In the world of stocks, getting caught up in the noise and overwhelmed with all the information being thrown out can be easy. There are countless metrics, 24/7 news coverage, and no shortage of "expert" opinions. Sometimes, it's good to have access to so much information; other times, it can lead to analysis paralysis, making it difficult to be confident when making investment decisions.
When it's all said and done, the reason a stock is a no-brainer can come down to a simple reason. In the case of Visa (V -1.19%) and Meta Platforms (META -0.57%), they share the same one: the network effect.
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How does the network effect work?
In business, the network effect is a phenomenon where the value of a product or service increases as more people use it.
Imagine you're the first person to have a telephone after Alexander Bell created it in 1875. At that point, a telephone is essentially useless because you're the only person with one. However, as more people get their own phones, the value of having one increases because you have more people you can use your phone to contact.
That's what the network effect is all about: a compounding effect that adds value with each additional user.
Companies with a network effect can be a blessing for investors because it adds to the company's competitive moat. It puts those companies in a position to more easily attract and retain customers and face less pressure from potential competitors. That's key to sustaining success, which should be a top priority for investors.
1. Visa's network effect in action
Visa is the world's leading payment-processing company and card issuer. It currently operates in over 200 countries with 4.2 billion cards in circulation and over 100 million merchants in its network. There may not be another company in the financial world that benefits from the network effect quite like Visa.
Visa's network effect is twofold. Consider this: How many times have you been somewhere that accepted cards but not Visa? Chances are not many, if any. If you're in the market for a card, there's an incentive to get a Visa card because you know there's a great chance you'll be able to use it anywhere that accepts cards.
Ask someone who owns an American Express or Discover card how many times they've been somewhere that accepted cards that didn't accept their card, and I'm willing to bet it's happened more often than for a Visa cardholder.
Now, think about merchants. When you're deciding on a payment processing network, there's an incentive to go with Visa because you know it's the most popular card by a large margin. Accepting cards but not accepting Visa is sure to limit your potential customer base.
2. Meta's network effect in action
Meta is the world's leading social media company with over 3.8 billion users across its family of apps. Social media, in general, is one of the more intuitive examples of how the network effect works. It's fairly straightforward: If your family and friends are on a social media platform, you're much more likely to join as well.
With Meta, the network effect goes beyond attracting new users to the platform. It's also about what those users do on the platform and their contribution to Meta's business model. More users mean more posts, pictures, videos, and discussions (for better or worse). The more content a platform has, the more engaging it's likely to be, ideally attracting more users.
Advertising is the backbone of Meta's business model, so the more users it attracts to the platform, the more advertisers are willing to pay for access to those users. As Meta's user base expands and interacts across its ecosystem, the company can gather more data, better target advertising, and further attract advertisers.
It's no coincidence that Meta's revenue growth has trended in the same direction as its user growth. It's a lucrative snowball effect, if you will.
Visa and Meta aren't one-off examples
Visa and Meta are great examples of the network effect driving the business forward, but they're not anomalies. The same can be applied to marketplaces like Amazon, platforms like Airbnb and Uber, companies with software ecosystems like Salesforce, and many other businesses.
The network effect isn't foolproof, but it's impactful enough to serve as the core component of a company's competitive advantages. In a world where complex financial metrics are often put on a pedestal, the simplicity of the network analysis is refreshing.
Sometimes, less is more.
