and therefore, I was content to simply watch and wait (no FOMO by the way). 

On another note, I have been applying the same approach to another company that you may hear of called Shopify. This model currently also looks promising, and the business is relatively successful so far, although there are questions around sustainability in the long term. It does look promising, though, and in the meantime, we could argue that I have missed out on some healthy trading profits sitting on the side-lines watching. 

The point about Zillow’s trading price decline more recently is that whilst, as e-Biz investors, we like lower prices because that means better buying, it does bring home the point that this is only the case if the business has strong underlying economics. This aspect of business generally takes time to develop and is not always obvious with innovative disruptors. 

Electric vehicles

The above graph shows electric vehicle sales across motor vehicle manufacturers.

“The trend is your friend.” That’s the solid mantra straight out of the technical analysis (share trading) manual.

In short, it says that when the market likes something, then you should jump on it and follow it.

It also says that you’re not supposed to catch falling knives, which means that you bail out when the market does not like something—a different approach, of course, from what we do at WISEplanning.

The reality is that no methodology is perfect. What we know about e-Biz investing is that it does provide us with a high degree of reliability, maximising the probability of our outcome regardless of market and economic conditions over time.

That cannot be said with the same confidence for other methodologies.

When we look at the graph above, we can see that boring old Volkswagen will probably be generating more electric vehicles than the more popular Tesla.  In fact, I hear anecdotally that Volkswagen is looking at hydrogen as a form of energy alongside electricity.  Anyway, those that follow Tesla have made a lot of money by following the trend. To my mind, Elon Musk is a living legend. His resilience and entrepreneurial success is difficult to match elsewhere.

Tesla’s financials have been untidy, although the business economics are developing well.

The trading price of Tesla has always been very expensive when looking at the fundamentals. We could say that this is an example where speculating does actually pay!

Of course, I am not promoting the idea as a way to build financial wealth with any reliability. Further, the question remains whether Elon Musk could have been so successful without the tailwinds of government subsidies and capital so freely available.

It might be nice to secure some Tesla shares at a reasonable price; however, that trading price would ideally be significantly lower than the current level, to take into account the risk. 

Volkswagen seem to be on track to generate more electric vehicles than Tesla and are also looking at other technology as well. Then again, Tesla supporters argue that Tesla is much more than an electric vehicle manufacturer and has a diverse product line, which is true.  The ecosystem is developing, which is potentially positive in terms of improving the quality of the Tesla business. 

PayPal vs. Square (soon to be called Block)

Just for fun, let’s take a look at two different businesses. Neither are recommendations. This is just for your information and learning.

The above comparison between PayPal and Square may offer limited clarity around the importance of the underlying economics of each business as it overviews the financials and, to a limited degree, the underlying economics of each business for comparison purposes.

So, we have two businesses. One is well-established with a solid competitive advantage and the other more innovative and up-and-coming. Which one would you prefer? 

PayPal offers a degree of certainty and reliability given its strong underlying business economics, including its well-known brand and developing ecosystem.

Competition is a factor to consider, although it’s too early to confirm that competition will create serious headwinds for PayPal, who are already adapting to the changing environment as they go along. 

Square’s offering is different to PayPal, and whilst there is a degree of unknown about the future of Square, with Jack Dorsey driving it and a reasonably different offering compared to the likes of PayPal and some others, if this business can scale up, then it may engineer a solid competitive advantage. Good levels of cash should mean that this process should not be overly risky, all things equal.

The graph on the left tracks the PayPal share price over the last five years.  The chart to the right tracks Square’s share price over the last five years.

So, PayPal represents a reliable sound option, although we’ll need to just be sure that they continue to maintain innovation and ongoing development of their ecosystem. 

Square is the new kid on the block to some degree and may be worth watching in the future. 

“The individual investor should act consistently as an investor and not as a speculator.” 

                                                                                                         Ben Graham