For investors, the end of the year is a good opportunity to take stock of your portfolio, review your decisions and holdings, and think about any changes to make in your investing approach.
2022 was certainly an eye-opener, especially for investors in tech and growth stocks. Through Dec. 23, the Nasdaq is down 33%, its worst yearly performance since 2008. And high-growth stocks in industries like software and e-commerce that boomed during the pandemic have fallen even further this year. Popular stocks like Shopify and Amazon have even given up gains that they'd accumulated over several years.
As I review my own holdings, which include more than a few stocks that have plunged this year, there are two lessons in particular that I'll take away from 2022.
Image source: Getty Images.
1. Be more skeptical of disruption
Many of the best-performing stocks of the last generation have been disruptors. Amazon, for instance, disrupted brick-and-mortar retail by scaling its e-commerce business through ideas like its Marketplace platform and Prime subscriptions, and Netflix disrupted video entertainment first with DVD-by-mail and later with video streaming.
Disruption is an attractive concept in business, as it makes for a good story and it can fuel dramatic growth.
The problem with investing in disruptive stocks is that the disruptions don't usually pan out, especially since so many companies now position themselves as disruptors because they know investors value that label at a premium.
Two disruptive stocks that burned me this year were Stitch Fix (SFIX 4.67%) and Teladoc Health (TDOC 3.86%), both of which are down more than 90% from their pandemic-era peaks.
I think both companies are trying to disrupt industries that are in need of it, but there was clearly a mismatch between their market value and the actual disruptive potential of the businesses.
Stitch Fix, for example, has a good idea -- making it more convenient for people to get the clothes that they want and that fit them. But it's been a difficult business to execute, and the market for its stylist-selected boxes of clothes seems to be smaller than the company had thought. It's also difficult to disrupt an industry like apparel that's so fragmented, because there are low barriers to entry and customers have different tastes.
Rather than disrupting the apparel industry, Stitch Fix is now just trying to stay relevant: Revenue growth has decelerated for six straight quarters, and it fell sharply in its most recent quarter.
Most Americans would probably agree that the healthcare industry could use some disrupting as well: We pay more for worse healthcare outcomes than other developed countries. Telehealth seems like one way to lower costs, and Teladoc Health is a leading provider of telehealth services.
However, the stock has struggled due to wide losses and slow organic growth. And the healthcare industry has proven to be difficult to disrupt, as there are a number of entrenched stakeholders with a vested interest in keeping it the way it is. Even Amazon has now failed in two attempts to disrupt the industry -- first through Haven, its now-defunct joint venture with Berkshire Hathaway and JPMorgan Chase, and later through Amazon Care, the telehealth and in-person clinic it's now abandoning.
Teladoc has also executed poorly; it's consistently lost money and I don't think it has a sustainable competitive advantage, which explains why it's grown mostly through acquisitions rather than organically. Earlier this year, it took a $6.6 billion write-down on Livongo Health, the diabetes-monitoring company it acquired in 2020 for $18.5 billion, showing it's also been a poor capital allocator.
2. Addressable markets don't always matter
In the tech sector, especially, it's popular to talk about addressable markets. Almost every slide deck, it seems, features a talking point about the total addressable market (TAM).
There's a reason for this. As they do with disruptors, investors look favorably at companies with large addressable markets. That makes sense. If a company says it's penetrating an addressable market worth $50 billion and it only has $1 billion in revenue, that lets investors know that it still has a large growth opportunity.
But there's a bit of sleight of hand here. If a company repeatedly tells you its total addressable market, that makes it easy to imagine the business growing to some fraction of that TAM, which is usually much larger than its current revenue.
The thing about the addressable market, though, is that it's not an asset -- it's just a fact of the market that any business potentially has access to. And usually it's a distraction for both investors and the business. It's much better to focus on execution instead; what counts is a company's ability to grow and attract new customers regardless of the market opportunity.
In its earnings slide deck, Stitch Fix said that it's addressing a massive opportunity in a market for apparel and related goods that's expected to grow to $544 billion by 2026. However, the more important issue is that the company is doing a poor job of addressing it, as revenue fell 22% in the most recent quarter. In other words, there's no need to discuss market size when revenue is moving in the wrong direction. The company has more pressing issues to address.
Similarly, Teladoc has claimed a $261 billion addressable market, but that doesn't really matter when the company lost $73.5 million on a generally accepted accounting principles (GAAP) basis in its most recent quarter, and revenue growth slowed to 17%. Investors should focus on whether Teladoc has a viable business, not on its market potential.
There are times when it does make sense to consider an addressable market. Netflix, for example, has seen growth plateau in North America because more than half of households in the region already subscribe to the streaming service. It's running out of room in that market.
If a company has demonstrated that it has a growing, viable business, then its addressable market deserves secondary consideration, but a large TAM shouldn't be a core part of your investing thesis. There are many more important things to consider, and focusing on the TAM can often be a distraction.
