Letter from Lex: Learning the hard way
Today is my last day on the Lex team. The job has exceeded my expectations in many ways.
For example, I knew at the outset that to write about finance is to be wrong a lot of the time. Yet I managed to be much more wrong about many more things than I could have possibly hoped at the outset.
I think it fitting then that in this, my valedictory note to readers, I catalogue a few of the more vivid instances in which, over five years, my preconceptions have been crushed flat under the wheel of fact.
At various times and in various ways, badly wrong about three of the most important companies in the world: Apple, Facebook and Amazon.
At Apple, I was mostly mistaken about the evolution of margins. I have spent years waiting for them to compress. They have not. My thinking was pretty straightforward. Start with the view (widely held yet widely disputed) that Apple is not a product innovator but a product perfecter. It didn’t invent MP3 files or touch screens; it figured out how to make them a frictionless pleasure to use. It follows from this that the distinctive features of its products are not terribly difficult for competitors to reproduce. Gloss is hard to patent. This has proven true: Samsung’s best phones can clearly go throw-for-throw with Apple’s. Idiotically, I made the further inference that Apple’s pricing power would therefore decline and take margins with it. Nope. Apple has worked feverishly to polish its brand and to make its users captive to applications (photo and music storage, say) with high switching costs. It has given up some growth by keeping prices high. If I had taken a moment to think about how Coca-Cola held on to customers and margins for a century or so despite selling sugar water, I would have realised that Apple need not follow in the footsteps of Motorola or Nokia. Under the right conditions, brands are astonishingly powerful things.
I also spent at least my first couple of years on Lex underestimating the power of network effects. This brings me to Facebook. I spilled a lot of words about how transient previous social networks had been, or on more or less esoteric complaints about the product, or bitching about the high growth rate implied by the company’s valuation. But once the network effect kicked in — in the sense that the sheer size of Facebook’s membership base became an unanswerable competitive advantage — the company became a natural monopoly and the only interesting question left was how Mark Zuckerberg was going to spend all the money.
I also spent a lot of time early on at Lex griping about Amazon’s valuation. At some point, I argued, it would have to show substantial profits to investors to support its share price, because that price reflected not only 20 per cent revenue growth out to the time horizon but a profit margin in excess of what traditional retailers manage. This has not turned out to be true. The company has been helped here by the emergence of its web services business. But all the same, lesson learnt: as long as a company has sales growth, is profitable enough to self-finance and has a more or less coherent strategic story, investors just don’t care about margins.
I was not only wrong about companies. I was wrong about markets, too. I have been waiting for about four years now for US stock valuations to come down from their historic highs. I never believed that artificially low interest rates could provide a stable underpinning for the market (I still don’t). I thought falling profits, mean-reverting profit margins and decelerating share buybacks would lead to a sustained correction. Those things have happened. Valuations remain high. It appears I’m missing something. Of course my scepticism about current share prices will be proven right eventually. Too bad that “proven right eventually” is (in markets at least) a synonym for “wrong”.
Have I, or Lex, got anything right over the past half decade? I leave it to readers to judge. Whatever their conclusion, I hope the column has been stimulating and amusing — in other words, I hope that when we have been wrong, we have been wrong in useful ways.
Thanks for reading, and stay in touch.
Head of Lex (Emeritus)
Email the Lex team at firstname.lastname@example.org
Video of the week
Low rates inflate US stocks valuations
The FT's Rob Armstrong explains why US stocks valuations have remained high and will remain so until monetary policy pushes up interest rates.