Over the past month, SolarCity (NASDAQ:SCTY.DL) shareholders have had their patience tested. From a high on August 5th of over $60 per share, SolarCity stock has fallen over 40%. And yet during that time, the fundamentals of the business have remained relatively unchanged.
Instead, the falling price of oil, legislative problems in Nevada, and the fact that famed investor Jim Chanos announced he was shorting SolarCity stock have all taken their tolls on the company.
I think that while these issues are likely to weigh on the company's stock -- and, perhaps, its business performance -- over the short-term, they can be ignored by long-term investors.
I bought a significant portion of SolarCity stock on Monday, and what was once a 0.7% allocation in my family's real-life holdings now occupies 2.5% of our portfolio.
The reason I love the company, however, is somewhat unconventional. Read below to find out what I mean.
Measuring a company's antifragility
Nassim Taleb gained fame for calling out -- and profiting from -- the fragility of the banking system and the subsequent Great Recession. His Fooled by Randomness and The Black Swan were instant hits. But his latest work, Antifragile, is perhaps his most important work for investors in individual stocks.
What does this have to do with SolarCity stock? The fact of the matter is this: I'm not an expert on solar energy. I suggest you check out Foolish colleague Travis Hoium to get an insider's perspective on the industry.
But as I've learned from studying Taleb's work, you don't have to be an expert in every area to be successful in your investing endeavors. Indirectly, he argues that when you invest in companies that stand to benefit from chaos and uncertainty -- "antifragile" companies, as he would call them -- you are setting yourself up for investing success.
An antifragile framework for evaluating investents
After reading Taleb's book, I began formulating a way to assess the stocks of companies I followed based on their antifragility. Overall, there were eight different facets of antifragility I believed were measurable.
Below are six of the eight areas where I believe the company is well positioned.
- Lots of unique customers. Taleb argues that when a company has to rely on too few customers, it is fragile to one of those customers removing their business. Currently, SolarCity has 262,495 cumulative customers, and believes that it can reach 1 million individual customers by 2018.
- Insider ownership. No one understands the hidden risks of a company better than those who run it. If these executives don't have skin in the game, via equity holdings, shareholders are at risk. This is even more important with SolarCity, because it has a unique way of reporting revenue (net retained value), and there are lots of moving pieces in the industry.
Currently, Elon Musk, the company's Chairman, owns 20.8 million shares, or over 21%. The company's everyday leaders and founders, the Rive brothers, own a combined 5.9 million shares, or 6% of the company. That level of ownership gives me confidence.
- Soul in the game. Beyond just having "skin in the game", Taleb believes that some have their "soul in the game." This is where individuals are taking risks not only for their own benefit, but for society's as well. Both the Rive brothers and Musk have famously been looking for ways to help the world transition to sustainable energy. When founders run a company, they often view it as an actual extension of their selves -- their soul is quite literally in the game.
- Sustainable competitive advantage. There are lots of solar companies to choose from, and no advantage is infinitely sustainable. That being said, SolarCity's vertical integration is a differentiator that could help lower input costs. Plus, many synergies could develop over time given the fact that Musk's Tesla (NASDAQ:TSLA) is increasingly becoming an energy provider via its Gigafactory. SolarCity is also the first mover in solar leasing, and has, by far, the largest installed base in the country.
- Convex optionality. Taleb broadly defines this as when a company can tinker with certain ideas that have low downside, and unlimited potential upside. A good example would be how Amazon (NASDAQ:AMZN) began giving away cloud space on its servers years ago -- almost as an after-thought to its core business. Today, it has become a major growth driver.
While SolarCity itself hasn't shown an enormous amount of optionality in the past, I think the potential is there. Elon Musk is a master at this, as he has morphed Tesla from "just" a car manufacturer to a force in energy as well. As long as he's involved with the company, I believe that it will benefit from such optionality.
- A good place to work. If a company is going to be flexible enough to change over time, it's employees need to be motivated to make changes with it. That's why company culture is so important.
Using Glassdoor.com as a proxy, I believe SolarCity has a solid workplace environment. Employees rate the company as a 3.9 on a 5 point scale, three-quarters have a positive outlook for the future and would recommend the company to a friend, and CEO Lyndon Rive has a 93% approval rating.
That being said, the company isn't without its faults. I gave it low marks on the following two tenets.
- Cash vs. Debt. Nothing is more fragilizing than debt, and SolarCity has a lot of it. Because the company pays for the hardware and installation of panels up front -- and then collects money over a 20-year timeframe -- it is both unprofitable and free cash flow negative. Overall, SolarCity has $489 million in cash and equivalents, while sporting just over $2 billion in debt.
- Mission statement. This is perhaps my biggest disappointment. An inspiring, holistic mission usually indicates a company's ability to have multiple futures. The closest thing SolarCity has to a mission statement is available here, and it simply leaves a lot to be desired.
By allocating 2.5% of my families holdings toward SolarCity, we have exposure to the vast upside that the company has, while not over-investing ourselves in an industry whose future winners are yet to be determined, and whose stocks are very volatile.
While my approach to the company may be unorthodox, I believe that investing with such proven (and "skin-in-the-game") management greatly reduces the number of hidden risks that come from being unfamiliar with the industry. I think it's at least worth a look for investors temped by the market sell off of the past few weeks.