Product Drivers stock investors should consider

As far as stocks are concerned future outlook is more important than current or past successes. The stock market has a way to project this outlook in the stock price. This projection largely depends on the product or service offered by the company. Looked another way, the stock market is about risk and the product(s), the backbone of the company, reflect the risk profile investors are willing to bear. Some products have a high risk factor than others; biotech, tech vs consumer staples. Investors expect greater risk products to yield greater returns.

In this post we evaluate some of the “drivers” that influence products (services) and how such drivers affect the company stock performance.

When evaluating a company product an investor should be able to easily know what the product is and easily be able to explain to a young child what the product does. A car is a car; different makes, different makers, different features but it still is a car. By understanding what the product is an investor can easily understand how the company makes money, how risky the stock is and what the future holds for the company.

As much as great products define a company, great products trump management (mismanagement), buck the markets and crush the competition.

Shiny little thing

If we look at GoPro as a company, the initial excitement seems to have fizzled. How many GoPro cameras does one buy. Is it a defining product or as Corey Johnson said “a camera on a stick” Does this paint the company as one dimensional, one trick pony? How about cheaper alternatives in a sector without much barrier to entry?

Companies come up with shinny little things all the time and its imperative upon savvy investors to look beyond the sheen and gloss for real products with staying power. As such you have to ask yourself is the product a fad (virtual gaming!!!) or does it have longevity? Rabid fan base does not a company make. If you get seduced by that spiffy shiny new thingy and buy into the company, is it a short-term trade meant to cash in on the craze or a long-term investment?

Of snake oil, hype and peddling

Sure GoPro went public with much hype from Wall Street and Silicon Valley. Bankers got to bank their checks and early investors got an exit. It shot up to $93 in Oct 2014 but it’s been downhill since. Whenever there is a defining product or technology, copycats crop up all over the place. Wall Street and Silicon Valley have a way to capitalize on this and regular investors may end up the losers. Remember the dot com this and the facebook of that? As an investor you have to be level headed or else you would easily buy into the hype and end up on the other end of the hook gasping for air.

A product may be good for consumers but bad for the company finances. Highly touted public companies like Etsy, which was founded more than 10 years ago, should demonstrate positive cash flow streams while they cope with increasing costs to justify investment, otherwise they are just a case of “hot potato” where everyone cashes out and you are the loser if you are left holding worthless stocks. An Investor has to be able to discern real products from spin, hype or hot air. In some instances, such early investors, venture capitalists and Wall Street firms, unload their stakes to a gullible public through a much hyped IPO. Financial media is no help either, buying into the lingo and running with it. What is PIVOT out of Silicon Valley? When did HITS and CLICKS become a valuation metric, Mr. Wall Street guy?

Innovation has taken a back seat to duct taped this, MacGyver that, a little tweak here, copy that, or the facebook of…. Real innovation is coming up with breakthrough technology and its high time Silicon Valley and Wall Street got back on track and fund technology companies instead of cheap three month tryouts. How did we buy into pins, badges, checkins, and pokes. Emojis. Cute and catchy. Monetize that.

There are phenomenon that will overtake our imagination and consume our lives but not all will become real products or real businesses. Flash sale. Pop up stores. Gimmickry.

Sticky

It may sound like I’m opposed to new products or services or like I’m scared of change but not. A product and company has to show success, or the potential, to be a great investment. I go with companies and products that are sticky. What we can’t or won’t do without, and we have to pay for them. Products that form a big part of our daily habits. This reminds me of the Clorox commercial where two boys are in the bathroom with tape on the floor when mom comes in to check what is going on: it’s a pissing contest. Boys will be boys and for such moments there are products we all use.

In such a situation you may reason I use the product, I like the product, so I invest in the company. This may be the right move if the market is big and durable otherwise decoupling product from company may be the right thing to do. You may like Groupon coupons but do business people and merchants stick with it? How about it as an investment? For any company look at the product, look at the financials, look at the charts.

Sticky products make for a great company to invest in. If they get you they have you for life. Think bookkeeping and tax software company Intuit. Tax laws change every year and small businesses need to balance their books. You have to have car insurance. Or just for kicks try not paying you electric bill for a few months. Such products (services) have you for life.

Product market fit is key for a company to do great. The problem comes when the market is too small or the market is too targeted; say dating site what happens when a couple gets married, they are out of the market. What happens when a free dating site crops up out of nowhere? A company may have the right product, market but the stock market does not bite

It’s hard to tell with new products. Only time will tell and that’s why it’s always a great idea for investors to diversify their holdings.

What comes first product or market? The Steve Jobs is said to have developed the product and we all gobbled them up. We didn’t know we needed it until the big unveiling. No matter what comes first the product or the market, the products made the company and the company made the stock rise.

Flagship product

Does a company have the right product mix. Some products may be seasonal so what will pay the bills when it’s out of season. Is there a flagship product, the bread and butter, carry the heavy load product. You may have a mainstay like coke, google search, or facebook which spits out so much positive cash flow a company can broaden its reach by either developing other products or acquiring them. Monster beverages acquired by coca cola Company, moonshots by google, now Alphabet or facebook acquiring instagram.

Pipeline

While at it how about the product pipeline. Before your bread and butter runs its course a great company will have other possibly viable products to replace eroding sales from older or maturing products. This is critical in the pharmaceutical industry where drugs are protected by patents but as the patents expire, a product faces what is called a patent cliff. If your star player brought in 60% of sales and 50% profit, how will a company replace such numbers when generics invade.

R&D = BETTER TOMORROW

Equally important companies should invest heavily on the next product to ensure the current product doesn’t end up as a one off shiny little thing with a short lifespan. There once was a “crackberry” , the very definition of a smart phone, but now we have a shrinking money hemorrhaging blackberry, is it the walking dead? The Coca Cola company, Apple, IBM and similar companies are big spenders in Research and development. But as you may know from Kodak, a company should not put all those resources to R&D and then sit on it.

As a company focuses on the future though, it’s very easy for the company and investors to get too optimistic about possible products before they are out in the wild. The hope and optimism demonstrated in the pharma industry and more so in pre-product biotech companies can be all consuming, but the reality is, most clinical trials do not result in marketable products. Remember hope is not a product.

Margins erosion

You have probably heard of a quote attributed to Jeff Zucker: analog dollars to digital pennies. If you are the only one running a water stand in the Sahara you can charge whatever you like, assuming there are people with money to buy. More dramatic though, check the product pricing at the ballparks. As an investor you want to invest in a company that has pricing power. And pricing power that is not easily eroded.

No matter the product or service what are the trends: technology or tastes. Music still remains a growing product in reach and verticals but the revenue base continues to erode as technology, piracy and consumer attitude (free free free) drive prices down in a sector depressed by unending race to the bottom in terms of price. Yes the costs of production may be coming down but how many artists can come up with hit after hit. They sure miss the days they used to fill an album with fluff and charge us big money for it. Does anyone make fluff anymore? Where does the fluff go. Does your company make stuff, throw it around with a big sales budget and hope it’s a hit? Where does this morphing world of ever-changing technology place any company. Who will win and who will go down. Anyone remember newspapers? All that content is fast, free and fresh. Where are the media companies of yore.

Unit economics is all the range now but it should always be the defining entity. The gospel truth is that a company has to have a product that it sells for more than it cost to make. This is contrary to the popular view out of Silicon Valley: grow, capture mindshare and then figure out the revenue model.

Cannibalism

Sometimes the product is so great, it’s the bread and butter for the company but the bottom could be falling. What can a company do when a new product would cannibalize on the tried and true? A case study of companies like Kodak, with all the resources and even the intellectual property for digital photography, protecting the current products at the expense of the future proved fatal.

I like watching nature channels and, on one episode on Galapagos Islands, I watched an albatross chick fight its sibling, choking it and head butting it out of the nest and into the elements. The mother just lay on the nest while all this bloodletting was going on. That’s a Kodak moment!

Evolution

Apple demonstrated its adaptability switching from a computer company to a music company to a phone maker with each evolution meeting greater success along the way. IPhones represents over 60% of net sales and due to competition, among other factors, the fat margins we are used to out of apple are slimming down. Has Apple stalled or is there an I something on the way. Are Apple investors in for another defining product or settling in for a utility like company that tweaks a product and manages… don’t say it… the decline. Transitioning from one product to another is extremely difficult and many companies do not manage that well

To a salesman the spoils

Every investor should be aware of what a company is doing to reach consumers and reach them where they are. Great companies have big marketing budgets. Companies like Nike, Coke, and Apple have big budgets for their sales and marketing departments because they recognize the effectiveness of “constant reminders “to the bottom line.

Salesmanship can be good for the product but it can also obscure product deficiencies especially if the salesman is a charismatic and magnetic leader. As an investor you have to learn how to cut through the sales pitch and critically analyze the product on its merits.

Moats

A product with exclusivity rights beats your ace. Intellectual property, especially in pharma, gives a company enough runway to recoup past investments in R&D. In such a situation a company has great leverage in product pricing and is potentially a good investment.

Differentiation or dressup

A product may differentiate itself as a luxury or high-end product and sell well. People, we buy flavored water for big bucks. What was that angus beef craze? I’m a meat loving, beef eating human who doesn’t care whether a cow is blue or purple. Beef is beef, a commodity. As an investor you have to see how the product fits in the market. How much do you grow a luxury brand before its value becomes diluted. We all suffer grand delusions, bigger, bigger, more, more, but there are laws of nature that should limit brand extension. Does a Whole foods fit in every neighborhood or will fatigue start to kick in?

Let the good times roll

A booming economy puts pressure on companies to grow and sometimes such companies overshoot. How about that housing boom? Want a third home as a middle class professional? It’s yours minus the paperwork of course. We knew the normal demand but the housing stocks were doing great, so, investors kept demanding: show me the product, more of the product. Come on build, build baby! You saw the latest out of the oil and gas industry. The horizontal drilling, the fracking, drill, drill, bust! How many publicly traded companies have filed for bankruptcy so far? Who could have seen that coming and so soon after the worst recession ever. Laws of supply and demand.

The hardest part in investing is taking the contrary view. Amongst the hysteria who wants to be the party pooper, who wants to bail out of a stock that’s roaring (at the peak). You stay at that party too long and what a nasty hangover can ensure!

Good times for sure. But do you wonna know the real shrinkage Mr. Costanza? “Only when the tide goes out do you discover who has been swimming naked” wisely put by the Oracle. Companies get complacent and careless during the good times.

Tidbits.

Not too long ago it was peak oil, now the good ol US is the biggest player in oil and gas. Did you get swept by the Molycorp tidal wave? If not wait a while, there is always a Molycorp situation around the corner.

All products sit on a platonic fault and shifts can bring ruin to a company. Yes Amazon ate every ones lunch, swallowed the bricks with the mortar whole. As an investor you have to be aware and ready to shift with the times. Anticipate the pac but be aware of the pitfalls. Online shopping was set to overhaul the shopping experience, usher in price transparency and greater product insights. Any company that did not foresee this lies at the feet of the Amazon, Netflix and Facebooks of this new world.

At its apex a company with a great product can leverage its status and power to acquire other companies and products. Yahoo did. According to the markets you can throw out core yahoo products like mail and finance (1 billion users). These are real products that make the company real money but the stock market, at current valuations, only cares about its holdings in yahoo Japan and Alibaba. This means were it not for the investments in Asia, Yahoo as we know it today may have gone the way of… Say it… AltaVista. Hope springs eternal “You got mail” still lives under now parent Verizon.

Sometimes you may not like the product or the company but facts and not feeling should guide a prudent investor. The adage “don’t fall in love with a stock” should play out the other way too “don’t hate a stock, company or product”. Feelings about a product can obscure from sight a well performing stock and it so hap pens your feelings will not affect stock performance. Now, if this is the “general feeling” in the market, stock performance will be affected. Do I understand “hate” of sin stocks like cigarette companies, yeah! but to hate an innocuous product or company without any ideological objection is frivolous. “I don’t like that burger maker (product)” Just happens to be selling lots of burgers, is a successful business and company and pays dividends. Check your emotions.

Where to play

In any product one can choose where to invest in the value (supply) chain. Take oil and gas for instance. With its booms and busts, ebbs and flows, an investor can invests in the bold and crazy wildcatters of the world. These are the companies known to push the envelope in technology, territory and financing. The risk is high as are the potential gains. The energy revolution of the fracking and horizontal drilling era was championed by companies such as Chesapeake Energy while the majors sat on their thumbs. As an investor you can play the majors with their diversified product lines and geographic reach. Or you can play the distribution and transport angle with pipeline, trucks or rail companies. Manufacturing and other auxiliary sectors are other great investing options that would put you in an industry.

Out of the original 49ers who came out ahead the gold miners or those who supplied the tools, creature comforts or a warm embrace. Find your spot.

As an investor you will make the wrong investments: that’s just the nature of the game. You will invest on Betamax instead of VHS, Blockbuster instead of Netflix. This may be because you got into the market too soon or the tide just turned on you. Savvy investors are resilient, know they will lose some but overall come out ahead because they play the game and play it well.