Editor’s Note: Yesterday, I introduced Whitney Tilson, an investment analyst friend of mine who has a fantastic track record. As I mentioned, we’re teaming up for a 2 Legends Predict 2023 event. (You can click here to sign up if you haven’t already.)
Today, I want to share a great article by Whitney, where he explains how to find the big stock winners. Check it out below.
First off, let me take a moment to thank my good friend Louis Navellier. Yesterday in this space, Louis was kind enough to introduce me to you – the InvestorPlace readership.
I really appreciate it.
In that article, Louis told you of how I discovered Amazon.com, Inc. (AMZN) before it became the trillion-dollar behemoth we know it as today.
And about how I bought…
These investments were one of the reasons I was able to grow my hedge fund from $1 million in assets in 1999 to more than $200 million at its peak.
In today’s essay, I’ll show you exactly how I spotted these moonshots well before they became the mega-cap blue chips we know them as today.
Let’s look at Apple first.
The “Network Effect” at Work
When I bought shares at a split-adjusted $0.35, legendary founder CEO Steve Jobs had just returned to the struggling company, which had recently launched its iMac desktop computer. This was years before iPods, iPads, iPhones, AirPods, and the App Store ever existed.
But I knew Apple was special at the time for a number of reasons:
- It had (and continues to have) a base of fiercely loyal users.
- At the time, 50 million U.S. homes in the didn’t have a personal computer (not to mention hundreds of millions of homes overseas). These people were significantly less technologically sophisticated than average, which played into Apple’s strengths: its products being easy to set up and user-friendly.
- Apple had a long history of developing stylish, innovative products that differentiated it from its competitors and allowed it to charge a premium price. This is still the case today, and we continue to see this with every new product Apple creates.
- The company’s balance sheet was pristine, with a huge cash hoard, little debt, and a “light” business model with low inventories and capital expenditures.
At the time, Apple was sitting on more than $4 billion in cash and short-term investments, and $819 million in long-term investments, offset by a mere $300 million in long-term debt. That added up to more than two-thirds of its share price.
Plus, Apple had the ultimate “wild card” in the form of Jobs, who was a genius and a visionary… and who deserved the lion’s share of the credit for engineering Apple’s comeback.
Jobs sadly passed away in 2011, but Apple continues to execute brilliantly.
The iPhone basically put the nail in the coffin of its top competitor, BlackBerry Limited (BB), which saw its market cap crater from $64 billion when Apple released the first iPhone in 2007 to around $3 billion today.
The iPhone was a total game changer, putting computers in the pockets of millions of Americans that allowed them to use social media, send emails, stream video, and play games anywhere they wanted.
Apple is the prime example of the “network effect” at work: The value of its products and services increases as the number of people who use them increases.
Think about the App Store. Rather than hiring hundreds of thousands of developers to create apps, Apple incentivized outside developers to create apps for its users – growing its ecosystem exponentially.
The more users there are to download apps, the more developers want to create apps for those users, and so forth. That’s why App Store revenues have ballooned from $39 billion in 2017 to more than $85 billion in 2022.
That’s what I mean when I say these companies are hyperscalable.
It was the same case with Microsoft…
How MSFT Unlocked Hyperscalability
I first bought Microsoft in mid-2010 before it went on to be a 17-bagger.
Despite controlling more than 90% of the world’s operating systems and sporting rising profits, the stock had fallen sharply.
Investors were worried that Microsoft was losing to Google in search engines and would lose market share in personal computing to Apple. Plus, its hardware business was struggling.
But backing out its nearly $40 billion pile of cash, MSFT shares were trading for just eight times earnings. As I told a reporter from Reuters at the time, “That’s insanely cheap for a company of this caliber and market position.”
A few years later, Microsoft transitioned to a software-as-a-service (SaaS) model, meaning that it charged a few bucks a month in perpetuity for access to the Microsoft Office Suite.
That allowed Microsoft to become extremely hyperscalable: It didn’t really cost the company anything extra whether it had 1,000 subscribers or 1 billion subscribers.
And like Apple, as more and more people used Word and Excel, other people wanted to share the compatibility, leveraging its network effect tremendously.
These powerful forces propelled MSFT shares higher, and in 2019, Microsoft joined Apple in the $1 trillion market-cap club.
Netflix took a similar path to stardom as Microsoft…
I Was Wrong on NFLX… Before I Was Right
At the turn of the century, Netflix had just 400,000 subscribers. Today, that number has exploded to nearly 233 million… a staggering increase of nearly 58,000%. Take a look…
In the process, Netflix put Blockbuster Video out of business entirely. (Ironically, Blockbuster had the opportunity to buy Netflix for $50 million back in 2000 but passed. A decade later, Blockbuster filed for bankruptcy.)
But as we saw with Apple and Microsoft, Netflix didn’t take a smooth ride up, either. In an ill-fated strategy, the company separated out its DVD-by-mail business from its streaming business in 2011 and gave it a new name – Qwikster – forcing people to subscribe to it separately.
Netflix customers revolted – the company lost 800,000 subscribers in that quarter alone – and in less than a month, CEO Reed Hastings walked back the decision. But the damage was done… Netflix went from growing 30% year over year to just above 10% for three quarters. Shares fell from $43 to less than $10.
I was short Netflix at the time and even published an article called “Why We’re Short Netflix”…
Which prompted Hastings to publish an article of his own, titled “Whitney Tilson: Cover Your Short Position. Now.”
Hastings and I connected through email, and he invited me to brunch at his house in California where he helped me realize I was looking at Netflix with a completely wrong lens.
I was looking at how many people were paying $8 per month and trying to figure out how much each subscriber was worth. Instead, Hastings explained that Netflix’s streaming platform was already built… and now it was enjoying the network effect as more and more people were using it.
Because Netflix paid a fixed amount for its content, it cost Netflix virtually nothing to add a new subscriber. Each new subscription was almost pure profit.
I immediately closed my short and, after the stock fell sharply, backed up the truck on Netflix shares. I went on CNBC the exact day Netflix bottomed following the stock’s crash in 2011 and predicted it would be the coming decade’s Amazon, whose shares were up 1,000% over the past decade.
It turns out I was far too conservative: NFLX shares rose 90-fold over the next nine years!
One Trait in Common
Apple, Microsoft, and Netflix all share one common trait: They’re extremely “hyperscalable.”
To see what I mean, take a look at the following chart…
As you can see, this hyperscalable model has led to massive revenue growth among all three companies over the past several years…
This has, in turn, led to massive returns for shareholders over the same period…
I talk to people all the time who kick themselves for not investing in Amazon, Apple, Microsoft, and Netflix…
Everyone wishes they had the opportunity to invest in these stocks back then. But I believe that right now, investors have a similar opportunity to make a fortune in the markets.
I think people who get into the right stocks today will look back at this the past two years’ volatile market as one of the best things that ever happened to their portfolio.
That’s why I’m joining forces with my friend Louis Navellier, an industry legend and billion-dollar money manager who has found 18 different 100-baggers in his career. We’re putting the finishing touches on a presentation where we’ll explain how a coming event could create a wave of millionaires in the markets.
Louie and I will share the details of our big prediction – and how you can profit from it – during our 2 Legends Predict 2023 event on Tuesday, May 23. Since you’ve already signed up, there’s nothing you need to do. We’ll send you a link to the event as soon as soon as it’s available.
Louie will be back in touch tomorrow with a special essay in which he discusses the first-quarter earnings season and a big catalyst that could boost two tech behemoths higher.
Sincerely,
Whitney Tilson
Editor, Empire Investment Report
