Picking Stocks Is Simple: Part One

It really is simple. We just complicate it with too much data that leads to rabbit holes of wasted time. Less is more. Especially when you start.

You have two axes.

1. How good is the business?
2. How expensive is the business?

It should always start here. Today, let’s tackle question No. 1.

How good is the business can be translated into a series of more specific questions.

How much money are we going to make in the future? Again, more specific, but not too specific.

The most important thing to remember is that you don’t paid for today’s performance. You get paid for tomorrow’s performance. I like to focus on five-year increments. Anything longer than that is tough for me to visualize and have a reasonable level of confidence.

There are two sides to this equation: price and quantity. I like to think about each of these questions as a probability.

How likely is it that:

1. The company will be selling more units (quantity)?
2. The company will be charging more for each unit they sell (price)?

This is just applied economics 101.

Let’s start with quantity. We’ll use Apple (AAPL, Financial), because most folks have a fair bit of working knowledge of the products and business, and I've written about it a fair amount. here and here.

Will Apple sell more iPhones in 2023 than 2018? Probably. 50%

Will Apple sell more devices related to the iPhone? Probably. 70%

Will Apple sell more services? Probably. 90%

It is easy to think about these questions statically instead of dynamically changing options. The question isn’t, "Will Apple sell more iPhones?" The questions are, "Will it sell more iPhones and other products that leverage Apple’s strengths? Is it creating other businesses that will allow it to sell more stuff?" (Note: I chose stuff, not devices. Apple’s services business is a bit of monster.)

Can it make a cheaper version of the iPhone to drive volume? Could it start making touch screen Macs? Could it make an elegant iPad that is a better way to take handwritten notes? What are the other devices that could use Apple’s strengths? I never envisioned AirPods, but looking back it was pretty obvious that an awesome wireless headset made a ton of sense to the company. Are there more of those?

You need to boil it down into something as simple as, “Will the quantity of stuff sold go up?" Once you have a clear-ish idea on this, move on to the whys attached to each questions.

Let’s dig into the whys related to question No. 2. Why more related devices?

Well, Apple seems to launch products that people really like. The world is getting more digital, not less. Apple Watch is doing pretty well three years after launch, owning 50% of the watch market. I would sooner sell my car and take the bus than give back my AirPods and return to the days of corded headphones. My bet is it probably has an idea or two as good as AirPods lying around. More broadly, I’m guessing that Apple’s core competency of great design of tech products is going to be more useful in 2023 than today.

Now let’s think about why not? What about the competition? They should be coming hard, right? Apple makes a lot of money. Samsung and LG want it. There must be some kid in Silicon Valley that want wants to build a better phone. But, with all of these incentives to steal Apple’s profits, in the last decade, no one has come close. Why?

There are lots of competencies to learn to get this right and actually compete with Apple. Ask Elon Musk about the difference between making a physical product and a digital one. It's infinitely more complicated. The supply chains and trade-offs between engineering and design. The manufacturing investment. It gets really hard, really fast. And then there is the brand. Who wants to say they have a more aspirational brand than Apple? What brand symbolizes affordable luxury better?

The only folks I see getting close are Google. Google has had the resources to lose a lot of money over the past decade. Smart Apple users I know have dabbled with the Pixel. That's one chink in the armor.

Will any of these reasons change over the next five years? Maybe. Apple is certainly behind on voice technology right now. Another ding against Apple. Nothing else material comes to mind.

I like to do this -- why and why not -- for all three of those questions. Go deep, but not too deep. Don’t get lost in market share studies and hours and hours of numerical nuance.

We're almost done. Before we're finished with the question, take a moment and think about moats. Are there any other factors that lead to a moat that will allow Apple to grow price and quantity? Pat Dorsey’s "The Little Book That Builds Wealth" is a great way to think about this. He looks for: cost advantages, network effects, switching costs, intangible assets. Yep, those all apply to Apple.

I write all of this out. Usually in messy long hand. I save it and put it into my desk drawer.

And then I read it a month later. Does it still make sense? Did I miss anything?

Try it. With Google or Pepsico or another business you know reasonably well.

When you’re finished, before you put it in the desk drawer, ask yourself if it makes sense. If it does, it is time to move on to the second axis. More on that next time.

Author's Note: I'm long Google and Apple. Do you our research before you make any investment decision.

About Ryan

Ryan Dolan is a regular guy who got interested in Warren Buffett at business school a decade ago. He launched the Mighty River in 2017 to share investing wisdom, hard-earned mistakes and his general approach to applying Warren and Charlie's values to life. He likes to call it the guide to getting rich slowly.Â