Mary Meeker is a partner at the venture capital firm Kleiner Perkins Caufield & Byers. Before becoming a venture capitalist she was a Managing Director, Research Analyst, and Technology Analyst at Morgan Stanley from 1991 to 2010. She previously worked at Salomon Brothers. Meeker received her MBA from Cornell.
Meeker and I lived through many of the same events, but in different places, which creates different perspectives. For example, Meeker said once: “I bought my first PC in 1981.” I bought mine around the same time (an Apple II). We both lived through the rise and fall of the Internet bubble in the 1990s. If you lived through that bubble as a participant, it changed you. Experiences as vivid and intense as the Internet bubble give you fundamentally different muscle memory about finance and the business world. Some people became rich on paper in just months and the impact of that was that envy and jealousy which caused some people to lose their tie to reality. The environment was literally nuts. Fear of missing out made people do things that in retrospect seem insane.
When I said that I was going to write this post on Meeker a few people said to me: “I lost money based on her recommendations in 2000.” I am not going to comment much on that set of issues in this post since Meeker makes her own case in a well-known Newsweek interview. http://www.prnewswire.com/news-releases/newsweek-interview-mary-meeker-morgan-stanley-stock-analyst-71696332.html I will say that the business model for sell-side research is problematic since few people (if any) are willing to pay for the work. This creates a free-rider problem and other issues. Meeker is no doubt much happier on the buy-side.
Now for the usual dozen quotations:
- “In a typical year, there are generally two technology companies that go public and become 10-baggers, which means they deliver a 10-times return on investment. We were trying to find those two companies.” This statement by Meeker reflects a fundamental truth about the venture capital business. There are firms like 500 Startups which are following a different venture capital model (see my blog post on Dave McClure) but what Meeker describes is the dominant model. The traditional venture business is all about the Babe Ruth effect (it is magnitude of success and not frequency of success that matters). Fred Wilson just wrote a post in which he explained that his firm loses all of its money in over 40% of its venture investments. This is normal and an essential part of the traditional venture capital business. The number of times something like Facebook can happen in the global economy is top down constrained by a number of factors including addressable market. It is simply not possible to have even a tiny number of Facebook style financial outcomes every few years.
- “The race is won by those that build platforms and drive free cash flow over the long-term (a decade or more). That was my view in 1990, 1995, 2000, 2005, 2010, and it remains the same today.” The grand-slam tape-measure home run financial wins that venture capitalists like Meeker seek are most often found in the form of multi-sided markets or platforms. To generate big returns you need a business that scales amazingly well and nothing scales better than software delivered as a service that creates a platform business. You also need a moat and that can sometimes, with a lot of effort and luck, be created through network effects. When a platform is created in the right way it has almost zero marginal cost to deliver the service and thus very attractive margins.
- “I [read] an article in the New York Times written by John Markoff about Jim Clark going to the University of Illinois at Urbana-Champaign to invest in a Web browser company called Mosaic Communications run by Marc Andreessen. It was one of those moments. I picked up the paper and said: That’s it. This was 1994. Morgan Stanley then raised money for Mosaic – I actually have that business plan somewhere. The company promised to ‘change the way the publishing world works.’” At the time Mary Meeker describes in the previous sentences I was working for Craig McCaw who is a good friend of Jim Clark. And Jim Barksdale, who was running McCaw Cellular at that time, would leave to be CEO of Netscape in 1995. So we were very curious about what was going on at Netscape. Craig McCaw sent me and a colleague down from Seattle to visit Netscape to see what Netscape was doing. We were impressed by the products but also the intensity of the battles with Microsoft at the time. Meeker was right that at tat time in history it seemed like liftoff was imminent. By 1995 the launch parties were getting bigger, spending more lavish and the stakes higher. Capital was starting to flood into the technology sector. In one sense, we were all frogs in a pot of water that was steadily getting hotter. People who spout off and say “I would have know what was happening” are fooling themselves. Things were euphoric enough in the markets in 1998-2001 that even the smartest people did dumb things.
- “It is one thing to be wrong about the valuation and the timing. It’s another thing to be wrong about the business model.” I addressed what a business model is in my posts on Steve Blank and Eric Ries. I like the definition used by Mike Maples, Jr.: “The way that a business converts innovation into economic value.” Steve Blank has his own definition: “A business model describes how your company creates, delivers and captures value.” If a startup can’t create, deliver and just as importantly capture economic value, it is going to fail. A business needs core product value, a scalable delivery system and a moat to protect itself from competitors. Just one or two is not enough. A winning business must achieve all three. In looking at issue like the business model it is possible to make mistakes. If your mistake concerns having an unsound business model that mistake is usually fatal unless you can correct it before you run out of cash. Meeker is saying that valuation and timing are much more solvable problems.
- “In general, a good rule of thumb is that for an attacker to beat an incumbent, the attacker’s product typically needs to be 50% better, and 50% cheaper, and sustain that competitive advantage for a year or two, to be able to gain material market share.” There is a lot of inertia in the behavior of humans. Consumers don’t always rationally address decisions like what product to use or whether to stop using a product. People in general in the mass market want a margin of safety when asked to move to a new product. The greater the value differential the lower the cost required to move the mass market customer to a new product. For this reason the value that a challenger must deliver is ratcheted up. The greater the value differential between the new product and the incumbent’s product the lower the customer acquisition cost and the lower the cash that will be burned in getting the business to the critical mass and network effects in my post on that topic.
- “Technology stocks are volatile.” JP Morgan once said the same thing about stocks generally: “The stock market will fluctuate.” And tech stocks can be especially volatile. The best way to deal with volatility is to remember that you can make it your friend. If stock prices were not volatile there would not be as many bargains. Remembering that risk is not the same thing as volatility, is very important.Why ate tech stock more volatile? Risk, uncertainty and ignorance have been shown to increase when research and development is a high. This is common sense – when conditions impacting a business change more often due to changes in technology prices are going to be more volatile. If tech falls within your circle of competence it can be a great place to invest. Warren Buffett who feel that tech falls outside his circle of competence has said: “I should emphasize that, as citizens, Charlie and I welcome change: Fresh ideas, new products, innovative processes and the like cause our country’s standard of living to rise, and that’s clearly good. As investors, however, our reaction to a fermenting industry is much like our attitude toward space exploration: We applaud the endeavor but prefer to skip the ride.”
- “You never want to catch a falling knife.” A falling knife is a term used to describe the price of an asset that has fallen significantly over a short period, and has significant uncertainty about how much further it will fall. Because momentum and emotions are involved when a knife is falling the risk of mistiming the bottom is significant. Making accurate predictions about human behavior is, ahem, hard to do in a way that creates a significant margin of safety, especially after costs are deducted. It would be great if someone rung a bell when a knife hits bottom, but that never happens. Knives can continue to fall irrationally further down longer that you can remain solvent. If you stay focused on valuation relative to a benchmark like intrinsic value, you are far better off than you will be be trying to time markets. One way to avoid catching a falling knife is to have a margin of safety when buying assets. The idea is that with that margin of safety you can make mistakes or have bad luck and still do fairly well. Having a margin of safety when buying assets is like keeping a safe driving distance between you and a car ahead of you when driving at 70 MPH.
- “One of the greatest investments of our lifetime has been New York City real estate, and investors made the highest returns when they bought stuff during the 1970s and 1980s when people were getting mugged. The lesson is that you make the most money when you buy stuff that’s out of consensus.” It is a mathematical fact that to outperform the market average results the investments must be contrarian in a way that is correct. Buying when other people are fearful can product great bargains. It can also produce great losses to. You must buy assets that are out of consensus and you must be right to outperform the market average. Many smart people have decided not to outperform market averages and instead buy a diversified portfolio of low cost index funds and ETFs.
- “Buy [technology stocks] when no one is interested in them. Sell when everyone is interested in technology (or when attendance at technology conferences reaches record levels or when your grandmother wants to buy a hot technology IPO).” This is of course a restatement of the Mr. Market metaphor that was the subject of the previous quote in number 8. Be greedy when others are fearful and be fearful when others are greedy. But Meeker is making the additional point about the folly stocks tips. When the shoe shine operator at the airport or your Uber driver tells you what stocks you should buy, that is a “tell” that the market is overheated.
- “Don’t fall in love with technology companies. Remember to view them as investments.” This statement by Meeker is also a bedrock tenant of value investing. A share of stock is not a piece of paper to be traded but instead a partial interest in a real business that must be understood fundamentally to be properly valued. The business should be evaluated dispassionately based on sound data and analysis and only when it is within your circle of competence. There is significant danger is getting swept up in the madness of the crowd.
- “I’ve made my best personal investments when I’ve been a user of the product.” This statement has similarities to a famous statement by Peter Lynch: “I’ve never said, ‘If you go to a mall, see a Starbucks and say it is good coffee, you should buy the stock.’” Lynch says: “People seem more comfortable investing in something about which they are entirely ignorant.” If you understand the steel industry deeply you are more likely to make better decisions about the steel industry. This is circle of competence thinking. Since risk comes from not knowing what you are doing, it best to be a real users of the product and even more importantly know that industry well. Meeker is famous for her long working hours, 200 slide presentations and extensive research. Lynch also said once: “Investing without research is like playing stud poker and never looking at the cards.” You can’t understand a business and its place in an industry without doing research. And in doing research you must find something that the market does not properly discount into the price of the stock or bond.
- “I love data. I think it’s very important to get it right, and I think it’s good to question it.” The amount of data in Meeker’s massive slide decks is legendary. And of course she has more data than ends up in the side decks. Some of that data is from companies talking their book and some not. She is saying in this sentence that you need to think carefully about any data to make sure it does not lead you to make a false conclusion. For example, it is easy to confuse correlation with causation. In thinking about any data it is best to avoid acting like the drunk who uses lamp posts for support rather that illumination. Sometimes the data you need is in a dark corner of the parking lot where there is no light. In that case you may need to put the decisions in the “too hard” pile.
Fred Wilson: http://avc.com/2016/04/losing-money/