The inspiration of this article is from a recent Wealth Track interview of the renowned value investor Tom Russo (Trades, Portfolio) (link). In the interview, Russo talked about in a card game called Hearts, “at some point of the game people are moving cards around, and somebody will have created a sequence in their hand that well before the hand’s actually played out secures them the certain victory at which point their colleagues look at them and say ‘you are going to shoot the moon.’ And Amazon has shot the moon.”
A bell suddenly rang in my head. For years, I have been loath to learn about tech companies which operate in rapid changing environments mainly because influences from Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio). For the past two to three years though, one of the major changes I made in how I allocate my time and effort in my investment research has been to spend more time on companies that traditional and conventional value investors shun – companies such as Amazon (AMZN, Financial), Priceline (PCLN, Financial), Google (GOOLG), Alibaba (BABA, Financial), Facebook (FB, Financial), Tencent (TCEHY, Financial), JD.com(JD, Financial) and Baidu (BIDU, Financial).
One of the major struggles that I’ve had with those companies have been to get comfortable with the growth rate. During the fall of 2015, Alibaba (BABA, Financial)’s share collapsed from the post IPO high of $120 a share to barely around $60. I rolled up my sleeves and spent a significant amount of time learning about Alibaba (BABA) and the other tech companies. After a while, I thought I was so smart and had figured out Alibaba (BABA)’s revenue drivers so I could make some projections, which I published on this forum on October of 2015 (link). Here is what I wrote:
“Alibaba’s China’s retail segment’s revenue growth has three components – active user growth, per user spending growth and change in monetization rate. The ideal model is more active users, more per capita spending and higher monetization rate. The revenue growth rate is the product of these three factors.
The question is can the growth sustain and if so, for how long? In investing it’s very easy to form an intuitive answer, because this is how the brain works. And my intuitive answer is no, the explosive growth is not sustainable. But we need take the numeracy step, which means gathering data to back up the statement.
Alibaba was riding three massive waves during this period of time – China’s internet penetration rate, percentage of internet users who shop online, and Alibaba’s penetration rates have all surged, especially Alibaba’s penetration rate.
Going forward, we know that Alibaba’s penetration rate is unlikely to increase further, because it’s already at 97%. Therefore, growth will have to come from the other two variables. If we make the assumption that China’s population grows at roughly 0.8% a year, and both internet penetration and percentage of internet online shopper continue to grow (I’m using a more conservative growth number as always), this is how the active buyers growth may look in the next five to six years.
One thing to note is that the projections are rough estimates and will be wrong. I don't have a crystal ball. But this does give me some idea of how things might turn out approximately. You can see that active buyers growth can taper off to below 15% in two years. If we pencil in a flat monetization rate and a 5% to 6% per capita consumption increase, we will get a 15% to 20% revenue growth rate for Alibaba in the next few years. Still very good, but much slower than the 48% and 37% Alibaba registered in fiscal 2014 and 2015.”
Based on the above foolish looking analysis, I came to the conclusion to pass on Alibaba (BABA, Financial) because back then, if you were to assume only 15-20% revenue growth rate, Alibaba’s share certainly wasn’t looking cheap.
I did the same analysis with Amazon (AMZN, Financial) and Facebook (FB, Financial) and came to similar conclusions – passed on all of them because valuation looked ridiculous if they were only going to grow 15-25%. I even thought that a growth rate of 20% was an aggressive assumption. After all, Alibaba (BABA, Financial), Facebook (FB) and Amazon (AMZN) were all large cap companies with tens of billions or even hundreds of billions of revenue. The law of large numbers should be kicking in.
Well, experience is what you got when you didn’t get what you wanted. Alibaba (BABA, Financial), Facebook (FB, Financial), and Amazon (AMZN, Financial) all completely crushed my expectations, by an embarrassingly large margin! Alibaba’s revenue grew 48%. Facebook’s revenue grew 54% and Amazon’s revenue grew only 27%.
How could this be possible? For companies as sizable as Alibaba (BABA, Financial), Facebook (FB, Financial) and Amazon (AMZN, Financial), such revenue growth numbers are truly staggering. It finally dawned to me that it was like playing chess of the game of Go – the best players would have the moves planned out many steps ahead, the opponent can watch each move but will certainly lose once the winning blueprint has been laid out. Or to use Russo’s analogy - they have all shot the moon in very large addressable markets. It took years to “create the sequences that will secure their certain victory” and once the sequences are created, they shot the moon, leaving the competitors in disbelief and a deep feeling of remorse.
Having missed out on Alibaba (BABA, Financial), Facebook (FB and Amazon (AMZN, Financial), I was not going to make the same mistake again if I see another company that had shot the moon. Last year when JD.com (JD, Financial)’s share collapsed due to short term profitability concerns, I swung hard as Richard Liu has certainly shot the moon in China and I was very comfortable with the growth rate projection of JD.com (JD), which I would not have been comfortable with had not for my experiences with Alibaba (BABA), Facebook (FB, Financial) and Amazon (AMZN).
While technology has certainly made the world around us changing more rapidly day by day, it has also made it easier for visionary leaders to create a company that will shoot the moon in a few years. It has also made it harder for the new entrants to over-rule the established tech giant as they have shot the moon – it has been a while since another tech giant was created even though many tried. As investors, we need to not only be aware of this relatively new phenomenon but also actively learn more about them as they are disrupting many of the companies which we used to think invincible.
Disclosure: Long JD and Tencent.
