It would be absurd to suggest that Peter Thiel doesn't understand tech investing: The venture capitalist earned more than 2,000% on his Facebook shares, turning a $500,000 investment into more than $1 billion.
In his new book, Zero to One, Thiel offers up a few rules investors can use to identify promising tech businesses. Admittedly, Thiel's rules are aimed more at early stage companies than mature public firms, but many of his ideas are equally as applicable to the public markets as they are to Silicon Valley start-ups.
I interviewed Thiel recently and during our conversation, he emphasized three factors investors should consider before buying shares in any tech company.
Seek out monopolies but watch for them to fade
Most of Thiel's thoughts center around monopoly -- the economic state where a single firm controls an entire market. Although monopolies are generally derided as evil institutions, Thiel argues that they are central to investing, believing that only monopolies are capable of capturing a substantial portion of the value they create and returning it to their shareholders.
For investors, identifying companies that have monopolies, companies that will have monopolies, and companies that once had monopolies but have lost them, is key. Unfortunately, it's not always easy to tell when a company has a monopoly, but of the various publicly traded tech firms, Thiel believes Google's (GOOG -0.74%) (GOOGL -0.80%) is the most significant:
I think the monopoly question is a very important one..It always get obscured. People who have monopolies don't talk about it...I think Google has by far the strongest [monopoly]. That's the clear one. The only risk is that it's so strong that it will come under intense regulatory pressure from the EU. But I would say Google is definitely [a monopoly].
Of course, there may be a time when Google's monopoly fades. It may not happen for many years, but when it does, the search giant -- and its investors -- could be in for some real pain writes Thiel:
The risk is that when you have a monopoly business, when you lose the monopoly, you're really in trouble. The newspaper industry in the U.S. [for example] -- it was a monopoly. But once you lose it, you're in unbelievably big trouble. There are points where people lose monopolies that are really important to be aware of.
Look for defensible growth
Perhaps more so than any other sector, tech investors are obsessed with growth. But Thiel believes growth can be deceiving -- regardless of how quickly a business is expanding, it only makes sense to invest if the growth is sustainable.
Once high-flying tech stocks like Zynga (ZNGA) and Groupon (GRPN -0.05%) have largely proved a disappointment, as investors have discovered that their rapidly growing business models were not stable over the long term:
It's not just growth, it's sustainability of growth. The durability of businesses is not something people paid enough attention to with Groupon and maybe with Zynga. Investors are too biased on growth metrics, because those things are measurable -- they don't ask enough questions about durability. Will the business be around in 10 years? I think it's a more important variable, but it's also more qualitative. I think investors would do well to think more about durability, and a little less about short-term growth.
Betting on, or against, innovation
Finally, Thiel believes it's important for investors to understand what they're betting on: Whether the company whose shares they're buying would benefit from innovation (because it would create, or strengthen their monopoly) or suffer from it (because it would erode their monopoly).
Some of the largest and most profitable tech companies fall into the later category -- though they're still described as tech stocks, their businesses have long matured, and their established monopolies are rewarding shareholders with impressive cash flows. According to Thiel, many of the Nasdaq 100 fall into this category, including Microsoft (MSFT -0.43%):
A whole bunch of the Nasdaq 100 stocks are bets against innovation. That's certainly true of an investment in Microsoft...The risk [for Microsoft] is that there is actually some innovation. So if the operating system moves to mobile, or if it moves to Linux or something like that -- innovation is a problem for Microsoft...[Tech stocks like Microsoft] can be very good investments, because maybe there's not much innovation happening, maybe people overestimate innovation. Microsoft has done quite well because its monopoly has been much more durable than people had thought. It's not always that easy to answer in a concrete case, but I think it's very helpful to get the framing right, and understand "OK, I'm betting against [innovation] here, and under these circumstances it will be a good investment, and under these other ones, it might not be."
