I get this email at least once a week:
How dare you say that about _________?! [Pick one: Baidu.com, Law Enforcement Associates, Capstone Turbine, XMSatellite Radio (NASDAQ:XMSR).]
Don't you realize that _________ [Chinese Internet, 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 Dell (NASDAQ:DELL) or Yahoo! out there, there are dozens, if not hundreds, of tech 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 not so many people did, at least not enough to fund all that technology up there in orbit. 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 over Google. Founders Larry Page and Sergey Brin are magazine cover boys, and as Google's profitability has increased, so have ridiculous expectations. (Let's all laugh at that $100 laptop rumor together, shall we?) It's to the point where even the founders are making fun of the Street scuttlebutt, making gag announcements for stuff like a Google burger dispenser for your car's dashboard. The real pyrotechnics, however, were with Google shares, which, until recently, did nothing but go up, even though they were already wickedly priced. Why did they do 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 Sun Microsystems? In the starry-eyed days of the late '90s and early 2000s, Sun was, like many techs, a prime example of the latest and greatest. Great tech. Great prospects! Gimme that market order! It'll look cheap later. Really? Sure, Sun has been a survivor, but anyone who bought back in the bad old days, or even much later, is still nursing some major wounds. And this is a reminder of another little-stated danger of the next big thing ...
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 don'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. Our great, crazy market gives you the occasional deal on incredible businesses.
Consider one of this decade's great opportunities, McDonald's. From mid-2002 until March 2003, it fought a brutal burger war with Wendy's and was floundering in the face of diversified fast food from the likes of Yum! Brands as well as theme-based upstarts like Sonic (NASDAQ:SONC) and sit-down concepts such as Outback Steakhouse (NYSE:OSI). It was a wounded giant -- and its share price reflected that -- but it was on solid footing, sported a world-beating market share, and had a plan to get things turned around.
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, it would. And it did, tripling in just over two years. There was a similar situation brewing with Inside Value pick Rent-A-Center (NASDAQ:RCII), which is up 32% since it was highlighted by the newsletter in November.
The best part about McDonald's then (and Rent-a-Center in November) 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 Eastman-Kodak (NYSE:EK) 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, something like boring old Altria (NYSE:MO), which has turned in a 40%-ish return over the past two years, while hot prospects like Netflix and TiVo have brought investors major losses.
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. XM is a Motley Fool Rule Breakers recommendation. Dell and Rent-A-Center are Motley Fool Inside Value recommendations. TiVo, Dell, and Netflix are Motley Fool Stock Advisor recommendations. View Seth's stock holdings and Fool profilehere. Fool rules arehere.
