Wednesday, January 12, 2011

The Gorilla Game by Geoffrey A. Moore

I have a bizarre passion for reading investment books that were written for past market cycles. I suppose I like the humiliation of it--it keeps me humble and helps me remember the fundamental truth that investment styles that look brilliant at one time can quickly destroy your wealth at other times.

It also helps me maintain an attitude of contrarianism and cynicism in my investing. I almost always avoid or trade counter to strategies that I consider trendy, overly popular, or too widely embraced by other investors. Ironically, this has turned out to be one of my most dependable strategies for staying alive in the stock market over the past 15 years.

Thus it is with a deep sense of irony that I say this: The Gorilla Game is exactly the kind of book that would have crushed you if you read when it was published, but it might be a perfect time to apply the strategies in this book right now.

The thing is, books on investment strategies tend to come into the marketplace exactly when their strategies are about to go stale. This happens for a variety of reasons: the investment style may not get widely disseminated or understood until too late in the game, the lead time for publishing books tends to be long, etc. And when this book was published in mid-1998, you had just about one year to try to take advantage of an investment strategy that was about to go horribly, horribly wrong.

It's a bit sad, because there's a lot of wisdom in this book's key general principles:

1) Look for industries that are in or about to begin a period of hypergrowth. Identify companies that provide new products or services that can bring about a sea-change in how companies do business, where new supply chains and new spending cycles can bloom quickly and create enormous economic value.

2) Find the dominant players in these spaces, first by making field bets on all the stocks in that space, and then gradually concentrating on the few dominant players once it becomes clearer who has the best competitive position.

In short, your job as a follower of this strategy is to identify hypergrowth markets and then identify the gorillas in those markets.

Here's the problem: the stocks that were in apparent hypergrowth back when this book was published were all in technology. In fact, reading through the types of stocks the authors trafficked in is deeply horrifying: large, dominant tech companies with stocks that absolutely cratered during the tech wreck, like ORCL, CSCO, INTC; or worse, tech stocks that totally disappeared, like has-been telecom names such as PairGain, Cabletron, Ascend, and so on.

And of course the authors cited the usual monster stocks of the 1990s as conclusive "evidence" of the success of the strategy: MSFT was a two-hundred bagger! If you had invested $10,000 in CSCO in 1990, you'd be sitting on $1,285,000 now! Ugh. Another horribly rich irony. The fact is, if you had picked this book up sometime in late 1998 (again, the year it was first published), and had then invested $10,000 into CSCO say in early 1999, you'd now have... $7,200.

Yep, buying one of the most dominant gorilla companies of all time would earned you a 28% loss after twelve years. Nice. And heaven help you if you bought CSCO in early 2000--you'd be down by 66% and you'd need to have a triple just to get back to even.

The irony gets worse. The authors claim that this process of focusing on the dominant players in each sub-industry of tech provides investors with limited downside. That obviously did not work during the 2000-2002 bursting of the NASDAQ bubble. While I'll admit that the downside for dominant stocks in that era was less than the downside of stocks like, this provides an exceptional example of how investors almost always fail to appreciate, in advance, the nature of the risks they face. The risk to these investments wasn't in the survival or dominance of the gorilla companies, it was in the egregiously high valuations of their stocks, and the demented expectations for growth that investors had banked on when they bought those stocks.

Thus you would have had your face ripped off and handed to you if you had followed this strategy right after the book was published. Like I said, the market is cruel, and from time to time it can make even really good strategies seem really, really dumb.

But when you read books like these out of their cycle, years after they were designed to be used, they often provide far more value--and far more profit. A reasonable and logical strategy that failed laughably in one era may work extremely well in other eras.

My point? This book and its strategy are perfectly suited for right now. Tech is out of favor and underowned by almost all investors, and valuations are attractive for nearly all tech stocks. Further, tech is widely seen as a low- or no-growth at a time when there are legitimate and underappreciated growth prospects in many tech subsectors. I'll leave it to you, readers, to find them.

Stay cynical my friends. The market has a cruel sense of irony. Take advantage of it.


MacMillan Hodges said...

Have you seen an example of a book with a strategy valid at the time it was written?

Daniel said...

Yes. I'd say Jim Cramer's book "Getting Back to Even" is one example. I'm sure there are others. But we'd probably both agree they're the exception, not the rule.


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