How to lose money in tech
The two most effective ways to lose money investing in technology companies are:
- Invest in bad companies; and,
- Invest in good companies at bad prices.
I have plenty of experience losing money in both of these types of dog investments, but as I have gotten older, I may not have gotten wiser but I have gotten better at avoiding losses and this is the single largest factor that has improved my investment performance. As Warren Buffet says, the first law of investing is ‘do not lose principal‘ and the second law of investing is ‘remember the first law‘.
There is no question that another silly period of stupid valuations in technology is upon us. The IPO of Shopify is just the latest Canadian example, but Uber and Airbnb blazed a big trail before it in the US with private placements at crazy valuations, and Stinyray Media, HootSuite, Desire2Learn and BuildDirect are private Canadian companies that may soon follow into the public markets (at least there is lots of fee-pig investment banker chatter that they will).
The IPO price of Shopify was approximately 17x last year’s revenue. Losses were 50% of revenue. Shopify looks, from afar, to be a good company in an interesting niche and it is growing very fast (100% per year). However, no matter how good a company is nor how fast it grows, ultimately the real value of the enterprise must be the net present value of the future cashflow available to owners. Assuming that ultimately Shopify will be valued at 15x earnings and net earnings will ultimately be 10% of gross revenue, Shopify needs to grow revenue >10x in order to properly justify the IPO price – and that is without any discount for systemic risk, opportunity cost, competitive threats or execution risk. Even if Shopify continues to double revenues every year (which is unlikely – growing from $50M to $100M is a very different thing from growing from $500M to $1B), and it suddenly becomes profitable, it will take 4 years for the real value of the business to support the current stock price. I am not saying that Shopify stock will crater. I am saying that on a ‘risk adjusted’ or ‘probabilistic’ basis, buying at the current price is a terrible trade. As a gamble, buying Shopify is probably no better or worse than going to the casino, but the purpose of going to the casino is not to make money – it is to lose money so that I can pay less tax.
Most IPO stocks are “sold not bought”. In other words, the sale is flogged by sellers earning commissions, not pulled by demanding buyers. My advice to you: do not pick up the phone when a broker calls flogging an IPO. No matter how good the company, if you pay the wrong price, it will be a bad investment. And if you don’t believe me, ask the folks who bought the last great sexy Canadian tech IPO, Halogen Software: nothing wrong with the company, but the price was way too high and they have paid the price accordingly.