As the saying goes, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know”. Recently, we have been seeing plenty of the latter kind, garbed as analysts, Unicorn founders, freshly-minted CEOs and “experts” as they engage in modern-day snake oil salesmanship, which is what passes for fundamental equity research these days. The difference between making forecasts and predictions is the difference between a rational investor and a soothsayer.
Today, some companies and analysts intentionally use a different set of rules. A new jargon-littered language has been invented and enthusiastically adopted by the investing community. Some of the words or phrases being used (and over-used) these days could cause confusion. Let’s look at a few.
TAM (Total Addressable Market)
When I started my career as an analyst 20 years ago, the key trying to forecast what might become of a business over the long-term (five to 10 years) was to understand the market size of any product or service; its growth potential, assessing why certain businesses in that industry were doing better or worse than others, evaluating management quality and figuring out the alignment (both financial and cultural). However, it appears that analysis is now captured in one acronym — “TAM” — which the companies are providing to analysts and they, in turn, end up using it to justify almost everything — from the current small scale of the business, low margins, an unfeasible sales/marketing strategy and an inflated valuation.
I used to think that, for a young business, one needs to see if it is able to generate a positive contribution margin to cover some of its fixed costs and then calculate how long it would take to achieve breakeven. But in the “free money” era, the term has become convoluted, as analysts are rewarding businesses who don’t want to do any of that. Customer Acquisition Cost is the new buzzword, and Unit Economics have been reduced to some sort of distortion aimed at justifying massive upfront costs. We used to look at fundamentals: how much a company is spending on sales and marketing, and the mix of short-term promotions and long-term advertising, how the sales team was organized, their incentive structures and the preventive measures to avoid mis-selling. Nowadays, that seems like a primitive way of trying to understand basic unit economics.
“What is your value proposition?” is what analysts are asking companies these days. Isn’t that something the analysts need to figure out by themselves? By all means, they can ask the management for their views, but regurgitating those same views without much critical reasoning is pointless. What is it that enables a company to generate superior ROCEs and what makes its growth and returns sustainable? It could be many elements - a brand, technology, licenses. But what I have been hearing (and what is often not said) is that the only value proposition which many of these new businesses have is access to unlimited funding.
A surprising number of management teams we meet these days are hard at work pushing “flywheels” as they attempt to defy the gravity of flawed business models. The term was made popular by Amazon as a way to describe the virtuous cycle that is created when a whole business model is aligned to offer a remarkable customer experience. The term now is being used to create a remarkable IPO roadshow experience, which some analysts are lapping up.
Path to profitability
Another recent favourite. By brewing a concoction of TAM, value proposition, unit economics, with some flywheels and pivots along the way, the modern soothsayers are able to discern a “path to profitability”.
I have heard this word more in the last 12 months than ever before in my life. Companies are desperate to tell analysts their pivots in life and they are pivoting quite often to the next fancy thing, which salivating analysts are gobbling up as it helps them see the “path to profitability”. I am not sure if even Hercules knew so many pivots existed. As more and more people are pivoting away from common sense, our team is resolved not to pivot away from our (admittedly) boring way of investing. We have been through these manias before and now, more than ever, we must be vigilant. Our goal is to keep it simple — to preserve our clients’ capital and grow it steadily by investing in good businesses, run by good people, for the long term.
Vinay Agarwal is a director at FSSA Investment Managers