Almost every day I am presented with numerous public and private equity opportunities. I examine each to understand what might be superior regarding their business. What I quickly learned in my career is that many of these opportunities tend to have an exciting story. Some have high revenue growth rates or new products, and some trade at low multiples but have deteriorating operations. Consequently, we created a psychological framework to sparse through ideas.
We have two motto’s toward investments to maintain a discipline:
1) "Defense is the best offense"
2) "it's either a heck yes or it's a heck no"
With over 14,000 publicly traded companies and the availability of private investing, there are so many directions for individuals to invest capital. Compound that with superficial excitement created through social media, CBNC, and other outlets, it is very easy to get caught up in an industry's hype (i.e. 3D printing, cannabis, crypto, autonomous driving, virtual reality).
Let's look at a controversial segment today, the cannabis (marijuana) industry.
The cannabis industry is generating a ton of hype due to the eventual legalization across the country. Forbes published an article projecting the industry sales to hit $57B within the next 10 years. I must admit, those are very large numbers and something to get excited about. Nevertheless, we have seen this story before in other industries and specifically other segments of commodities. As the cannabis industry develops and regulations weaken, competition will become fierce, eventually cutting into margins across the industry. For example, Bunge LTD is a publicly traded global agricultural business with over $43 billion in revenue with a focus on grains, sugar, and oil seeds. Bunge has over 60,000 farms, controls its operations horizontally, and has great scale for defending competition. However, even with this level of economic scale, Bunge has averaged less than 2% profit margins since 2000. Therefore in a commoditized industry such as cannabis, for investment purposes it is important to find the areas which have the highest barriers of entry and say no to everything else.
Here's another example for you. Uber (which is private) has taken the globe by storm and now sports a valuation of $49 billion based on its latest funding round. This is down from its peak valuation, which was closer to $80B a year ago. Here's what I said a year ago,
"The initial growth and the visibility by consumers has created what I would consider a bubble-like valuation. Here's why... Uber generates roughly $4 billion in annual revenue. So already a new investor would need to pay 17.2 times sales. On the bottom line, Uber generates a whopping negative (yes negative) $2.4 billion. This lack of profitability has much to do with increased global competition, low barriers of entry, and a reduction of transportation regulations. So, Uber it’s a “heck no” as an investment opportunity at this valuation, despite all the hype. "
At Avory we take a concentrated approach to investing and seek out only those businesses in which we believe can generate sustainable growth and maintain margins for years to come. This discipline means saying “heck no” to most investment opportunities that cross our desk, and “heck yes” to only the very best.
Have a good one!
Sean D. Emory
Avory & Co. Founder & Chief Investment Officer
Disclaimer: This is not a recommendation for purchase or sale of any securities.
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