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The Five Traits of True Tech

Posted by hkarner - 3. Dezember 2019

Date: 02‑12‑2019

Source: The Wall Street Journal By Andy Kessler

Every company wants the label, but real highly valued tech has defining features.

It seems everyone wants to be a technology company these days. But not every company is worth 40 times earnings and 15 times sales in the stock market. How can you tell which growing companies might sustain that valuation? Put more broadly, in the wake of WeWork’s woes, what qualifies a company as highly valued tech?

Any company can call itself tech. Heck, Long Island Iced Tea Corp. changed its name in 2017 to Long Blockchain Corp. and the stock popped 400% to $13 (it’s now $0.16). But can companies that sell razors, glasses or mattresses be high tech? Exercise bikes? Insurance? Or even ads?

I came up with a list of five attributes of real high tech that investors should study. Let’s call it the GRuMPS™: Growth, Research and development, Margins, Productivity and Spending. Score one point for each—get enough, win valuable prizes. Collect all five and you’ll have a company that might trade at a high earnings multiple for a long time, not just the day of the IPO.

High growth: Two friends writing code to automate a lemonade stand is not high tech. Growth is key. The growth I’m enamored with usually comes from scale, meaning technology lowers the cost of a business model for which customers are clamoring. Intel lowered the cost of computing. Facebook lowered the cost of reaching consumers. Salesforce lowered the cost of using software. Even though prices go down, units go up faster so you get rapid and sustainable growth. Beware of fake growth like market‑share growth: If you sell seat cushions for a 50,000‑seat stadium, you can double sales every year but eventually you’ll run out of seats. Instead look for giant markets.

High R&D: Technology is never static. Hot products today are obsolete within a year. Huge R&D spending is critical to stay ahead. Look for intellectual property that scales. Companies often boost earnings by starving research, a serious red flag.

High margins: The best products have huge value to consumers, often with little relation to the actual cost of making them. This gets investors excited because high margins mean companies can afford that huge R&D spending, along with marketing to create new markets. Be suspicious when margins drop, even if sales are growing fast. In fact, the ideal tech product doesn’t cost anything to distribute—roughly zero marginal cost, like software. Sure, it might cost hundreds of millions to develop, but customers can run it off a server. Bits are free. Even chips, despite billion‑dollar fabrication facilities, have very low marginal costs: They’re just melted sand and some chemicals. If you sell one more unit, most of the sale drops to the bottom line. Same for ads in social media.

Now think about markets in which for each piece of new revenue, you need to hire more workers. Take consulting—certainly a nonzero marginal cost, and hardly any scale. I’d often tease my consultant friends that they have none of the upside and all of the downside.

High productivity: Productivity means doing the right things the right way. It also means doing more with less. Making a factory efficient is not highly productive, not anymore. Replacing taxi dispatchers, movie theaters, doctors and teachers with software is.

High digital spending: When health insurance companies update their computer systems every 10 to 15 years, they do what is known as a forklift upgrade—removing old mainframes and dropping in new ones to run the latest versions of their software. How quaint. The best corporate software upgrades now are done on the fly. Servers are delivered as blades: You pull out the old one, pop in the new one and voilà—you’re running three times faster and with 10 times the capacity. Easy, relative to forklifts anyway. But expensive, and never ending, year after year: the technology treadmill.

OK, here’s the GRuMPS™ high‑tech rating scale. One point makes your company a user of high tech. Two points, an implementer. Three, a creator; 4, a transformer; and 5 points, a platform.

Facebook and Google are 5s, without question. Twitter is a 4 but only because of questionable growth. Apple is probably a 4 because it wraps its intellectual property (operating system and apps) in metal and glass before it sells them to you, which reduces margins. Amazon? Its retail business is a 2, and Alexa and its content business are a 4, but Amazon Web Services is as close to a 5 as you can get. Uber and Lyft, maybe even Airbnb, are roughly 3.5s.

How about over‑the‑web goods sellers, like Stitch Fix (fashion), Casper (mattresses) or Warby Parker (hipster glasses)? Solid 2s. Same for WeWork, which might even be a 1. Lot’s of new business models will be tried. Don’t be fooled by the hype—make sure you’re investing in a real high‑tech company. What’s your score?

Write to kessler@wsj.com

 

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