I get this email at least once a week:
How dare you say that about _________?! [Pick one: Taser International, Capstone Turbine (NASDAQ:CPST), WorldSpace, Sirius Satellite Radio.]
Don't you realize that _________ [stun guns, micro turbines, satellite radio broadcasts, sharks with laser beams on their heads, etc.] are the next big thing?
How I usually respond: "Good luck with that."
What I usually leave unsaid: "You're going to need it."
It's not that I don't enjoy investing in companies with the capacity for monstrous growth. I do. But I keep these holdings small, because too much can go wrong with the next big thing. Finding it, and paying the right price, is far more difficult than anyone lets on. Here's why.
The next big thing may not be big, or next, or even much of a thing. For every dot-com success story out there like Yahoo! (NASDAQ:YHOO), there are dozens, if not hundreds, of wannabes that crashed and burned and never came back.
How do you tell them apart? It's not easy, especially in the beginning. If there's such a thing as a superior crystal ball, I haven't seen it. I certainly don't have one, and I'm willing to bet most of you don't, either. Anyone remember Iridium? The satellite phone biz seemed like a great idea to plenty of happy investors (me included). Who wouldn't want a phone that worked anywhere? It turned out that most people didn't. Oops. By 1999, Iridium was toast, taking billions of dollars down the drain.
You'll probably be late to the party anyway. You don't need to see a company drop all the way to zero to get in on the catastrophe. When the next big thing's CEO is on the cover of magazines and the guy washing your car is telling you to buy the stock, it's probably too late already, no matter how great the story seems. Consider the hype at Apple. Steve Jobs has been a magazine cover darling, and as iPod sales have continued to explode over the past months, buzz has only intensified. The real pyrotechnics, however, have been with Apple shares, which have done nothing but go up and look wickedly priced. Why would I say that? Because ...
The next big thing is always overpriced. You know why? Because it's the next big thing! Everybody wants it! No matter what you pay now, the story goes, it will seem cheap in retrospect because the next big thing will grow so quickly and become so huge. But that attitude can get your portfolio killed. Do we need to talk about Cisco Systems (NASDAQ:CSCO)? In the starry-eyed days of the '90s, Cisco was the picks-and-shovels story that wouldn't quit. Internet! Everyone needs routers! Tons of them! A router in every pot! Wow, Cisco was growing at manic rates! Gimme that market order. It'll look cheap later. Really? Sure, Cisco was a survivor, but investors are still in the hole, at least if they purchased just about any time between 1999 and 2001, when the hype (or was that hope?) was the highest. But don't read too much into the survivor status of your next big thing, because ...
The next big thing might not make any money, even if it's "successful." What do I mean? There are companies out there that achieve a great measure of "success" in the marketplace but rarely scrape together a dime to repay shareholders. TiVo is a primo example of all fame, no gain. Everyone likes TiVo, right? Well, everyone except those who've held the stock since day one. What happens when the realization finally hits that the next big thing isn't making money? The shareholders share the losses. And those can be steep. The long-term TiVo chart is an object lesson in the harsh realities of faith in the next big thing.
The sickness
Why do people make these kinds of mistakes over and again? Greed may be a part of it. Everyone likes money, right? But I think it's more than that. My guess for the real reason is this: hubris. Everyone loves to think he knows more than the next guy. Everyone loves to think he's in front of the curve. And the trouble with that pride is this: It don't goeth before a fall. In the stock market, pride leadeth directly to the fall. If you're smart, it will goeth. Afterward-eth ... OK, let's drop that for now.
The cure
Here's a modest proposal, one we espouse at the Motley Fool Inside Value newsletter. Toss the pride. Admit your limitations. Concentrate on the obvious. And limit your risk.
I have no faith that I can see the future better than anyone else. But there's a secret Wall Street won't tell you: You don't need to. You won't need to because you're going to concentrate on obvious stuff that you can actually measure, like free cash flow, market position, and price.
Take, for instance, the recent history of McDonald's. From mid-2002 until March 2003, it fought a brutal burger war with Wendy's (NYSE:WEN) and was floundering in the face of diversified fast food from the likes of Yum! Brands (NYSE:YUM). It was a wounded giant -- and its share price reflected that -- but it had a great balance sheet, sported a world-beating market share, and continued to produce massive amounts of cash.
Those who bought at the bottom, in March 2003, didn't need to see the future, or predict when McDonald's would go back up. They only knew that the odds were huge that it would. And it did, tripling in just over two years. There was a similar situation brewing with Inside Value pick Accenture (NYSE:ACN), which is up 20% since it was highlighted by the newsletter in July.
The best part about McDonald's then (and Accenture in July) was that the downside risk was limited because everyone already expected the worst and had bid the stock down accordingly. It was limited because these firms were and continued to be stellar performers. This is in stark contrast to a company like GM (NYSE:GM) today, which only looks "cheap" to those who have a far sunnier view of its very potent risks.
The Foolish bottom line
If you're interested in repeatable, time-tested methods for market-beating returns, stop looking for the world-beater of tomorrow. Instead, look for the obvious thing right under your nose. Anyone who's followed the stock market for even a brief period knows that it's a fickle beast at best, and an absolute psychotic most of the time. Paying bargain prices for top-notch companies is the best way to build wealth over time, and better yet, it helps you avoid those stomach-churning screamers that can turn the next big thing into the next big joke. That's what Inside Value is all about.
Click here to try a free 30-day trial and have lead analyst Philip Durell guide you along this path.
For related Foolishness:
- It's just a simple trick: Buy when the Street won't.
- There's a method to finding dirt cheap dream stocks.
- Learn how to find relentless growers.
This article was first published on May 19, 2005. It has been updated.
Seth Jayson likes growth, but he'll take a lead-pipe cinch on a stable cash-maker any day of the week. At the time of publication, he did not have a financial position in any company mentioned in this article. Taser is Motley Fool Rule Breakers recommendation.TiVo is a Motley Fool Stock Advisor recommendation. View Seth's stock holdings and Fool profilehere. Fool rules arehere.
