Founding several companies during the last 35 years I have come to know the sacrifice one has to make to create a viable organization. Creating and nourishing your own company is a way to great success or, much more often, to starting all over again with no money and some expensively bought learning experiences.
Now, as part of VISTEM, I am helping others to create this miracle of a flourishing organization while sharing their success.
But there is another way to have an impact in the world, to help organizations grow and earn more and more money as a mean to achieve their and our goals - Investing.
A warning: This article is my personal opinion and no investment advice.
That said: I call my strategy ‘Slow Investing’. A viable investment strategy identifies (with a high hit rate) companies with a viable strategy and excellent execution. Looking at your own company from an investor's perspective you may come to see it with new eyes.
In this article I will present seven criteria which I use to estimate the potential of a company. With these criteria I establish whether a company has the potential to grow tenfold over the next five to ten years. Hence the acronym ‘10X-Companies’ in the title. In this context I only consider companies offering shares or private companies going for IPO (Initial Public Offering) in the foreseeable future. Also please note that startups and small businesses need a different set of investment criteria, and are not covered by this article.
Developing a strategy is work. Defining an investment strategy for yourself needs investment of your time or you must trust in the insight - and often only opinion - of others.
I see investment very much like gardening. You plant a tree, and you wait patiently for it to bear fruit. To cut it down for an emergency is a terrible loss. My first investment in amazon in the 19-nineties was 500€. I sold because of an emergency regarding my first company. This small investment would now be worth 200.000€ with room to grow. At the time, I had the philosophy that the best investment is your own company. This is right if you are aged thirty-five. Now I am in my sixties. I need another strategy.
Perspectives for ‘Slow Investors’:
Vision
The Product
The Masterplan
Leadership
Market Position and Investor Discord
Financial Position
… the right moment
1. Vision
A company has high potential if it connects its dreams and vision to the fate of humanity. Helping to create a healthy planet, healthy social systems, sustainable technology, and other components of sustainable infrastructure give founders, employees, customers, political operators, and investors a purpose, a reason to work for and support the company.
It is possible to earn money by playing the market, by creating an addictive harmful product, by exploiting political circumstances. You may build lifelong success on an abusive investment or company strategy. But this is not the world I want to live in and not the vision I want to contribute to. And above that I think that a global and sustainable vision is safer for everyone in the end and helps me live a happier life.
BeyondMeat, for instance, delivers food without causing animal pain, using fewer resources, that is also healthier for the customers. Arcimoto delivers small electric vehicles for delivery services and fire brigades, as well as private vehicles just for fun or inner-city travel, saving hopefully in a few years millions of tons of CO2 and making cities less noisy.
2. The Product
One company alone will not save the planet. Good, because in that case you would have only one company to invest in. Anything which helps people or organizations to be more productive, healthier, and happier can be the product.
It is important, that the product can scale.
Is there the potential of millions of people or thousands of companies enjoying the service?
Is there room for a high (>30%) exponential growth rate in the market?
Is this need already covered by the competition?
Is there a 800 pound gorilla which could take that market in an instance?
When we (VISTEM) work on a business model with a client, one of the key steps is to identify why a customer will buy - the motivation. Which problem is solved? Is a chronic pain healed or avoided? Does the product provide a new way to happiness, success, fulfillment, … ?
Ideally, it should be a ‘hidden’ market. Clearly visible for the entrepreneur, but unseen, underestimated or even ridiculed by the press, economic mainstream, and public opinion.
3. The Masterplan
As a next step I do some archeology. What is the history of the company? What was their plan from the outset? Did they execute it well? Is at least one of the founders on board?
I expect an explicit plan for at least 10 years how to scale the business and hints for options which expand possible growth far beyond the current product.
4. Leadership
Executive owners and top management must authentically live the vision. The achievement of such a vision usually requires strong, empowering habits within the organisation which must be nourished by management.
Examples are Google’s ‘Fail often, fail fast, fail forward!’ or Elon Musk’s ‘Trust in first principles not other’s opinions’. Typically, I analyze videos of the company’s leaders in several situations and evaluate the impact on employees, customers, competitors, and other stakeholders. What kind of culture is expressed by this person?
To be willing to invest, I must trust the management of the company.
5. Market Position and Investor Discord
As previously determined, the company has the potential for a dominant market position but not yet fully developed its capabilities and scale. This is the timespan when investors have a wide spread of opinions. Some push the ‘Bull-Case’ and buy stock for the long term. They are ridiculed by the ‘Bears’, who shorten the stock and call the company a fraud, a candidate for bankruptcy. Discord in the market is ideal for 10X-investors, because the stock comes down again and again, offering good buying opportunities.
As a 10x- or Slow-Investor I am looking at the raw data, not assumptions and beliefs of analysts. How does delivery scale? Does the company have an aggressive investment plan for future growth? What happens to competitors when the company enters the market?
AMAZON was undervalued for a long period, because Jeff Bezoes decided to invest and reinvest in the company again and again instead of showing a profit. In this "stealth mode", AMAZON captured the market for delivering ‘Everything’. Early, in 1998 Bezoes told the world ‘It's Software, stupid’. He meant the ability to create services out of thin air by enhancing AMAZON’s software. Now the most profitable part of AMAZON is AWS, its cloud service provider. Clearly there is much investment in hardware, warehouses, … but the defining element is AMAZON's ability to react fast to the customer’s demands and wishes - especially those the customers might not be aware of themselves. Once Jeff Bezoes said “I am not interested in what changes in the world, I am interested in what remains the same. For AMAZON this is the customer’s wish for low prices and instant, reliable delivery. This is a constant. We can build the business on that assumption.”
It is a good sign, when customers pay more with pleasure, because the value delivered is so attractive compared to competition. When TESLA introduced Model S in the US, the car captured the dominant market position within 4 years (2013 - 2016), selling more than the next four in the category combined (Mercedes, Audi, BMW, Lexus). The same with Model 3 in 2019 in a less expensive product category (think BMW3). In 2019, when production already scaled exponentially, mainstream analysts looked at the balance sheet and sensational stories and dumped TESLA shares. This leads to the next perspective …
6. Financial Data, Operations
From this perspective I am not all that interested in the current share price. The deciding factor is the trend of operational and financial performance.
Many analysts of leading financial institutions are under pressure to make no errors or support a current clientele. They base their estimates of future success and profitability on audited top line numbers like net profit looking back in time. Usually they are experts in the current power web of the industry they cover. In the car industry Toyota, VW, GM, Ford, … are powerful players. Their numbers dwarfed TESLA’s for a long time.
To identify a market disruption in the making, you have to identify exponential trends in the numbers. Humans tend to think in linear trends. Humans tend to think from a mindset of scarcity, not unlimited abundance which allows exponential growth. Healthy exponential growth considers current limitations and comes up with sustainable solutions which remove current limitations. We at VISTEM use paradigms expressed very well in the Theory of Constraints (TOC), LEAN and other successful bodies of knowledge based on optimizing flow.
Looking at financial data, TOC puts throughput - generated cashflow minus external costs (total variable costs) – at center stage. In GAAP (Generally Accepted Accounting Principles), which sets the norm in the US, you could call it 'contribution margin'.
Throughput can be measured in output of products, too. For a growing car company the growing number of produced vehicles is critical - and derived from this number are sales and contribution margins. If you look at TESLA from a profit perspective in 2019 you see 15 years of losses and you give up hope. If you look at production, at built capacity and planned capacity, you see fast continuous exponential growth of throughput in years past and future.
Trend in free Cashflow - TESLA 2012-2019 (HyperCharts)
‘It's Throughput, stupid’ - TESLA 2012-2019 (HyperCharts)
The three important categories in throughput accounting are Throughput (T), Investment(I) and Operating Expenses (OE). For TESLA, throughput is growing continuously, they invest as fast as possible, not limited by cash but by their ability to invest wisely. Only since 2020 are they covering their operational expenses (=generating profits) and are self-reliant regarding cashflow. The exponential curve needed more than 15 years to reach this threshold.
The car industry is hard to disrupt because of high barriers of entry. Solely digital products and services can move much faster. You have to discover the laws currently governing the industry you want to invest in. These laws can be disrupted, but you have to know the environment.
Looking into the future, a company must provide earnings to enable fast growth and be able to take advantage of opportunities. Investors often look at earnings per share or earnings as percentage of investment. If you see a market capitalization of 50Mio and a net profit of 2.5Mio you look at a PE-ratio (Price-Earnings) of 20 and 5% profit margin. Simple interpretation: low PE-Ratio means high profitability compared to sales, not bad. Often such companies pay dividends which are a welcome fixed income for conservative investors. BUT this is also a sign of a stagnating industry.
This is not our playing field. Dynamic companies often have no or small profits. PE makes no sense. Prioritizing the ability to cover operating expenses and huge investments make much sense during the first years. When the company dominates its market, we have to look how it uses the huge cashflow it is generating. If a company buys back its shares or starts paying dividends, I know that I have to sell. Such a company has run out of ideas where to invest. The dynamic is lost.
How do operating expenses trend compared to other indicators? - TESLA 2012 - 2019 (HyperCharts)
Regarding finances and operations I look at trends in the data, not current data points and opinions. I determine what represents throughput for the company (pieces, cars, cashflow minus external costs,… ). I observe the management's investment strategy and the trend in operating expenses, which must grow slower than throughput.
7. … the right Moment
There is that thing with the money … A good basis to start investing is to have a stable income to cover your living expenses and several months worth of savings for unforeseen crises. Usually it suffices to cover 3 to 6 months, because this gives you time enough to recover from a health or employment crisis.
And then you need some money to invest - your investment pool. The goal is to multiply this investment pool fast and further the good fortune of humanity at the same time.
We already discussed how to identify the right companies.
Now we discuss the ‘right moment’ to invest.
At this time you will have a list of companies you want to be invested in. You will have maintained this list, added new companies which fit your criteria and removed those which did not deliver. You have money in an investment account and are ready to go.
We discussed the perspective ‘Investor Discord’. As a ‘Slow Investor’ you know that your chosen company can be expected to grow tenfold or more over the years and the share price will sometimes rush ahead and then crash again on bad news. Typically a 10X stock is highly volatile. Sometimes, especially in the early days, you have years of stagnation in share price. As a long-term investor you already see the exponential growth in capability, but financial performance and market sentiment may still be in stagnation.
The ‘right moment’ is when bad news hammer the stock. BUY! And if you follow the company closely you will know good news several weeks, sometimes months in advance and buy before the message reaches the mainstream media.
Here are three examples. TESLA was hammered by the media in 2018 and 2019 when they started producing the first mass market car, the Model 3 and Elon Musk made several public statements which enhanced doubts in his ability to lead TESLA. Public opinion condemned TESLA to the graveyard of badly executed good intentions or even fraud. Looking at the data you could see a fast ramping up of deliveries, each car produced was delivered, hundred thousands of buyers were waiting for their own TESLA. Every buyer of a TESLA convinced two others to buy. Up to this day TESLA needs no advertising. The cars sell themselves. The following graph shows the price/timeframe, when I bought the stock.
In March 2019 UBER was hit by several crises at the same time. Covid-19 reduced business to a trickle and unions in several countries and states litigated to change the contracts for UBER drivers. The stock tanked. Observing the reaction of management and the actual numbers coming in, I assumed that UBER had the resources to overcome both challenges.
During summer the business normalized, ‘UBER eats’ profited handsomely from the situation and in November California’s voters decided in UBER’s interest regarding the status of UBER’s drivers.
The graph shows the price/timeframe, when I bought the stock.
ARCIMOTO is a very small company currently. It is just starting to grow. IPO was recently in June 2020.
I knew, that after much turmoil because of Covid-19 the third quarter would bring a flood of good news. I bought before the quarterly report of management.
The graph shows the price/timeframe, when I bought the stock.
As for the Exit-Strategy. This is longterm investing. Shares may go down or up. Crises come and go. The general trend of operational measures must point into the right direction. Only when my assets have reached a planned threshold or if I lose trust, I start selling.
Conclusion
These are my seven criteria I want to see before I put my money into a company:
I like the Vision of the company. It is my vision. It moves the world in the right direction.
I like the product and it will reach millions.
I know their Masterplan and I have seen indications that they execute well.
The company’s leadership expresses vision, values and habits needed for sustainable success.
The numbers talk the right trend. There is discord in the investor community. Many bears.
The balance sheet is evolving well. Investment is covered by cashflow. Return on assets grows.
I heard the bad news. Shares go down. I wait a moment, observe … and buy. I expect good news based on data … and buy before they are breaking news in the media.
To know a company that way you need to invest some time in research. I have no trained financial analysts at hand to do that for me. I have to do it on the cheap. I practice my throughput accounting skills by exchanging experience with other practitioners, read ‘The Economist’ for overview and general perspective and use YouTube channels to get in depth information about the companies. One channel I trust: Dave Lee on Investing. People like Dave do the heavy lifting. Analyzing companies for us. Financial data for many companies are well represented at HyperCharts .
Following companies that way you are learning step by step to read balance sheets and to draw your own conclusions based on data, not hype.
For German-speaking readers you may find the following online training fruitful:
Der Kennzahlen-Alptraum - Welche Kennzahlen braucht ein Unternehmen wirklich?
Want to share your thoughts? Contact me franz.nowak@vistem.eu
