Sometimes it is helpful to think of companies like teams competing against each other. There are big, strong, elite teams and there are wannabes.
Recessions are viewed as bad by investors because profitability is impaired. Investors become pessimistic about the future.
The question investors need to answer is how long profitability will be impaired, and when things improve; will profitability recover to past levels of growth or has something material changed? It has always been a good time to buy when pessimism is high, or investors are worried about profitability.
It is especially good to buy when the worries don’t fit the facts. There is an old sports saying that when the going gets tough, the tough get going. In this case, the tough are the elite companies that get stronger because they have all the money and buy stuff on the cheap.
We invest in companies like these.
Recessions pose big problems for less financially strong companies. These are the new entrants, the up-and-comers, where all the hype is focused. Let’s call them the new wannabes. Often these companies have rapidly growing sales but no profits. These are the companies chasing the large incumbents in an industry. These new wise guys and gals offer cool new services often at cheaper prices than the big firms. The promises of riches are enormous. Elite companies don’t like these newbies. Strong, winning teams have seen this “bad behaviour” before, so they pull out their playbooks. They copy the new guys, they cut price, they lean on old friendships and alliances, but the best solution to solve for these pesky new companies is a good old-fashioned business slow down.
The problem with the new entrants is that they rely on investors who project an opportunistic, and some would say, overly generous estimate about the future, and plow too much money, at too high valuations into these companies. We certainly have seen an abundance of this behaviour the past eight years, especially the past four years.
These are the companies you hear about at parties, and wish you had bought before they quadrupled in price. Take solace in the fact that most are down 80% over the past year.
When the music inevitably stops the fast money dries up. Money is officially expensive now. The music has stopped. The party is over. Time for the big dogs to roll in and pick over the bits.
Today, many venture investors are licking their wounds after having been made to look silly, funding at crazy prices all kinds of hallucinations. Today, investors continue to punish companies that make no money. Meanwhile, elite companies pick up the pace of investment. This is a huge opportunity for the big companies to consolidate power. Cut price, add new ideas and services to their current offering, and build even bigger moats around their businesses for when the times improve. The wannabes get obliterated.
The future, in spite of the tough times right now, looks even brighter for those with the chops to build when it’s cheap to do so. This is exactly what the big companies in your portfolio are doing today. For example, many are worried about Amazon’s AWS (Amazon Web Services) division only growing at 20%. But what Amazon is doing right now is locking in their customers for longer terms, offering even more features, and in some cases allowing the customer to defer some current expenses. Giving their customers a helping hand. This is great for their customers today and amazing for Amazon’s long-term profitability because their clients are thrilled but also stuck with them for even longer.
It’s not so great for the new entrants who can’t afford to sell at that new low price or continue the pace of investment that Amazon is pushing.
Proof that rich companies get richer when things are bad.
