What's an algorithm worth? Hundreds of billions, potentially.
Ask Google (Nasdaq: GOOG ) . Its search algorithm was worth $180 billion as of yesterday's close. Akamai's (Nasdaq: AKAM ) algorithm for Web-content delivery was worth $6 billion. EMC (NYSE: EMC ) spent $2.1 billion to acquire RSA in 2006, in part for its encryption algorithm. Cisco (Nasdaq: CSCO ) , worth $159 billion in market value, uses algorithms to increase the usefulness of its routers.
Smaller companies are profiting as well. Consider VASCO Data Security (Nasdaq: VDSI ) , an RSA competitor, which says that a proprietary algorithm is key to its Digipass technology for secure banking. It commands a $472 million market value.
Math in your investing future
I mention all of this because, if you want to invest in information technology, you ought to understand (a) what an algorithm is and (b) why it's important. Let's begin with a definition: "In mathematics, computing, linguistics, and related disciplines, an algorithm is a ... type of effective method in which a list of well-defined instructions for completing a task will, when given an initial state, proceed through a well-defined series of successive states, eventually terminating in an end state. The transition from one state to the next is not necessarily deterministic; some algorithms, known as probabilistic algorithms, incorporate randomness."
I emphasized that last sentence because it best describes why a company like Akamai is so valuable. The Web is complex, redundant, and unwieldy. That's both a strength (bringing down the entire Internet is nearly unthinkable) and a weakness (organizing and making business sense out of it is extremely difficult).
Hence the pressing need for rich and unique algorithms.
And think about this: Patenting a "process" or "method" is often weak. Just ask Research In Motion (Nasdaq: RIMM ) how it feels about NTP, for which it paid more than $600 million in 2006 to settle a patent tussle. Algorithms -- especially Web algorithms -- are math: a unique formula that can't be duplicated once patented.
Not exactly the Next Big Thing ...
Perhaps the ubiquity of algorithms is the reason that, two years ago, BusinessWeek published a cover story in which it proclaimed that math would "rock your world."
Or maybe it was about the money, since investments in math-driven start-ups continue to proliferate. Popular news-ratings site Digg uses an algorithm to rank articles and, according to press reports, has taken in at least $10 million in venture funding.
Venture capitalists are still on the hunt. Aster Data Systems recently unveiled a product that pulls together off-the-shelf components to create a massive, clustered database capable of crunching terabytes of data extremely quickly. News Corp.'s (NYSE: NWS ) MySpace is already a customer. And superstar tech financier Sequoia Capital joined other early backers of Google in providing what press reports say is at least $6 million in early-stage financing.
What's so special about Aster? The algorithm, of course. As its "hello, world" press release states, "The key to the Aster nCluster architecture is a series of patent-pending algorithms and processes that control the placement, partitioning, balancing, replication and querying across clusters of intelligent nodes."
Not surprisingly, Aster founder Mayak Bawa cut his coding teeth creating algorithms for querying distributed systems -- think of far-flung computers connected over a network that crunch bits by the terabyte -- while at Stanford, home to a certain Googley, algorithm-creating pair you've heard of.
There are still billions of dollars to be made on the Web. Unlocking that value will demand richer and more complex algorithms. I want to invest in the best of them early, as I did with Akamai.
Fool contributor Tim Beyers also writes for Rule Breakers. He owned shares of Akamai at the time of publication. Akamai is a Rule Breakers recommendation. VASCO is a Stock Advisor selection. The Motley Fool has a market-beating disclosure policy.