Investors get excited about new tech investments, but it can sometimes be hard to differentiate between the next big thing and a company that doesn't quite have what it takes to be a long-term winner.
In this segment of Motley Fool Live, Motley Fool analyst Tim Beyers chats with "Industry Focus" podcast host Dylan Lewis about the process he uses when considering a new potential investment opportunity.
Tim Beyers: I start with the product and the customer. I look for the ideal customer and I look for the appeal of the product, is there a real connection to the product. And if the founder or even the CEO or the team, if there is a customer zero mentality there, if those three things, if I can check the box on those three things, there's a clear product here that really has a big customer base and that customer base is obviously growing, they have an attachment to it, because there's a clear need. That really excites me. And sometimes I get that from developers, sometimes I get that from articles. But if I can identify that, that's the first thing I look for.
And then, you know, customer enthusiasm wrapped around that, so I can tell that there's a big problem here, it's a meaty problem and a lot of people have it, then I'm really interested. And if there's a customer zero mentality here, so that I know that there's going to be more building, more improving, like there's a lot of investment that's going to grow this company over time, I'm interested. But I get to the financials at the end of the process. I'm really looking at, is this a migraine-level problem? Are customers really excited, and I can identify who those customers are? And you know, is this a killer product? Like, that's what I want to know; that's what I want to know.
Dylan Lewis: I think I know the answer to this, but is there a point where valuation factors in?
Beyers: There is. Like, in the case of Snowflake (NYSE:SNOW), which is a company that I love, but there's no way I can justify that valuation, because the amount of growth required is, you know, so massive that I'm just not willing to make a big bet on it. So, for me, a company like that, I might even want to own, like, one share, but that's it, and then I'm kind of waiting to see, because, you know, I can be patient, the market is always going to give you more opportunities. So, yeah, my valuation exercises, Dylan, are working back to see what's the required revenue growth or cash flow yield for some of these companies. So, if I can justify the revenue growth that's required, given the present valuation, then I'm interested. And I have a little bit of a model to do that, it's not the same thing as a discounted cash flow analysis, but it's kind of close. And that's how I look at it. But it's the end of the process.
It's more important for me to see that this is a company that actually has rabid customers and has a market that it can grow over a long period of time, because the products are clearly needed. Because this is the thing with tech, right, there are a lot of faker products, in tech in particular. You know, boy! You want to have a drinking game, play buzzword bingo on any kind of tech. [laughs] You will not survive the night. [laughs]
Lewis: [laughs] To make sure we didn't miss anything, Tim, we have the focus on the product, the users, leadership team, the founding story, financials and valuation wind up coming in there at the end; is there anything that we missed in that process where you're ultimately saying, like, yep, this is something I want to put some money behind?
Beyers: Incentives. I mean, incentives do matter. So, when I see how a company and a leadership team measures itself, and if it is consistent with what we want as investors, that is usually a nice proof point. If it's really off-kilter, then I get a little bit concerned. It's something I check; it's definitely something I check. It's not the first thing I check, but I do want to know how the incentives line up.