Most Large Tech Companies Are Systematically Undervalued

N Is Small

Technology companies succeed because they do a million minor things right and get two or three really big things right. This is most visible in their financials: it’s extremely rare for a growing tech company to have two or three sources of revenue that are similar in size. More common is the situation at Facebook or Google, where 85%+ of their revenue and 100% or more of their profits comes from just one line of business.

  1. Universities form a natural, preexisting network; instead of launching everywhere at once, you can launch to 1k-20k students at a time. (Early on, this also meant that Facebook could defer tough scaling questions. They didn’t have to learn how to run a million-user site; they could just run five hundred copies of the site on five hundred separate databases.)
  2. Time and dollars will move from desktop to mobile, and mobile ads will eventually have a higher CPM because they’re more precisely targeted. In 2012, investors were worried that mobile would blindside Facebook; Facebook was talking about the importance of mobile in 2006, nine months before the iPhone.
  3. A billion dollars is a ridiculously low price for the best photo-sharing app.

Exceptions

There are several exceptions to this rule, mostly falling into the category of companies that do things with computers but aren’t actually tech companies. The two biggest categories of fake tech companies are sales companies that use computers and marketing companies that use computers.

What’s Next?

I’ve spent most my career, both at a hedge fund and as a consultant for hedge funds, using data to make more informed investing decisions. Knowing that a company has a high probability to succeed over the next five years is valuable, but if you want that sweeet 2 & 20, you also want to know whether they’ll be up or down this quarter. When you zoom out, the long-term chart for Facebook or Netflix looks pretty good: since its IPO, Facebook has delivered 28% annual returns. Since their 2002 IPO, NFLX has returned 39% compounded. But Facebook had a brutal drawdown, from $42 to $18 in its first six months. And NFLX dropped from $5.00 to $1.30, and then from $40 to $10, on the way to hitting their current $144. Every downdraft in that long-term chart is a short story about some smart analyst feeling vindicated, but only after they got fired.

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Byrne Hobart

Byrne Hobart

I write about technology (more logos than techne) and economics. Newsletter: https://diff.substack.com/