The Non-Consensus View: To Be or Not to Be Profitable
Being non-consensus and right is the only way to generate superior returns in investing. Even if consensus is right, those who follow it only do as well as everyone else. Howard Marks detailed why in his 1993 memo, “The Value of Predictions, or Where’d All This Rain Come From?” But even before Marks and certainly after, other great investors recognized the importance of being non-consensus.
- Templeton: It is impossible to produce superior performance unless you do something different from the majority
- Buffett: Be fearful when others are greedy and greedy when others are fearful.
- Keynes: Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.
- Fisher: Huge profits are frequently available to those who zig when most of the financial community is zagging, providing they have strong indications that they are right in their zigging.
- Dalio: You have to be an independent thinker because you can’t make money agreeing with the consensus view, which is already embedded in the price. Yet whenever you’re betting against the consensus, there’s a significant probability you’re going to be wrong, so you have to be humble.
Consensus in the tech world right now is that the growth-at-all-costs mindset of the past near-decade is over, and profitability is the new game. Even before the coronavirus pandemic, tech investors were becoming wary of the disappointing public market performance of unprofitable growth stories like Uber, Slack, and Pinterest. WeWork served as the ultimate cautionary tale in growth over profitability with a side of poor corporate governance. Then the economic shutdown happened, private capital markets tightened, and the gradual lean into profitability now feels like a full careen of almost every tech company and investor focusing on profitability and sustainability.
Does the widespread shift of companies and investors to focus on profitability in tech create an opportunity to be non-consensus and right by embracing a passé growth mindset?
I think it does with caveats.
Growth is existentially important to tech companies. To deploy capital into technology is to deploy capital into innovation. Innovation is, by definition, new. If some new technology isn’t growing, then it isn’t creating meaningful value for customers to adopt it. The market doesn’t want it. A true tech company, first and foremost, must grow, otherwise it is dying. The speed of growth in tech adoption should happen as a byproduct of creating meaningful value for the customer such that the customer cannot ignore the tech. Likewise, the greater the value a technology creates for customers, the greater the pricing power the company possesses over the long term, which should lead to strong profit potential.
Tech and growth are necessarily intertwined, and the mechanism of value creation for the customer that fuels growth should also lead to profitability; however, growth alone doesn’t make for a great company or great investment.
Record levels of private capital available to tech startups over the past several years distorted this reality. Companies armed with tens or hundreds of millions of dollars could pour capital into not only building new technology but heavily marketing that technology. Pouring money into marketing and promotion can make the underlying demand for some new technology appear greater than the underlying reality of the value that the technology creates for customers. High growth begets more capital at higher valuations and the cycle continues until a high-growth company fueled by endless promotion needs to demonstrate profitability. If the technology doesn’t provide as much value to the customer as the growth trajectory would indicate, the company and investors are likely to be disappointed with the profit the business ultimately generates, and the more rational valuation that comes with it.
It’s not enough to ask only if there is a huge potential market. There are many potentially huge markets that can support tremendous growth when fueled by strong promotion. The question must include whether the tech truly changes the customer’s life or if it only makes the customer’s life a little better. Companies that really change the lives of customers usually get growth and the pricing power that can create great returns on capital. Companies that don’t, usually don’t.
Now we’re focused on profitability, but profitability alone also doesn’t make for a great company or great investment. Both growth and profitability are required for a company to be great, and the current growth shakeout should make us all realize there just aren’t that many great companies.
Therefore, the answer to our question about being non-consensus and pushing growth during a profitability trend is, yes, now is a great time to deploy capital into growth if you are one of those great companies that actually provides value for customers that will generate strong future profit. For these rare great companies, it makes sense to reinvest any profit and take on new capital to accelerate customer acquisition during what should be a period of lesser competition for new customers. The easy capital available to many growth-focused tech companies will be absent in the market for some period of time. Logically, this should create a window where customer acquisition can happen at much more reasonable levels than in the recent past.
Now is a great time for the few great companies to invest in growth, but what about tech investors? That leads us to another non-consensus opinion.
Investing, per Buffett, will likely always be a non-consensus act when it comes to tech growth.
A key factor that exacerbated growth-at-all-costs over the past several years is the nature of tech “investing.” Most private and public capital allocated to tech is speculative, not an investment in the parlance of Buffett. Buffett says we speculate when we focus on price, and we invest when we focus on what the asset is going to generate. A large portion of venture and growth capital is expected to be returned through M&A or IPOs done at a higher share price than the cost basis of the asset without the underlying company ever having to generate a profit. When your exit plan relies on someone paying a higher price than you, you are speculating. This has worked over the last decade because high growth results in increasing private valuations on larger funding rounds to fuel more growth, which generate large markups in private portfolios and set a bar for future valuations or exits. So has been the nature of tech investing in the past, and so it shall likely be again at some point after the private markets regroup post-pandemic.
Investors, rather than speculators, get paid back through the return on capital generated by the asset, whether that return gets paid out in dividends, used for share repurchases, or reinvested back into the business through retained earnings. Because some great technology companies can take years, even a decade or more, to become hugely profitable, true tech growth investors must have a sufficiently long-term investment horizon. This potentially very long timeline to profitability for growth-focused companies is why most people who deploy capital into tech companies are speculators — it’s hard to wait for potentially 10+ years to start to see a traditional return on capital rather than just a higher price.
There is nothing wrong with speculation provided that you know you are speculating. The problem comes when you speculate but think you are investing. When many tech “investors” give capital to growth companies, they do so with the hopes of creating greater growth in the business that results in a higher price rather than investment returns generated by the business itself. The speculative nature of tech investing means that growth-at-all-costs was destined to be overdone and is destined to return and be overdone again at some point in the future.
Now is a great time for tech investors to deploy capital into those great companies that should be focused on growth, but investing, per Buffett, will likely always be a non-consensus act when it comes to tech growth.