Many growth investors unknowingly sabotage their portfolios by attempting to pick the big winner in a fast-expanding sector.
Try this, and you may be lucky enough to choose the next Microsoft Corp.or Apple Inc. But there’s also a risk that the company you choose will disappoint.
Rather than focusing on just one potential winner, you should consider at least a couple of possible stars.
In the world of mobile computing, for instance, the two obvious leaders are Apple and Google Inc. The vast majority of smartphone and tablets run operating systems made by these two companies. But it would be a brave investor who would decide which of these two companies will eventually emerge as the dominant force.
That doesn’t stop people from trying, however. Patrick Gibson, a former Apple engineer, wrote a blog post last week that examined how Apple is falling behind on web services. He goes on to assert that Apple should buy Twitter to solve this problem.
If Mr. Gibson is right, Apple’s share price will be vulnerable. His main assertion – which I agree with – is that Google is improving its design abilities faster than Apple is improving its web services.
Google has succeeded in making the Android operating system slick and elegant. It’s adding the polish for which Apple has always been famous. And on the web services side, it is already quite strong. It has built some incredible services such as Google Now, a feature that uses its knowledge of a smartphone user to feed him the information he needs before he requests it.
Apple, on the other hand, has stunning hardware and operating systems but has struggled to offer that same quality of experience with its web services.
Notable hiccups include the iCloud service. It offers synchronization of messages, documents and other data among multiple devices, but is not particularly reliable. Notes sent through the new “Messages” application often arrive after a long delay, if they’re not lost.
Based on the disparity between their web offerings, Google seems to be the superior company – right now. But then there’s the question of how much you’re willing to pay for that supposed superiority.
According to S&P Capital IQ, Apple trades at about 12 times its estimated earnings for the year ahead while Google trades at 15.6 times, so much of Google’s advantage seems to already be reflected in its price tag.
Apple isn’t run by idiots. It knows its web services are falling behind. CEO Tim Cook has often said that iCloud, the foundation of its web services, is not a product but a “strategy for the next decade.” It seems hard to imagine Apple accepting mediocrity.
But good companies do mess up. Look at Research In Motion, which invented the smartphone market and then ignored the threats posed by Apple and Google.
I don’t think Apple’s going to fall into the same trap, but it could happen. Google might leave Apple in the dust.
So do you pay more for the company that might have stronger positioning? Or do you gamble on the cheaper stock, hoping it fixes its weaknesses?
I think most investors should avoiding betting too much money on such a finely balanced decision. Why choose Apple or Google when you can own both companies?
My thinking on this issue was formed by reading The Gorilla Game by Geoffrey Moore. This classic of technology investing taught me an important lesson: When investing in a fast growing sector, you should buy a basket of leaders, not just one overachieving firm. Then, as it becomes clearer who will ultimately win the fight, you can sell the also-rans and consolidate your holdings into the eventual leader.
Trying to predict the winner too early into the game adds unnecessary risk. That’s why, in my Strategy Lab portfolio and in real life, I own both Apple and Google.
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