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June 12, 2000
The Gorilla Game
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Comparing RB and GG Investing
Comparing RB and GG investing methods
Ever since I took the RB seminar last March I have become a more active member of the TMF community. One of the things I discovered in my search to become a better investor was the Gorilla Game (GG) board. I had some idea of what the GG principles were, but I hadn't read the book. Now having read the book I realize that both the GG and RB methods of investing have a lot in common.
Let's first review the basic criteria for both methods:
1. The top dog and first-mover in an important, emerging industry...
2. Sustainable advantage gained through business momentum, patents,
visionary leadership, and/or inept competition...
3. Excellent past share appreciation, measured by a relative strength of
90 or higher...
4. Good management and smart backing...
5. The greater the consumer brand, the better...
6. A significant constituent of the financial media is recently on record
for calling it overvalued...
RB investing was invented by Dave Gardner, Chief Fool here at TMF. It is a LTBH strategy. The goal is to pick those companies that are breaking the rules early on and that are destined for greatness.
GG criteria (from SI GG FAQ):
1. Discontinuous innovation
2. Proprietary open architecture
3. High barriers to entry
4. High switching costs
5. Strong value chain formation
6. Tornado market exists or foreseeable
Ten rules of GG (from the book by Geoffrey A. Moore, Paul Johnson and Tom Kippola):
1. If the category is application software, begin buying in the bowling alley.
2. If the category is enabling hardware or software, begin buying after the tornado has formed.
3. Buy a basket comprising of all the gorilla candidates-usually at least two, sometimes three, and normally no more than four companies.
4. Hold gorilla stocks for the long term. Sell only on proven substitution threat.
5. Hold application software chimp stocks as long as they exhibit potential for further market expansion. Do not hold enabling-technology chimps.
6. Hold kings and princes lightly, selling individual stocks on a marketplace stumble and the category upon deceleration of hypergrowth.
7. Once it becomes clear to you that a company will never become a gorilla, sell its stock.
8. Money taken out of non-gorilla stocks should immediately be reinvested in the remaining gorilla candidates.
9. In a gorilla collision, hold your gorilla candidates until there has been a definitive outcome.
10. Most news has nothing to do with the gorilla game. Learn to ignore it.
Let's go in order by using the RB criteria as our guide.
The first one is for the company to be top dog and first mover in an important, emerging industry. As a GG investor your hunting grounds are purely in high technology and most important and emerging industries can be found in this sector of the economy. Discontinuous innovation (DI) is analogous to breaking the rules. A company introduces technology that shakes the established players out of their complacency. I would argue that DI is an essential component of rule breakers by definition. An example would be Dell using superior business practices to dethrone Compaq (both of which are not really in a GG but in a Royalty game), another would be ORCL and its DI of a relational database.
The second RB principle states that the potential RB must have sustainable advantage gained through business momentum, patents, visionary leadership, and/or inept competition. This goes hand in hand with GG criteria 3 and 4 since you are trying to build a moat around your business. You need high barriers to entry and high switching costs as part of that moat. Patents and business momentum can provide this. Owning a proprietary open architecture in many cases provides the key element to achieving this moat protecting the business. Examples such as KO with its secret formula, MSFT with its secret Windows source code, QCOM with CDMA patents.
The third RB principle is to look at stocks with excellent past share appreciation, measured by a relative strength of 90 or higher. This is simply a measure of hypergrowth (tornado) as seen through the eyes of the stock market. A tornado can be defined quantitatively as when the year-to-year growth approaches or exceeds 100% and when quarter-to-quarter growth is also rapidly accelerating. Both RS and a tornado are trying to point at a similar situation, a hypergrowth sector of the economy. For example, look at year over year growth figures for a company like JDSU, currently growing revenues at about 100%.
RB criteria number four, having a good management and smart backing, is not specifically a part of GG investing, but should be. Execution is critical in determining which company of those that enter a tornado in a given sector will emerge as the Gorilla. Smart backing goes with having a strong value chin to support the gorilla. Once the value chain is formed, its members will work together to support the gorilla. Apple couldn't execute in the 1980s and thus had MSFT become the gorilla. Even now with the antitrust trial, many of MSFT's critics wouldn't want the disappearance of the Windows value chain unless there is some DI that could replace it.
The next RB criteria looks at consumer brand, the greater, the better. This goes along with strong value chain formation and having Main Street adopt your product. So the RB picks are probably made sometime after the Bowling Alley at a time when the early adopters in the mainstream get involved. PALM may be a good example, a critical mass of people now carry around PalmOS PDAs so it has a strong value chain and good consumer brand recognition.
A significant constituent of the financial media is recently on record
for calling it overvalued is the last RB criteria. This also goes along with one of the GG tenets, that gorillas always look overvalued because the stock market hasn't learned how to put a value on the total domination that a gorilla brings to their sector. As an example just look at CSCO, a true gorilla, with a PE of greater than 100 it is frequently mentioned as overvalued. I couldn't think of too many better companies to hold long term in this world.
What are some of the differences between RB and GG investing? RB investing is not restricted to high tech like GG. I believe that GG investors have a much better defined sell strategy, you hold a basket of stocks and you sell off the ones that are not emerging as gorillas (see above GG rule #7). You hold gorillas until there is a successful DI that threatens their business (see GG rule #4. Hold gorilla stocks for the long term. Sell only on proven substitution threat; also GG rules #5 and 6). RB principles only say to sell when "you've found a better place for your money".
My belief is that both methods are complementary to each other and you can use the tools in both to greatly increase your returns as a long term investor.
Some sources and resources:
SI GG FAQ (as of 5/28/2000):
The Gorilla Game: Picking Winners in High Technology written by Geoffrey A. Moore, Paul Johnson and Tom Kippola.
Resources from the RB seminar (FAQ)
Summary of RB seminar lessons:
Rule Breakers, Rule Makers written by David and Tom Gardner
I hope this helps. As always feel free to point out any errors in my flimsy use of what passes for logic.
P.S. I'm putting the finishing touches on a FAQ for this board. It should be ready by tomorrow (6/11/00).
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