Spotting a Revolution is not Required

Course Section 1 - Lesson 2

In the lesson, we looked at the rise of the Ford Motor Company and how Henry Ford's company became extremely valuable by producing a product that millions of people wanted and could afford.

You might be thinking to yourself: 

"Yea, that's great for investors that were around in 1910 and could buy shares of Ford, but it's not every day that a new mode of transportation is popularized."

And you'd be right. Revolutionary products like the rise of automobiles are rare. But it's important to remember that even when you're witnessing a revolutionary product, it's often far from clear that an investment in the company that makes the product will pay off.

When you are watching the rise of a product like the automobile in 1910, it's almost impossible to foresee its impact on the world. Even if you're confident that the product will change the world, it's not always clear that the current leader will be the one to win. 

Let's look at a more recent example that demonstrates both of these points.

The Rise of Social Media

In 1997 SixDegrees.com was launched to the world. What is SixDegrees.com, you ask? It was the very first social network. The site grew to over a million users in a matter of months. It appeared to be so promising that it was acquired for 125 million dollars just 3 years after launch. By the year 2000, it was dead.

Not long after SixDegrees.com closed, Friendster was launched. This site offered many of the same features popular on the most prominent social media networks today, including contact messaging, status updates, profile creation, and many others. On top of that, they had the users! The site received so much traffic in 2003 that its infrastructure crumbled under the load and forced most of its user base to search for a more stable platform.

As users fled Friendster, droves moved over to the newest social media site MySpace. In a very short period, MySpace grew to over 25 million users. But just as MySpace was achieving orbital velocity, a new competitor entered the market. It's not clear exactly MySpace lost. They did have a buggy site with frustrating navigation. Still, they had users and for a social media platform being where the users are is the most important thing. The only thing we can say is that they got outcompeted.  

Now you probably know how this story ends, but assume for a second that you don't. Would you bet your hard-earned money that the next social media platform to enter the market and gain traction would survive the next 5, 10, or even 25 years? I don't know; it's tough to make that call in real-time.  

Of course, the next social media platform to rise was Facebook. And its rise was fast. It went from a million users in year 1, to 6 million in year 2, to 12 million in year 3. And then something big happened to the owners of Facebook. They received an offer of $1 billion from Yahoo.  

Sit back and think about that for a second, and imagine that you were an owner of Facebook stock at the time. You have just watched 3 major social networks rise and fall in less than a decade. In 3 years, your investment has gone from basically 0 to $1 billion. Would you have enough confidence in the staying power of your website to turn the offer down?

Or think about it from the other side, from the standpoint of someone considering investing in Facebook. Obviously, you wouldn't invest the entire $1 billion yourself, but if you had an opportunity to buy a small fraction of the company at Facebook at that price in 2006, would you have enough faith in its long-term prospects to pay? I'm not sure that I would.

Picking Revolutionary Companies is Hard

In hindsight, it always appears that identifying and investing in companies with revolutionary products is easier than it truly is. And the stories of these companies that turn people into millionaires with a small early investment are alluring. But is extremely hard to know where to place these investments in real-time.  

Luckily for us, we don't need to have clairvoyant-like powers to make profitable investments in companies. We simply need to understand the dynamics of competition and estimate the cash flow generating capabilities of a company to identify great opportunities.

Mark Complete