Investors are always looking for an edge -- a new and better way to understand and analyze their current and future stocks. One of the best ways to improve in any endeavor is by learning from the wisdom of world-class performers, and this is true in investing, too.
I've been researching the best quotes from venture capitalists on technology, innovation, and investing and this called to mind a terrific article from years ago by famed venture capitalist Marc Andreessen. Andreessen casts a long shadow in Silicon Valley. Among his many accomplishments, he helped invent the internet browser, co-founded dot-com era darling Netscape, co-founded one of the first cloud-computing companies (LoudCloud), and made early investments in Facebook and Twitter. When it comes to creating and investing in technology companies, the dude knows what's up.
In the aforementioned 2007 writeup, Andreessen puts forth his view on the question of what single factor most directly leads to success in a start-up. Thankfully, his answer and the framework that guides his thinking are directly applicable to investing in publicly traded stocks as well.
What matters most?
In the piece, which you can and should read here, Andreessen tackles the question of which of three elements -- product, market, or team -- most directly influences a start-up's odds of success. His answer might surprise you.
He begins by briefly defining what he means by each term:
- Team is how well the group of people in a start-up are suited to solve the problem in front of them.
- Product is seen as how "impressive" a given product is to those who will actually use it, the customers.
- Market refers to the number of potential users for the given product. Is the start-up trying to swim in a pond or an ocean?
He then examines the pros and cons for each of the three key inputs since they all have merit and in some way influence a start-up's success or failure. Finally, Andreessen makes his case for which of the three core start-up elements matters the most. His choice? The market.
By his reckoning, "In a great market -- a market with lots of real potential customers -- the market pulls product out of the startup." In a space where a major need is going unmet, users will happily adopt and regularly use a service or product even if it doesn't perfectly fulfill all their needs or it comes from a suboptimal team. The opposite is also true: An incredible team can produce the best product for a certain problem. But if the product is relevant only to a handful of possible users, then the start-up is unlikely to succeed.
A light to guide your search
This is powerful insight for tech investors, one that can prove immensely useful in searching for tech stocks to buy in a few different respects.
First, Andreessen's insight suggests that the biggest winners come from companies that gain leadership advantages in massive markets. Here, Amazon.com (NASDAQ:AMZN) is a natural example. In our commercial world, retail transactions make the world go round. Amazon has turned in truly blockbuster results from gradually expanding its market from just books at its founding to nearly everything under the sun today. The sheer potential size of the global e-commerce market is another reason I think Amazon still has decades of growth ahead of it, even though it's reached an age when most companies mature. In this way, using market size as a framework to guide your research process can lead you to the companies, like Amazon, that can continually compound at above-average rates over the long term.
Second, using market size as a theme to guide your investing search can also bring to light interesting niche players you might otherwise overlook. Continuing with the e-commerce example, companies like Shopify (NYSE:SHOP) have also thrived by tapping into a need larger providers like Amazon are unable or unwilling to address. By explicitly developing its product as an easy-to-use e-commerce platform for small businesses, Shopify has been able to differentiate itself from larger platforms like Amazon and eBay to incredible results. Shopify continues to grow like a weed -- customer count grew 60% and gross merchant value doubled in its most recent quarter -- and an important reason underpinning that growth is akin to Amazon's use case in which the size of the market fuels success.
This isn't to say Andreessen's framework is the best way to uncover winning investments. However, his approach does nicely present a somewhat counterintuitive way for investors to think about winning companies and what drives their success, and that's certainly a valuable insight all investors should understand.