The most powerful question in investing is: What is something you do today that everyone is going to do in the future, and the market doesn’t know it?
Imagine yourself back in 2008 or 2009 when you got your first iPhone, started using Amazon Prime for everything, or got lost on Facebook. Whether invested in those companies then or not, you couldn’t help but sense that everyone was going to use those products eventually. The same could be said for Netflix’s streaming service and PayPal accounts.
The idea is underappreciated to investors because it’s so simple and profound. It’s more analytically rigorous to estimate returns on incremental invested capital, and it’s more fun to opine about future products that don’t even exist, but The Question hits the most important things you need to know about an investment: market size, product, and valuation. Everyone is the target market, the thing you do is the product, and the market not knowing is valuation.
Everyone is an exaggeration to act as a screen for the few market opportunities scale to everyone. If you can’t say “everyone should have one of these” or “everyone is going to use this” without laughing or flinching, then the market probably won’t warrant a massive company.
Here are a few obvious everyone companies that serve hundreds of millions or billions of customers. All everyone companies should be painfully obvious in hindsight:
Microsoft: Everyone needs to be productive
Google: Everyone needs information
Apple: Everyone needs to communicate
Amazon: Everyone needs stuff
Facebook: Everyone needs friends
Netflix and Disney: Everyone needs entertainment
Visa and Mastercard: Everyone needs to pay for stuff
Coke and Pepsi: Everyone needs food and drink
Nike: Everyone needs shoes
These companies won the right to serve everyone by delivering superior product, developing a network effect, building unmatched scale, creating the best IP, and/or establishing a brand that creates a certain feeling. The more of these advantages a business can create, the more likely they are to serve everyone. In the age of Internet scale, companies benefit from natural winner-take-all outcomes. Why use second best?
It’s sometimes worth scaling the idea of “everyone” to “everyone that X.” Everyone who dates uses Match. Everyone who plays video games plays Call of Duty and Grand Theft Auto. Every graphic designer uses Adobe Creative Suite. Everyone that X companies aren’t going to be as big as pure everyone companies, but they can still be great if they offer an obsessive product, and the market doesn’t see it.
Everyone’s Going to do This
In an ode to Peter Lynch, things you love are always a powerful investment signal. The product in question should be something you’re using now and can’t stop. When you can’t stop using something, either it’s addictive (iPhone, Facebook, Netflix), or it has extreme utility (iPhone again, Amazon, PayPal). You might be able to notice things other people love, too. What is your significant other obsessed with? What are your kids obsessed with? Your friends? Your parents?
Be careful not to go too far into the realm of science fiction. The spirit of the question is to recognize the present, not predict the future. Predicting that some imaginary product that doesn’t exist yet and hasn’t found a passionate user base will eventually be used by everyone is a dangerous game. This is where the greatest speculative excesses are found.
While the examples I’ve presented are obvious now, they weren’t as they slowly gained early users. Investors thought the iPhone was too expensive to go mainstream, they thought Android would eat into their share, and they didn’t think the device would work in emerging markets. You need to reasonably assess concerns as to why the thing you love isn’t going to expand to everyone. Investor concerns about the iPhone meant its promise wasn’t fully appreciated by the market.
The Market Doesn’t Know
To be a great investment, the market can’t know it’s dealing with an everyone company.
Apple traded around a 7% free cash flow yield in 2009, right as the iPhone was breaking out as a hit. The stock is up around 34x since mid 2009, about a 43% compound annual return. If Apple traded at a 1% FCF yield at that time, the stock would only have increased 5x, a 17.5% compound annual return. If it traded at 0.5% FCF yield, it would have been a 9.5% compound annual return.
Price matters whether any of us like it or not.
Believers in the power of The Question when they ignore what’s priced into the stock. If the market agrees that a company is going to be a massive hit, that future is discounted into the price.
As a simple rule, any profitable growth company trading at a high-single digits or better free cash flow yield doesn’t have much priced into forward expectations. Inversely, any profitable growth company trading at sub 1% free cash flow yields probably has a lot priced in. Unprofitable companies with high sales multiples obviously have a lot priced in.
It’s ok for companies to have strong futures priced in. They can still turn out to be good investments, but we should accept another simple rule: The biggest layup investments are usually those where the business is already great, the price is great, and the future is great. When you have all three, you should swing big.