Why Investors Should Support the Tesla, SolarCity Merger

Why Investors Should Support the Tesla, SolarCity Merger

In early August Tesla announced it would be buying SolarCity. The New York Times discussed how this combination would help CEO Elon Musk move toward his aspirations for greater clean energy use. But the Los Angeles Times took the companies to task for merging in the face of tremendous capital needs at both, while Tesla was far short of hitting its goals for auto and battery production.

Since then the press has been almost wholly negative on the merger. Marketwatch’s Barry Randall wrote that the deal makes no sense. He argues the companies are in two very different businesses that are not synergistic – and he analogizes this deal to GM buying Chevron. He also makes the case that SolarCity will likely go bankrupt, so there is no good reason for Tesla shareholders to “bail out” the company. And he argues that the capital requirements of the combined entities are unlikely to be fundable, even for its visionary CEO.

musk-tesla-solarcityFortune quotes legendary short seller Jim Chanos as saying the deal is “crazy.” He argues that SolarCity has an uneconomic business model based on his analysis of historical financial statements. And now Fortune is reporting that shareholder lawsuits to block the deal could delay, or kill, the merger.

But short-sellers are clearly not long-term investors. And there is a lot more ability for this deal to succeed and produce tremendous investor returns than anyone could ever glean from studying historical financial statements of both companies.

GM buying Chevron is entirely the wrong analogy to compare with Tesla buying SolarCity. Instead, compare this deal to what happened in the creation of television after General Sarnoff, who ran RCA, bought what he renamed NBC.

The world already had radio (just as we already have combustion powered cars.) The conundrum was that nobody needed a TV, especially when there were no TV programs. But nobody would create TV programs if there were no consumers with TVs. General Sarnoff realized that both had to happen simultaneously – the creation of both demand, and supply. It would only be by the creation, and promotion, of both that television could be a success. And it was General Sarnoff who used this experience to launch the first color televisions at the same time as NBC launched the first color programming – which fairly quickly pushed the industry into color.

Skeptics think Mr. Musk and his companies are in over their heads, because there are manufacturing issues for the batteries and the cars, and the solar panel business has yet to be profitable. Yet, the older among us can recall all the troubles with launching TV.

Early sets were not only expensive, they were often problematic, with frequent component failures causing owners to take the TV to a repairman. Often reception was poor, as people relied on poor antennas and weak network signals. It was common to turn on a set and have “snow” as we called it – images that were far from clear. And there was often that still image on the screen with the words “Technical Difficulties,” meaning that viewers just waited to see when programming would return. And programming was far from 24×7 – and quality could be sketchy. But all these problems have been overcome by innovation across the industry.

Yes, the evolution of electric cars will involve a lot of ongoing innovation. So judging its likely success on the basis of recent history would be foolhardy. Today Tesla sells 100% of its cars, with no discounts. The market has said it really, really wants its vehicles. And everybody who is offered electric panels with (a) the opportunity to sell excess power back to the grid and (b) financing, takes the offer. People enjoy the low cost, sustainable electricity, and want it to grow. But lacking a good storage device, or the inability to sell excess power, their personal economics are more difficult.

Electricity production, electricity storage (batteries) and electricity consumption are tightly linked technologies. Nobody will build charging stations if there are no electric cars. Nobody will build electric cars if there are not good batteries. Nobody will make better batteries if there are no electric cars. Nobody will install solar panels if they can’t use all the electricity, or store what they don’t immediately need (or sell it.)

This is not a world of an established marketplace, where GM and Chevron can stand alone. To grow the business requires a vision, business strategy and technical capability to put it all together. To make this work someone has to make progress in all the core technologies simultaneously – which will continue to improve the storage capability, quality and safety of the electric consuming automobiles, and the electric generating solar panels, as well as the storage capabilities associated with those panels and the creation of a new grid for distribution.

This is why Mr. Musk says that combining Tesla and SolarCity is obvious. Yes, he will have to raise huge sums of money. So did such early pioneers as Vanderbilt (railways,) Rockefeller (oil,) Ford (autos,) and Watson (computers.) More recently, Steve Jobs of Apple became heroic for figuring out how to simultaneously create an iPhone, get a network to support the phone (his much maligned exclusive deal with AT&T,) getting developers to write enough apps for the phone to make it valuable, and creating the retail store to distribute those apps (iTunes.) Without all those pieces, the ubiquitous iPhone would have been as successful as the Microsoft Zune.

It is fair for investors to worry if Tesla can raise enough money to pull this off. But, we don’t know how creative Mr. Musk may become in organizing the resources and identifying investors. So far, Tesla has beaten all the skeptics who predicted failure based on price of the cars (Tesla has sold 100% of its production,) lack of range (now up to nearly 300 miles,) lack of charging network (Tesla built one itself) and charging time (now only 20 minutes.) It would be shortsighted to think that the creativity which has made Tesla a success so far will suddenly disappear. And thus remarkably thoughtless to base an analysis on the industry as it exists today, rather than how it might well look in 3, 5 and 10 years.

The combination of Tesla and SolarCity allows Tesla to have all the components to pursue greater future success. Investors with sufficient risk appetite are justified in supporting this merger because they will be positioned to receive the future rewards of this pioneering change in the auto and electric utility industries.

A salute to immigrants, America’s unsung national treasure

A salute to immigrants, America’s unsung national treasure

I’m amazed about Americans’ debate regarding immigration. And all the rhetoric from candidate Trump about the need to close America’s borders.

I was raised in Oklahoma, which prior to statehood was called The Indian Territory. I was raised around the only real Native Americans. All the rest of us are immigrants. Some voluntarily, some as slaves. But the fact that people want to debate whether we allow people to become Americans seems to me somewhat ridiculous, since 98% of Americans are immigrants. The majority within two generations.

immigrationThroughout America’s history, being an immigrant has been tough. The first ones had to deal with bad weather, difficult farming techniques, hostile terrain, wild animals – it was very difficult. As time passed immigrants continued to face these issues, expanding westward. But they also faced horrible living conditions in major cities, poor food, bad pay, minimal medical care and often abuse by the people already that previously immigrated.

And almost since the beginning, immigrants have been not only abused but scammed. Those who have resources frequently took advantage of the newcomers that did not. And this persists. Immigrants that lack a social security card are unable to obtain a driver’s license, unable to open bank accounts, unable to apply for credit cards, unable to even sign up for phone service. Thus they remain at the will of others to help them, which creates the opportunity for scamming.

Take for example an immigrant trying to make a phone call to his relatives back home. For most immigrants this means using a calling card. Only these cards are often a maze of fees, charges and complex rules that result in much of the card’s value being lost. A 10-minute call to Ghana can range from $2.86 to $8.19 depending on which card you use. This problem is so bad that the FCC has fined six of the largest card companies for misleading consumers about calling cards. They continue to advise consumers about fraud. And even Congress has held hearings on the problem.

One outcome of immigrants’ difficulties has been the ingenuity and innovativeness of Americans. To this day around the world people marvel at how clever Americans are, and how often America leads the world in developing new things. As a young country, and due to the combination of resources and immigrants’ tough situation, America frequently is first at developing new solutions to solve problems – many of which are problems that clearly affect the immigrant population.

So, back to that phone call. Some immigrants can use Microsoft Skype to talk with their relatives, using the Internet rather than a phone. But this requires the people back home have a PC and an internet connection. Both of which could be dicey. Another option would be to use something like Facebook’s WhatsApp, but this requires the person back home have either a PC or mobile device, and either a wireless connection or mobile coverage. And, again, this is problematic.

But once again, ingenuity prevails. A Romanian immigrant named Daniel Popa saw this problem, and set out to make communications better for immigrants and their families back home. In 2014 he founded QuickCall.com to allow users to make a call over wireless technology, but which can then interface with the old-fashioned wired (or wireless) telecom systems around the world. No easy task, since telephone systems are a complex environment of different international, national and state players that use a raft of different technologies and have an even greater set of complicated charging systems.

But this new virtual phone network, which links the internet to the traditional telecom system, is a blessing for any immigrant who needs to contact someone in a rural, or poor, location that still depends on phone service. If the person on the other end can access a WiFi system, then the calls are free. If the connection is to a phone system then the WiFi interface on the American end makes the call much cheaper – and performs far, far better than any other technology. QuickCall has built the carrier relationships around the world to make the connections far more seamless, and the quality far higher.

But like all disruptive innovations, the initial market (immigrants) is just the early adopter with a huge need. Being able to lace together an internet call to a phone system is pretty powerful for a lot of other users. Travelers heading to a remote location, like Micronesia, Africa or much of South America — and even Eastern Europe – can lower the cost of planning their trip and connect with locals by using QuickCall.com. And for most Americans traveling in non-European locations their cell phone service from Sprint, Verizon, AT&T or another carrier simply does not work well (if at all) and is very expensive when they arrive. QuickCall.com solves that problem for these travelers.

Small businesspeople who have suppliers, or customers, in these locations can use QuickCall.com to connect with their business partners at far lower cost. Businesses can even have their local partners obtain a local phone number via QuickCall.com and they can drive the cost down further (potentially to zero). This makes it affordable to expand the offshore business, possibly even establishing small scale customer support centers at the local supplier, or distributor, location.

In The Innovator’s Dilemma Clayton Christensen makes the case that disruptive innovations develop by targeting a customer with an unmet need. Usually the innovation isn’t as good as the current “standard,” and is also more costly. Today, making an international call through the phone system is the standard, and it is fairly cheap. But this solution is often unavailable to immigrants, and thus QuickCall.com fills their unmet need, and at a cost substantially lower than the infamous calling cards, and with higher quality than a pure WiFi option.

But now that it is established, and expanding to more countries – including developed markets like the U.K. – the technology behind QuickCall.com is becoming more mainstream. And its uses are expanding. And it is reducing the need for people to have international calling service on their wired or wireless phone because the available market is expanding, the quality is going up, and the cost is going down. Exactly the way all disruptive innovations grow, and thus threaten the entrenched competition.

The end-game may be some form of Facebook in-app solution. But that depends on Facebook or one of its competitors seizing this opportunity quickly, and learning all QuickCall.com already knows about the technology and customers, and building out that network of carrier relationships. Notice that Skype was founded in 2003, and acquired by Microsoft in 2011, and it still doesn’t have a major presence as a telecom replacement. Will a social media company choose to make the investment and undertake developing this new solution?

As small as QuickCall.com is – and even though you may have never heard of it – it is an example of a disruptive innovation that has been successfully launched, and is successfully expanding. It may seem like an impossibility that this company, founded by an immigrant to solve an unmet need of immigrants, could actually change the way everyone makes international calls. But, then again, few of us thought the iPhone and its apps would cause us to give up Blackberries and quit carrying our PCs around.

America is known for its ingenuity and innovations. We can thank our heritage as immigrants for this, as well as the immigrant marketplace that spurs new innovation. America’s immigrants have the need to succeed, and the unmet needs that create new markets for launching new solutions. For all those conservatives who fear “European socialism,” they would be wise to realize the tremendous benefits we receive from our immigrant population. Perhaps these naysayers should use QuickCall.com to connect with a few more immigrants and understand the benefits they bring to America.

Facebook’s Surge, Apple’s Slide and Chipotle’s Stall – It’s All About Growth

Facebook’s Surge, Apple’s Slide and Chipotle’s Stall – It’s All About Growth

Growth fixes a multitude of sins.  If you grow revenues enough (you don’t even need profits, as Amazon has proven) investors will look past a lot of things.  With revenue growth high enough, companies can offer employees free meals and massages. Executives and senior managers can fly around in private jets.  Companies can build colossal buildings as testaments to their brand, or pay to have thier names on  public buildings.  R&D budgets can soar, and product launches can fail. Acquisitions are made with no concerns for price. Bonuses can be huge.  All is accepted if revenues grow enough.

Just look at Facebook.  Today Facebook announced today that for the quarter ended March, 2016 revenues jumped to $5.4B from $3.5B a year ago.  Net income tripled to $1.5B from $500M.  And the company is basically making all its revenue – 82% – from 1 product, mobile ads.  In the last few years Facebook paid enormous premiums to buy WhatsApp and Instagram – but who cares when revenues grow this fast.

Anticipating good news, Facebook’s stock was up a touch today. But once the news came out, after-hours traders pumped the stock to over $118//share, a new all time high. That’s a price/earnings (p/e) multiple of something like 84.  With growth like that Facebook’s leadership can do anything it wants.

But, when revenues slide it can become a veritable poop puddle. As Apple found out.

Rumors had swirled that Apple was going to say sales were down.  And the stock had struggled to make gains from lows earlier in 2016. When the company’s CEO announced Tuesday that sales were down 13% versus a year ago the stock cratered after-hours, and opened this morning down 10%.  Breaking a streak of 51 straight quarters of revenue growth (since 2003) really sent investors fleeing.  From trading around $105/share the last 4 days, Apple closed today at ~$97.  $40B of equity value was wiped out in 1 day, and the stock trades at a p/e multiple of 10.

The new iPhone 6se outsold projections, iPads beat expectations.  First year Apple Watch sales exceeded first year iPhone sales.  Mac sales remain much stronger than any other PC manufacturer. Apple iBeacons and Apple Pay continue their march as major technologies in the IoT (Internet of Things) market. And Apple TV keeps growing.  There are about 13M users of Apple’s iMusic.  There are 1.5M apps on the iTunes store.  And the installed base keeps the iTunes store growing.  Share buybacks will grow, and the dividend was increased yet again.  But, none of that mattered when people heard sales growth had stopped.  Now many investors don’t think Apple’s leadership can do anything right.

Growth StallYet, that was just one quarter.  Many companies bounce back from a bad quarter.  There is no statistical evidence that one bad quarter is predictive of the next.  But we do know that if sales decline versus a year ago for 2 consecutive quarters that is a Growth Stall.  And companies that hit a Growth Stall rarely (93% of the time) find a consistent growth path ever again.  Regardless of the explanations, Growth Stalls are remarkable predictors of companies that are developing a gap between their offerings, and the marketplace.

Which leads us to Chipotle.  Chipotle announced that same store sales fell almost 30% in Q1, 2016.  That was after a 15% decline in Q4, 2015. And profits turned to losses for the quarter.  That is a growth stall.  Chipotle shares were $750/share back in early October. Now they are $417 – a drop of over 44%.

Customer illnesses have pointed to a company that grew fast, but apparently didn’t have its act together for safe sourcing of local ingredients, and safe food handling by employees.  What seemed like a tactical problem has plagued the company, as more customers became ill in March.

Whether that is all that’s wrong at Chipotle is less clear, however.  There is a lot more competition in the fast casual segment than 2 years ago when Chipotle seemed unable to do anything wrong.  And although the company stresses healthy food, the calorie count on most portions would add pounds to anyone other than an athlete or construction worker – not exactly in line with current trends toward dieting.  What frequently looks like a single problem when a company’s sales dip often turns out to have multiple origins, and regaining growth is nearly always a lot more difficult than leadership expects.

Growth is magical.  It allows companies to invest in new products and services, and buoy’s a stock’s value enhancing acquisition ability.  It allows for experimentation into new markets, and discovering other growth avenues.  But lack of growth is a vital predictor of future performance.  Companies without growth find themselves cost cutting and taking actions which often cause valuations to decline.

Right now Facebook is in a wonderful position.  Apple has investors rightly concerned.  Will next quarter signal a return to growth, or a Growth Stall?  And Chipotle has investors heading for the exits, as there is now ample reason to question whether the company will recover its luster of yore.

Can Netflix Double Pivot to Be a Media Game Changer?

Can Netflix Double Pivot to Be a Media Game Changer?

Netflix has been a remarkable company.  Because it has accomplished something almost no company has ever done.  It changed its business model, leading to new growth and higher profits.

Almost nobody pulls that off, because they remain stuck defending and extending their old model until they become irrelevant, or fail.  Think about Blackberry, that gave us the smartphone business then lost it to Apple and its creation of the app market.  Consider Circuit City, that lost enough customers to Amazon it could no longer survive.  Sun Microsystems disappeared after PC servers caught up to Unix servers in capability. Remember the Bell companies and their land-line and long distance services, made obsolete by mobile phones and cable operators?  These were some really big companies that saw their market shifts, but failed to “pivot” their strategy to remain competitive.

Netflix built a tremendous business delivering physical videos on tape and CD to homes, wiping out the brick-and-mortar stores like Blockbuster and Hollywood Video.  By 2008 Netflix reached $1B revenues, reducing Blockbuster by a like amount.  By 2010 Blockbuster was bankrupt.  Netflix’ share price soared from $50/share to almost $300/share during 2011.  By the end of 2012 CD shipments were dropping precipitously as streaming viewership was exploding.  People thought Netflix was missing the wave, and the stock plummeted 75%. Most folks thought Netflix couldn’t pivot fast enough, or profitably, either.

But in 2013 Netflix proved the analysts wrong, and the company built a very successful – in fact market leading – streaming business.  The shares soared, recovering all that lost value.  By 2015 the company had more than doubled its previous high valuation.

But Netflix may be breaking entirely new ground in 2016.  It is becoming a market leader in original programming.  Something we long attributed to broadcasters and/or cable distributors like HBO and Showtime.

Today’s broadcast companies, like NBC, CBS and ABC, are offering less and less original programming.  Overall there are 3 hours/night of prime time television which broadcasters used to “own” as original programming hours.  Over the course of a year, allowing for holidays and one open night per week, that meant about 900 hours of programming for each network (including reruns as original programming.)  But that was long ago.

Netflix Original ProgrammingThese days most of those hours are filled with sports – think evening games of football, basketball, baseball including playoffs and “March Madness” events.  Sports are far cheaper to program, and can fill a lot of hours.  Next think reality programming.  Showing people race across countries, or compete to survive a political battlefield on an island, or even dancing or dieting, uses no expensive actors or directors or sets.  It is far, far less expensive than writing, casting, shooting and programming a drama (like Blacklist) or comedy (like Big Bang Theory.)  Plan on showing every show twice in reruns, plus intermixing with the sports and reality shows, and most networks get away with around 200-250 hours of original programming per year.

Against that backdrop, Netflix has announced it will program 600 hours of original programming this year.  That will approximately double any single large broadcast network.  In a very real way, if you don’t want to watch sports or reality TV any more you probably will be watching some kind of “on demand” program.  Either streamed from a cable service, or from a provider such as Netflix, Hulu or Amazon.

When it comes to original programming, the old broadcast networks are losing their relevancy to streaming technology, personal video devices and the customer’s ability to find what they want, when they want it – and increasingly at a quality they prefer – from streaming as opposed to broadcast media.

To complete this latest “pivot,” from a video streaming company to a true media company with its own content, Morgan Stanley has published that Netflix is now considered by customers as the #1 quality programming across streaming services.  29% of viewers said Netflix was #1, followed by long-time winner HBO now #2 with 21% of customers saying their programming is best.  Amazon, Showtime and Hulu were seen as the best quality by 4%-5% of viewers.

So a decade ago Netflix was a CD distribution company.  The largest customer of the U.S. Postal Service. Signing up folks to watch physical videos in their homes.  Now they are the largest data streaming company on the planet, and one of the largest original programming producers and programmers in the USA – and possibly the world.  And in this same decade we’ve watched the network broadcast companies become outlets for sports and reality TV, while cutting far back on their original shows.  Sounds a lot like a market shift, and possibly Netflix could be the game changer, as it performs the first strategy double pivot in business history.

 

Tesla Model 3 – This is What a “Game Changer” Looks Like

Tesla Model 3 – This is What a “Game Changer” Looks Like

Tesla started taking orders for the Model 3 last week, and the results were remarkable.  In 24 hours the company took $1,000 deposits for 198,000 vehicles.  By end of Saturday the $1,000 deposits topped 276,000 units.  And for a car not expected to be available in any sort of volume until 2017.  Compare that with the top selling autos in the U.S. in 2015:

U.S.-Auto-Sales1Remarkably, the Model 3 would rank as the 6th best selling vehicle all of last year!  And with just a few more orders, it will likely make the top 5 – or possibly top 3! And those are orders placed in just one week, versus an entire year of sales for the other models.  And every buyer is putting up a $1,000 deposit, something none of the buyers of top 10 cars did as they purchased product widely available in inventory. [Update 7 April – Tesla reports sales exceed 325,000, which would make the Model 3 the second best selling car in the USA for the entire year 2015 – accomplished in less than one week.]

Even more astonishing is the average selling price.  Note that top 10 cars are not highly priced, mostly in the $17,000 to $25,000 price range.  But the Tesla is base priced at $35,000, and expected with options to sell closer to $42,000.  That is almost twice as expensive as the typical top 10 selling auto in the U.S.

Tesla has historically been selling much more expensive cars, the Model S being its big seller in 2015.  So if we classify Tesla as a “luxury” brand and compare it to like-priced Mercedes Benz C-Class autos we see the volumes are, again, remarkable.  In under 1 week the Model 3 took orders for 3 times the volume of all C-Class vehicles sold in the U.S. in 2015.

[Car and Driver top 10 cars; Mercedes Benz 2015 unit sales; Tesla 2015 unit sales; Model 3 pricing]

Although this has surprised a large number of people, the signs were all pointing to something extraordinary happening.  The Tesla Model S sold 50,000 vehicles in 2015 at an average price of $70,000 to $80,000.  That is the same number of the Mercedes E-Class autos, which are priced much lower in the $50,000 range.  And if you compare to the  top line Mercedes S-Class, which is only slightly more expensive at an average $90,0000, the Model S sold over 2 times the 22,000 units Mercedes sold.  And while other manufacturers are happy with single digit percentage volume growth, in Q4 Tesla shipments were 75% greater in 2015 than 2014.

In other words, people like this brand, like these cars and are buying them in unprecedented numbers.  They are willing to plunk down deposits months, possibly years, in advance of delivery.  And they are paying the highest prices ever for cars sold in these volumes.  And demand clearly outstrips supply.

Yet, Tesla is not without detractors.  From the beginning some analysts have said that high prices would relegate  the brand to a small niche of customers.  But by outselling all other manufacturers in its price point, Tesla has demonstrated its cars are clearly not a niche market.  Likewise many analysts argued that electric cars were dependent on high gasoline prices so that “economic buyers” could justify higher prices.  Yet, as gasoline prices have declined to prices not seen for nearly a decade Tesla sales keep going up.  Clearly Tesla demand is based on more than just economic analysis of petroleum prices.

People really like, and want, Tesla cars.  Even if the prices are higher, and if gasoline prices are low.

Emerging is a new group of detractors.  They point to the volume of cars produced in 2015, and first quarter output of just under 15,000 vehicles, then note that Tesla has not “scaled up” manufacturing at anywhere near the necessary rate to keep customers happy.  Meanwhile, constructing the “gigafactory” in Nevada to build batteries has slowed and won’t meet earlier expectations for 2016 construction and jobs. Even at 20,000 cars/quarter, current demand for Model S and Model 3 They project lots of order cancellations would take 4.5 years to fulfill.

Which leads us to the beauty of sales growth.  When products tap an under- or unfilled need they frequently far outsell projections.  Think about the iPod, iPhone and iPad.  There is naturally concern about scaling up production.  Will the money be there?  Can the capacity come online fast enough?

Of course, of all the problems in business this is one every leader should want.  It is certainly a lot more fun to worry about selling too much rather than selling too little.  Especially when you are commanding a significant price premium for your product, and thus can be sure that demand is not an artificial, price-induced variance.

With rare exceptions, investors understand the value of high sales at high prices.  When gross margins are good, and capacity is low, then it is time to expand capacity because good returns are in the future.  The Model 3 release projects a backlog of almost $12B.  Booked orders at that level are extremely rare.  Further, short-term those orders have produced nearly $300million of short-term cash.  Thus, it is a great time for an additional equity offering, possibly augmented with bond sales, to invest rapidly in expansion.  Problematic, yes.  Insolvable, highly unlikely.

On the face of it Tesla appears to be another car company.  But something much more significant is afoot.  This sales level, at these prices, when the underlying economics of use seem to be moving in the opposite direction indicates that Tesla has tapped into an unmet need.  It’s products are impressing a large number of people, and they are buying at premium prices.  Based on recent orders Tesla is vastly outselling competitive electric automobiles made by competitors, all of whom are much bigger and better resourced.  And those are all the signs of a real Game Changer.

 

Apple’s Debacle – Why Growth is All That Matters

Apple’s Debacle – Why Growth is All That Matters

Apple announced earnings for the 4th quarter this week, and the company was creamed.  Almost universally industry analysts and stock analysts had nothing good to say about the company’s reports, and forecast.  The stock ended the week down about 5%, and down a whopping 27.8% from its 52 week high.

Wow, how could the world’s #1 mobile device company be so hammered?  After all, sales and earnings were both up – again!  Apple’s brand is still one of the top worldwide brands, and Apple stores are full of customers.  It’s PC sales are doing better than the overall market, as are its tablet sales.  And it is the big leader in wearable devices with Apple Watch.

Yet, let’s compare the  stock price to earnings (P/E) multiple of some well known companies (according to CNN Money 1/29/16 end of day):

  • Apple – 10.3
  • Used car dealer AutoNation – 10.7
  • Food company Archer Daniel Midland (ADM) – 12.2
  • Industrial equipment maker Caterpillar Tractor – 12.9
  • Farm equipment maker John Deere – 13.3
  • Defense equipment maker General Dynamics – 15.1
  • Utility American Electric Power – 16.9
  • Industrial product company Illinois Tool Works (ITW) – 17.7
  • Industrial product company 3M – 19.5

isadWhat’s wrong with this picture?  It all goes to future expectations.  Investors watched Apple’s meteoric rise, and many wonder if it will have a similar, meteoric fall.  Remember the rise and fall of Digital Equipment? Wang? Sun Microsystems? Palm? Blackberry (Research in Motion)?  Investors don’t like companies where they fear growth has stalled.

And Apple’s presentation created growth stall fears.  While iPhone sales are enormous (75million units/quarter,) there was little percentage growth in Q4. And CEO Tim Cook actually predicted a sales decline next quarter!  iPod sales took off like a rocket years ago, but they have now declined for 6 straight quarters and there was no prediction of a return to higher sales volumes.  And as for future products, the company seems only capable of talking about Apple Watch, and so far few people have seen any reason to buy one.  Amidst this gloom, Apple presented an unclear story about a future based on services – a market that is at the very least vague, where Apple has no market presence, little experience and no brand position.  And wasn’t that IBM’s story some 2.5 decades ago?

In other words, Apple fed investor’s worst fears.  That growth had stopped.  And usually, like in the examples above, when growth stops – especially in tech companies – it presages a dramatic reversal in sales and profits.  Sales have been known to fall far, far faster than management predicts.  Although Apple has not yet entered a Growth Stall (which is 2 consecutive quarters of declining sales and/or profits, or 2 consecutive quarters  than the previous year’s sales or profits) investors are now worried that one is just around the corner.

Contrast this with Facebook.  P/E – 113.3.  Facebook said ad revenues rose 57%, and net income was up 2.2x the previous year’s quarter.  But what was really important was Facebook’s story about its future:

  • Facebook is now a “must buy” for advertisers
  • Mobile is the #1 ad trend, and 80% of revenues are from mobile
  • Revenue/user is up 33%, and growing
  • There are multiple unmonetized new markets that Facebook is just developing – Instagram, WhatsApp, FB Messenger and Oculus

In other words, the past was great – but the future will be even better.  The short-term result?  FB stock rose 7.4% for the week, and intraday hit a new 52 week high.  Facebook might have seemed like a fad 3 years ago, especially to older folks.  But now the company’s story is all about market trends, and how Facebook is offering products on those trends that will drive future revenue and profit growth.

Amazon may be an even better example of smart communications.  As everyone knows, Amazon makes no profit.  So it sells for an astonishing P/E of 846.9.  Amazon sales increased 22% in Q4, and Amazon continued gaining share of the fast growing, #1 trend in retail — ecommerce.  While WalMart and Macy’s are closing stores, Amazon is expanding and even creating its own logistics system.

Profits were up, but only 2/3 of expectations – ouch!  Anticipating higher sales and earnings announcements the stock had run up $40/share. But the earnings miss took all that away and more as the stock crashed about $70/share!  A wild 12.5% peak-to-trough swing was capped at end of week down a mere 2.5%.

But, Amazon did a great job, once again, of selling its future.  In addition to the good news on retail sales, there was ongoing spectacular growth in cloud services – meaning Amazon Web Services (AWS.)  JPMorganChase, Wells Fargo, Raymond James and Benchmark all raised their future price forecasts after the announcement, based on future performance expectations.  Even analysts who cut their price targets still kept price targets higher than where Amazon actually ended the week.  And almost all analysts expect Amazon one year from now to be worth more than its historical 52 week high, which is 19% higher than current pricing.

So, despite bad earnings news, Amazon continued to sell its growth story.  Growth can heal all wounds, if investors continue to believe.  We’ll see how it plays out, but for now things appear at least stable.

Steve Jobs was, by most accounts, an excellent showman.  But what he did particularly well was tell a great growth story.  No matter Apple’s past results, or concerns about the company, when Steve Jobs took the stage his team had crafted a story about Apple’s future growth.  It wasn’t about cash flow, cash in the bank, assets in place, market share or historical success – boring, boring.  There was an Apple growth story. There was always a reason for investor’s to believe that competitors will falter, markets will turn to Apple, and growth will increase!

Should investors think Apple is without future growth?  Unfortunately, the communications team at Apple last week let investors think so.  It is impossible to believe this is true, but the communicators this week simply blew it.  Because what they said led to nothing but headlines questioning the company’s future.

What should Apple have said?

  • Give investors a great news story about wearables.  Show applications in health care, retail, etc. that really makes investors think all those people with a Timex or Rolex will wear an AppleWatch in the future.  Apple sold investors the future of iPhone apps long before most of people used anything other than maps and weather – and the story led investors to believe if people didn’t have an iPhone they would miss out on something important, so they were bound to go buy one.  Where’s that story when it comes to wearables?
  • ApplePay is going to change the world.  While ApplePay is #1, investors are wondering if mobile payments is ever going to be big.  What will make it big, when, and what is Apple doing to make this a multi-billion dollar business?  ApplePay launched to a lot of hype, but very little has been said since.  Is this going to be the Apple version of Microsoft’s Zune?  Make investors believers in ApplePay.  Convince them this is worth a lot of future value.
  • iBeacons are one of the most important technology products in retail and inventory control.  iBeacons were launched as a great tool for local businesses, but since then Apple has said almost nothing.  B2B may not be as sexy as consumer markets, but Microsoft made investors believers in the value of enterprise products.  Demonstrate that Apple’s technology is the best, and give investors some stories about how companies are winning.  Most investors have forgotten about beacons and thus they no longer plan for substantial revenues.
  • Apple has the #1 mobile developer community, and the best products are yet to come – so sales are far from stalling.  Honestly, the developer war is critical.  The platform with the most developers wins the most customers.  Microsoft taught investors that.  But Apple never talks about its developer community.  IBM has made a huge commitment to develop iOS enterprise apps that should drive substantial future sales, but Apple isn’t exciting investors about that opportunity.  Tell investors more stories about how Apple is king of the developer world, and will remain in the top spot – better than Android or anyone – for years.  Tell investors this will turn users toward tablets from PCs faster, and iPod sales will start growing again as smartphone and wearable sales join suit.
  • Apple will win big revenues in auto markets.  There was lots of rumors about hiring people to design a car, and now firing the lead guy. What is going on?  Google has been pretty clear about its plans, but Apple offers investors no encouragement to think the company will succeed at even winning the war to be in other manufacturer’s cars, much less build its own.  Given that the story sounds limited for Apple’s “core” products, investors need some stories about Apple’s own “moonshot” projects.
  • Apple is not a 1-pony, iPhone story.  Make investors believe it.

Tim Cook and the rest of Apple leadership are obviously competent.  But when it comes to storytelling, this week their messaging looked like it was created as a high school communications project.  Growth is what matters, and Apple completely missed the target.  And investors are moving on to better stories – fast.

 

The 5 Stocks You Should Buy This Week

The 5 Stocks You Should Buy This Week

Stocks are starting 2016 horribly.  To put it mildly.  From a Dow (DJIA or Dow Jones Industrial Average) at 18,000 in early November values of leading companies have fallen to under 16,000 – a decline of over 11%.  Worse, in many regards, has been the free-fall of 2016, with the Dow falling from end-of-year close 17,425 to Friday’s 15,988 – almost 8.5% – in just 10 trading days!

With the bottom apparently disappearing, it is easy to be fearful and not buy stocks.  After all, we’re clearly seeing that one can easily lose value in a short time owning equities.

But if you are a long-term investor, then none of this should really make any difference.  Because if you are a long-term investor you do not need to turn those equities into cash today – and thus their value today really isn’t important.  Instead, what care about is the value in the future when you do plan to sell those equities.

Investors, as opposed to traders, buy only equities of companies they think will go up in value, and thus don’t need to worry about short-term volatility created by headline news, short-term politics or rumors.  For investors the most important issue is the major trends which drive the revenues of those companies in which they invest.  If those trends have not changed, then there is no reason to sell, and every reason to keep buying.

(1) Buy Amazon

Take for example Amazon.  Amazon has fallen from its high of about $700/share to Friday’s close of $570/share in just a few weeks – an astonishing drop of over 18.5%.  Yet, there is really no change in the fundamental market situation facing Amazon.  Either (a) something dramatic has changed in the world of retail, or (b) investors are over-reacting to some largely irrelevant news and dumping Amazon shares.

Everyone knows that the #1 retail trend is sales moving from brick-and-mortar stores to on-line.  And that trend is still clearly in place.  Black Friday sales in traditional retail stores declined in 2013, 2014 and 2015 – down 10.4% over the Thanksgiving Holiday weekend.  For all December, 2015 retail sales actually declined from 2014.  Due to this trend, mega-retailer Wal-Mart announced last week it is closing 269 stores.  Beleaguered KMart also announced more store closings as it, and parent Sears, continues the march to non-existence.  Nothing in traditional retail is on a growth trend.

However, on-line sales are on a serious growth trend. In what might well be the retail inflection point, the National Retail Federation reported that more people shopped on line Black Friday weekend than those who went to physical stores (and that counts shoppers in categories like autos and groceries which are almost entirely physical store based.)  In direct opposition to physical stores, on-line sales jumped 10.4% Black Friday.

And Amazon thoroughly dominated on-line retail sales this holiday season.  On Black Friday Amazon sales tripled versus 2014.  Amazon scored an amazing 35% market share in e-commerce, wildly outperforming number 2 Best Buy (8%) and ten-fold numbers 3 and 4 Macy’s and WalMart that accomplished just over 3% market share each.

Clearly the market trend toward on-line sales is intact.  Perhaps accelerating.  And Amazon is the huge leader.  Despite the recent route in value, had you bought Amazon one year ago you would still be up 97% (almost double your money.)  Reflecting market trends, Wal-Mart has declined 28.5% over the last year, while the Dow dropped 8.7%.

Amazon may not have bottomed in this recent swoon.  But, if you are a long-term investor, this drop is not important.  And, as a long-term investor you should be gratified that these prices offer an opportunity to buy Amazon at a valuation not available since October – before all that holiday good news happened.  If you have money to invest, the case is still quite clear to keep buying Amazon.

FANGs(2) Buy Facebook

The trend toward using social media has not abated, and Facebook continues to be the gorilla in the room.  Nobody comes close to matching the user base size, or marketing/advertising opportunities Facebook offers.  Facebook is down 13.5% from November highs, but is up 24.5% from where it was one year ago.  With the trend toward internet usage, and social media usage, growing at a phenomenal clip, the case to hold what you have – and add to your position – remains strong.  There is ample opportunity for Facebook to go up dramatically over the next few years for patient investors.

(3) Buy Netflix

When was the last time you bought a DVD?  Rented a DVD?  Streamed a movie?  How many movies or TV programs did you stream in 2015? In 2013?  Do you see any signs that the trend to streaming will revert?  Or even decelerate as more people in more countries have access to devices and high bandwidth?

Last week Netflix announced it is adding 130 new countries to its network in 2016, taking the total to 190 overall.  By 2017, about the only place in the world you won’t be able to access Netflix is China.  Go anywhere else, and you’ve got it.  Additionally, in 2016 Netflix will double the number of its original programs, to 31 from 16. Simultaneously keeping current customers in its network, while luring ever more demographics to the Netflix platform.

Netflix stock is known for its wild volatility, and that remains in force with the value down a whopping 21.8% from its November high.  Yet, had you bought 1 year ago even Friday’s close provided you a 109% gain, more than doubling your investment.  With all the trends continuing to go its way, and as Netflix holds onto its dominant position, investors should sleep well, and add to their position if funds are available.

(4) Buy Google

Ever since Google/Alphabet overwhelmed Yahoo, taking the lead in search and on-line advertising the company has never looked back.  Despite all attempts by competitors to catch up, Google continues to keep 2/3 of the search market.  Until the market for search starts declining, trends continue to support owning Google – which has amassed an enormous cash hoard it can use for dividends, share buybacks or growing new markets such as smart home electronics, expanded fiber-optic internet availability, sensing devices and analytics for public health, or autonomous cars (to name just a few.)

The Dow decline of 8.7% would be meaningless to a shareholder who bought one year ago, as GOOG is up 37% year-over year.  Given its knowledge of trends and its investment in new products, that Google is down 12% from its recent highs only presents the opportunity to buy more cheaply than one could 2 months ago.  There is no trend information that would warrant selling Google now.

(5) Buy Apple

Despite spending most of the last year outperforming the Dow, a one-year investor would today be down 10.7% in Apple vs. 8.7% for the Dow.  Apple is off 27.6% from its 52 week high.  With a P/E (price divided by earnings) ratio of 10.6 on historical earnings, and 9.3 based on forecasted earnings, Apple is selling at a lower valuation than WalMart (P/E – 13).  That is simply astounding given the discussion above about Wal-mart’s operations related to trends, and a difference in business model that has Apple producing revenues of over $2.1M/employee/year while Walmart only achieve $220K/employee/year.  Apple has a dividend yield of 2.3%, higher than Dow companies Home Depot, Goldman Sachs, American Express and Disney!

Apple has over $200B cash. That is $34.50/share.  Meaning the whole of Apple as an operating company is valued at only $62.50/share – for a remarkable 6 times earnings.  These are the kind of multiples historically reserved for “value companies” not expected to grow – like autos!  Even though Apple grew revenues by 26% in fyscal 2015, and at the compounded rate of 22%/year from 2011- 2015.

Apple has a very strong base market, as the world leader today in smartphones, tablets and wearables.  Additionally, while the PC market declined by over 10% in 2015, Apple’s Mac sales rose 3% – making Apple the only company to grow PC sales.  And Apple continues to move forward with new enterprise products for retail such as iBeacon and ApplePay.  Meanwhile, in 2016 there will be ongoing demand growth via new development partnerships with large companies such as IBM.

Unfortunately, Apple is now valued as if all bad news imaginable could occur, causing the company to dramatically lose revenues, sustain an enormous downfall in earnings and have its cash dissipated.  Yet, Apple rose to become America’s most valuable publicly traded company by not only understanding trends, but creating them, along with entirely new markets.  Apple’s ability to understand trends and generate profitable revenues from that ability seems to be completely discounted, making it a good long-term investment.

In August, 2015 I recommended FANG investing.  This remains the best opportunity for investors in 2016 – with the addition of Apple.  These companies are well positioned on long-term trends to grow revenues and create value for several additional years, thereby creating above-market returns for investors that overlook short-term market turbulence and invest for long-term gains.

Will Jack Dorsey “Get It” At Twitter?

Will Jack Dorsey “Get It” At Twitter?

Twitter’s Board decided in July to oust the CEO, Dick Costolo, due to frustration over company profits.  As I wrote at the time, Twitter had continued to add members, at a rate comparable to its social media competition.  And it had grown revenues, while remaining the industry leader in revenue per active user.

But the concern was a lack of profits.  Oh my, if rapid revenue growth but weak profits were a reason to fire a CEO, how does Jeff Bezos keep his job?

Twitter DorseyAnyway, Mr. Costolo was replaced by an original founder and former Twitter CEO Jack Dorsey on an interim basis.  Four months later, after failing in its effort to find a suitable full-time CEO, the Board has made Mr. Dorsey the permanent CEO.  While he simultaneously remains full time CEO of Square, a mobile payments processing company.

As I said in my last column on this subject, investors better beware.

Facebook is tearing up the social media market.  It has grown to be not only #1 in active monthly users, but at 1.5B monthly active users (MSUs) the site has 5 times the number of users that Twitter has.  By adding a slew of new features and functions Facebook has become more valuable to its users – and advertisers.

According to Statista, simultaneously Facebook has grown Facebook Messenger to 700M MSUs, acquired WhatsApp with 800M MSUs and Instagram with 400M MSUs.  By constantly expanding the ecosphere Facebook now has 3.4B MSUs – over 10 times the number of Twitter.  Facebook is so dominant that even muscular Google, with all its resources, abandoned its efforts to compete with the juggernaut by killing Google+ (which had 300M MSUs) earlier in 2015.

Twitter had great organic growth numbers, but unlike competitors it does not dominate any particular category of social media.  Linked in, with only 100M MSUs dominates business networking, and bosts a user base that skews older and more professional.  Pinterest and Instagram are battling it out for leadership in photo sharing.  But it is unclear how one would describe a social growth category that Twitter dominates.

I actively use Twitter.  But among my peers I am the exception.  When I ask people over 40 if they use Twitter I regularly hear “I don’t get it.  It all looks completely chaotic.  Why would I want to follow people on Twitter, and why would I want to post.”  This sounds a lot like what people said of Facebook and Linked in 5 years ago.  But those companies found their connection with users and people now “get it.”

So the question is whether Mr. Dorsey will make Twitter into a site that is ubiquitous, at least for one category.  Can he make the product so useful that users can’t live without it, and that continues drawing in massive new numbers of users?

Twitter has not changed much at all since it was founded.  It still depends on users to sign on, start tweeting, and search out others a user wants to follow.  And that means follow for some reason other than that person is a celebrity or politician that simply can’t stop spouting off.  The Twitter user has to hunt for like minded individuals, find a way to connect with folks who are informative to their needs and then create a dialogue — and all with pretty much the same character limits and shrunken link technology available many years ago.

Apple floundered as a manufacturer of niche PCs.  The returning CEO, Steve Jobs, resurrected the company by putting all his money on mobile.  It wasn’t an improved Mac that turned around Apple, but rather the launch of the iPod and iTunes, followed by the iPhone and the iPad. The way Apple stole the thunder from previously dominant Microsoft was by creating new products built on the mobile trend that led to explosive growth.

Mr. Costolo left Twitter in far better shape than Apple was in when Mr. Jobs retook the reins.  But will Mr. Dorsey be able to launch a series of new products that can create an Apple-like growth explosion?

Square, where Mr. Dorsey ostensibly spends half his time, is preparing to go public.  But, even though it is currently considered by many the leader in its marketplace, Square is looking down the barrel of ApplePay – a technology on every iPhone that could make it obsolete.  Then there’s also Google Wallet that is on all the other smartphones.  Plus well funded outfits like PayPal and Mastercard.  Square will need a very competent, capable and visionary CEO to guide its development competing with these – and other – well funded and powerful companies.  Square will need to add features, functions and benefits if it is create long-term value.

A lot of new products are needed by two relatively small companies in short order if they are to survive.  Success will not happen by cutting costs in either.  It will require intensive product development with very rapid product cycles that bring in millions upon millions of new users.

Twitter was once a disruptive innovator.  Now it is hard to recognize any innovation at Twitter.  Does Mr. Dorsey get it?  And if he does, can he do it?  And do it twice, simultaneously?

 

Why Tesla Could Be the Next Apple – and Put a Hurt On Exxon

Why Tesla Could Be the Next Apple – and Put a Hurt On Exxon

A recent analyst took a look at the impact of electric vehicles (EVs) on the demand for oil, and concluded that they did not matter.  In a market of 95million barrels per day production, electric cars made a difference of 25,000 to 70,000 barrels of lost consumption; ~.05%.

You can’t argue with his arithmetic.  So far, they haven’t made any difference.

Charging_Tesla_Model_S_01But then he goes on to say they won’t matter for another decade.  He forecasts electric vehicle sales grow 5-fold in one decade, which sounds enormous.  That is almost 20% growth year over year for 10 consecutive years.  Admittedly, that sounds really, really big.  Yet, at 1.5million units/year this would still be only 5% of cars sold, and thus still not a material impact on the demand for gasoline.

This sounds so logical.  And one can’t argue with his arithmetic.

But one can argue with the key assumption, and that is the growth rate.

Do you remember owning a Walkman?  Listening to compact discs?  That was the most common way to listen to music about a decade ago.  Now you use your phone, and nobody has a walkman.

Remember watching movies on DVDs?  Remember going to Blockbuster, et.al. to rent a DVD?  That was common just a decade ago.  Now you likely have shelved the DVD player, lost track of your DVD collection and stream all your entertainment.  Bluckbuster, infamously, went bankrupt.

Do you remember when you never left home without your laptop?  That was the primary tool for digital connectivity just 6 years ago.  Now almost everyone in the developed world (and coming close in the developing) carries a smartphone and/or tablet and the laptop sits idle.  Sales for laptops have declined for 5 years, and a lot faster than all the computer experts predicted.

Markets that did not exist for mobile products 10 years ago are now huge.  Way beyond anyone’s expectations.  Apple alone has sold over 48million mobile devices in just 3 months (Q3 2015.)  And replacing CDs, Apple’s iTunes was downloading 21million songs per day in 2013 (surely more by now) reaching about 2billion per quarter.  Netflix now has over 65million subscribers. On average they stream 1.5hours of content/day – so about 1 feature length movie.  In other words, 5.85billion streamed movies per quarter.

What has happened to old leaders as this happened?  Sony hasn’t made money in 6 years.  Motorola has almost disappeared.  CD and DVD departments have disappeared from stores, bankrupting Circuit City and Blockbuster, and putting a world of hurt on survivors like Best Buy.

The point?  When markets shift, they often shift a lot faster than anyone predicts. 20%/year growth is nothing.  Growth can be 100% per quarter.  And the winners benefit unbelievably well, while losers fall farther and faster than we imagine.

Tesla was barely an up-and-comer in 2012 when I said they would far outperform GM, Ford and Toyota.  The famous Bob Lutz, a long-term widely heralded auto industry veteran chastised me in his own column “Tesla Beating Detroit – That’s Just Nonsense.”

Mr. Lutz said I was comparing a high-end restaurant to McDonald’s, Wendy’s and Pizza Hut, and I was foolish because the latter were much savvier and capable than the former.  He should have used as his comparison Chipotle, which I predicted would be a huge winner in 2011.  Those who followed my advice would have made more money owning Chipotle than any of the companies Mr. Lutz preferred.

The point? Market shifts are never predicted by incumbents, or those who watch history.  The rate of change when it happens is so explosive it would appear impossible to achieve, and far more impossible to sustain.  The trends shift, and one market is rapidly displaced by another.

While GM, Ford and Toyota struggle to maintain their mediocrity, Tesla is winning “best car” awards one after another – even “breaking” Consumer Reports review system by winning 103 points out of a maximum 100, the independent reviewer liked the car so much. Tesla keeps selling 100% of its production, even at its +$100K price point.

So could the market for EVs wildly grow?  BMW has announced it will make all models available as electrics within 10 years, as it anticipates a wholesale market shift by consumers promoted by stricter environmental regulations. Petroleum powered car sales will take a nosedive.

The International Energy Agency (IEA) points out that EVs are just .08% of all cars today. And of the 665,000 on the road, almost 40% are in the USA, where they represent little more than a rounding error in market share.  But there are smaller markets where EV sales have strong share, such as 12% in Norway and 5% in the Netherlands.

So what happens if Tesla’s new lower priced cars, and international expansion, creates a sea change like the iPod, iPhone and iPad?  What happens if people can’t get enough of EVs?  What happens if international markets take off, due to tougher regulations and higher petrol costs?  What happens if people start thinking of electric cars as mainstream, and gasoline cars as old technology — like two-way radios, VCRs, DVD players, low-definition picture tube TVs, land line telephones, fax machines, etc?

What if demand for electric cars starts doubling each quarter, and grows to 35% or 50% of the market in 10 years?  If so, what happens to Tesla?  Apple was a nearly bankrupt, also ran, tiny market share company in 2000 before it made the world “i-crazy.” Now it is the most valuable publicly traded company in the world.

Already awash in the greatest oil inventory ever, crude prices are down about 60% in the last year.  Oil companies have already laid-off 50,000 employees.  More cuts are planned, and defaults expected to accelerate as oil companies declare bankruptcy.

It is not hard to imagine that if EVs really take off amidst a major market shift, oil companies will definitely see a precipitous decline in demand that happens much faster than anticipated.

To little Tesla, which sold only 1,500 cars in 2010 could very well be positioned to make an enormous difference in our lives, and dramatically change the fortunes of its shareholders — while throwing a world of hurt on a huge company like Exxon (which was the most valuable company in the world until Apple unseated it.)

[Note: I want to thank Andreas de Vries for inspiring this column and assisting its research.  Andreas consults on Strategy Management in the Oil & Gas industry, and currently works for a major NOC in the Gulf.]

F.A.N.G Investing Makes Sense – Facebook, Amazon, Netflix, Google

F.A.N.G Investing Makes Sense – Facebook, Amazon, Netflix, Google

As market volatility reached new highs this week, CNBC began talking about something called “FANG Investing.”  Most commentators showed great displeasure in the fact that prior to the recent downturn high growth companies such as Facebook, Amazon, Netflix and Google (FANG) had performed much better than all the major market indices.  And, in the short burst of recent recovery these companies again seemed to be doing much better.

tesla-facebook-netflix-amazon-google-twitter100-_pd-1414591845697_v-z-a-par-a-lCoined by “CNBC Mad Money” host Jim Cramer, he felt that FANG investing was bad for investors.  He said he preferred seeing a much larger group of companies would go up in value, thus representing a much more stable marketplace.

Sound like Wall Street gobblygook?  Good.  Because as an individual investor why should you care about a stable market?  What you should care about is your individual investments going up in value. And if yours go up and all others go down what difference does it make?

Most financial advisers today actually confuse investors much more than help them.  And nowhere is this more true than when discussing risk.  All financial advisers (brokers in the old days) ask how much risk you want as an investor.  If you’re smart you say “none.”  Why would you want any risk?  You want to make money.

Only this is the wrong answer, because most investors don’t understand the question – because the financial adviser’s definition of risk is nothing like yours.

To a broker investment risk is this bizarre term called “beta,” created by economists.  They defined risk as the degree to which a stock does not move with the market index.  If the S&P down 5%, and the stock goes down 5%, then they see no difference between the stock and the “market” so they say it has no risk.  If the S&P goes up 3% and the stock goes up 3%, again, no risk.

But if a stock trades based on its own investor expectation, and does not track the market index, then it is considered “high beta” and your broker will say it is “high risk.”  So let’s look at Apple the last 5 years.  If you had put all your money into Apple 5 years ago you would be up over 200% – over 4x.  Had you bought the S&P 500 Index you would be up 80%.  Clearly, investing in Apple would have been better.  But your adviser would say that is “high risk.”  Why?  Because Apple did not move with the S&P. It did much better.  It is therefore considered high beta, and high risk.

You buy that?

Thus, brokers keep advising investors buy funds of various kinds.  Because the investors says she wants low risk, they try to make sure her returns mirror the indices.  But it begs the question, why don’t you just buy an electronic traded fund (ETF) that mirrors the S&P or Dow, and quit paying those fund fees and broker fees?  If their approach is designed to have you do no better than the average, why not stop the fees and invest in those things which will exactly give you the average?

Anyway, what individual investors want is high returns.  And that has nothing to do with market indices or how a stock moves compares to an index.  It has to do with growth.

Growth is a wonderful thing.  When a company grows it can write off big mistakes and nobody cares.  It can overpay employees, give them free massages and lunches, and nobody cares.  It can trade some of its stock for a tiny company, implying that company is worth a vast amount, in order to obtain new products it can push to its customers, and nobody cares.  Growth hides a multitude of sins, and provides investors with the opportunity for higher valuations.

On the other hand, nobody ever cost cut a company into prosperity.  Layoffs, killing products, shutting down businesses and selling assets does not create revenue growth.  It causes the company to shrink, and the valuation to decline.

That’s why it is lower risk to invest in FANG stocks than those so-called low-risk portfolios.  Companies like Facebook, Amazon, Netflix, Google — and Apple, EMC, Ultimate Software, Tesla and Qualcomm just to name a few others — are growing.  They are firmly tied to technologies and products that are meeting emerging needs, and they know their customers.  They are doing things that increase long-term value.

McDonald’s was a big winner for investors in the 1960s and 1970s as fast food exploded with the baby boomer generation.  But as the market shifted McDonald’s sold off its investments in trend-linked brands Boston Market and Chipotle.  Now its revenue has stalled, and its value is in decline as it shuts stores and lays off employees.

Thirty years ago GE tied its plans to trends in medical technology, financial services and media, and it grew tremendously making fortunes for its investors.  In the last decade it has made massive layoffs, shut down businesses and sold off its appliance, financial services and media businesses.  It is now smaller, and its valuation is smaller.

Caterpillar tied itself to the massive infrastructure growth in Asia and India, and it grew.  But as that growth slowed it did not move into new businesses, so its revenues stalled.  Now its value is declining as it lays off employees and shuts down business units.

Risk is tied to the business and its future expectations.  Not how a stock moves compared to an index.  That’s why investing in high growth companies tied to trends is actually lower risk than buying a basket of stocks — even when that basket is an index like DIA or SPY.  Why should you own the low-or no-growth dogs when you don’t have to?  How is it lower risk to invest in a struggling McDonald’s, GE or Caterpillar or some basket that contains them than investing in companies demonstrating tremendous revenue growth?

Good fishermen go where the fish are.  Literally.  Anybody can cast out a line and hope.  But good fisherman know where the fish are, and that’s where they invest their bait.  As an investor, don’t try to fish the ocean (the index.)  Be smart, and put your money where the fish are.  Invest in companies that leverage trends, and you’ll lower your risk of investment failure while opening the door to superior returns.