Why Tech Stocks Are “Win-Win” Situations

“Technology made large populations possible; large populations now make technology indispensable.”

– Joseph Krutch

investing in tech stocks

These young geniuses pocket enormous sums of money by solving seemingly intractable problems. Rather than simply poaching market share from older companies, they use technology to create win-win situations, thus opening up new spaces of commerce.

They are the “creative” part of “creative destruction,” yet the sight of them can stir feelings of panic in the average investor.

“Why them?” says a little voice in the back of our heads. “Why not me?”

While envy is the easiest road to walk in such cases, this article offers (or at least I hope it does) a different path. The first step in walking this path is to accept that young Pimple-Faced Geniuses (PFGs) are a good thing. Not just for society at large, but for YOU as well.

It may seem a little strange at first, because we are raised to think in zero-sum terms. From our earliest days, we are told that success is finite—that if your slice of winning gets smaller, someone else’s must have gotten bigger. It’s a very seductive way of looking at the world, and, to be quite honest, it’s often true.

As someone who played competitive sports throughout their childhood, I understand what it means to crave victory.

No amount of purple “Participation Trophies” quelled my fury at losing a basketball game. Nothing erased the naked truth that I had lost (on the rare occasion that I did). The very idea of “Participation Trophies” was an insult to my competitive spirit! Winning was the only redemption.

But part of growing up is realizing that what’s true in sports is not necessarily true in life. The real world is full of win-win situations, especially where technology is involved.

Example #1: Netflix, Inc.

Netflix, Inc. (NASDAQ:NFLX), for example, managed to add new value to the television industry. Over 104 million users flocked to its streaming service in the last decade, hungry for its all-you-can-watch buffet of movies and TV shows.

Collectively, these subscribers watch one billion hours of content every week. One billion hours a week. Videos load without a second of advertising or buffering, giving customers an uncomplicated viewing experience that they didn’t realize they were missing.

It’s light years ahead of traditional television, which begs the question: why did networks and production studios allow Netflix to exist in the first place? They could have starved Netflix of content licenses if they wanted. So why didn’t they?

It wasn’t like Netflix appeared overnight…Reed Hastings founded the company in 1997. Netflix climbed its way into relevance over a decade, shipping DVD rentals right to your doorstep. Any TV executive worth their salt knew it would become a powerhouse in television.

Yet they did nothing…Why?

The answer is unoriginal. Networks and studios did not attack Netflix because it would have been against their financial interests. So long as Netflix continued paying for content, it was a customer, not an existential threat.

Imagine if a local butcher refused to sell meat to a new restaurant. Even if the butcher had an existing relationship with another restaurant, it would be idiotic for him not to expand his clientele.

Those kind of mistakes aren’t made in the big leagues, which is why Hollywood studios opened their backlists to Netflix. They go where the money is.

Considering that Netflix is spending $6.0 billion to acquire content in 2017, and the bulk of that goes to major Hollywood studios and development companies, it appears to be a very good customer. Plus, movies that underperform at the box office get a second life on Netflix, increasing the odds that they’ll “earn out” their budgets.

So it’s hardly a surprise that TV executives looked the other way. To them, Netflix was an additional buyer that had carved out its niche from thin air.

“We’re a big fan of Netflix,” said CBS Corporation (NYSE:CBS) President Leslie Moonves. “We don’t think they’re eating the world.”

Skeptics might argue that Moonves is only saying this to keep his investors calm, but he has no reason to lie. CBS’s advertising revenue was up eight percent in 2016 (the most recent full year at the time of writing). That counts as a win for CBS.

Meanwhile, Netflix continues to add subscribers, revenue, and gains to its share price. That counts as a win for Netflix. And the ability for two wins in a single transaction is what makes technology special.

Below is a chart showing the performance of NFLX stock and CBS stock over the last 10 years. It demonstrates exactly what I’m talking about.

Chart courtesy of Stockcharts.com

Chart courtesy of StockCharts.com

You can see that Netflix stock far outstripped CBS stock. However, investors would still have doubled their money on CBS, which would not have happened in any other industry. History is full of exactly the opposite.

Zero-sum transactions, where one group rips wealth from another group, was the norm. But technology increases the pie rather than just shifting the portion sizes, making it the only opportunity for growth in a world of scarce resources.

But if you’re still not convinced, consider the quintessential Pimple-Faced Genius: Mark Zuckerberg.

Example #2: Facebook Inc

The story of Zuckerberg creating Facebook Inc (NASDAQ:FB) in a college dorm is now more than legend—it has passed into cultural mythology. However, the trouble with mythology is that it often rewrites history.

We forget, for instance, all the raised eyebrows at Facebook’s $1.1-billion acquisition of Instagram. FB stock was mere months away from its initial public offering when Zuckerberg decided to offer his competition the carrot instead of the stick. Investors did not look upon the deal with a kind eye.

They viewed it as the reckless actions of a young CEO in over his head. And so they punished Facebook stock in its opening months. Too bad Zuckerberg turned out to be right.

Instagram is now the second largest social media network in the world, after Facebook, of course. It provides a younger, more status-conscious segment of the public to Facebook-the-company, which obviously leaves advertisers salivating for access.

Although Facebook doesn’t segment its revenues by app, it seems likely that Instagram more than earned back its acquisition price. There is a robust economy around Instagram that includes content marketing for health products and luxury items. Another side-effect was that we learned not to doubt Facebook’s young CEO. He knows what he is about.

In creating Facebook, though, it’s not clear that Zuckerberg was “taking down” an existing industry. There were forerunners of social media, like MySpace and Friendster, but they fell apart for other reasons. In this example, technology created an entirely new industry where none had previously existed.

Once again, this is a feature that is exclusive to technology companies, and it pays extraordinarily well. Just look at FB stock’s incredible run over the last five years.

FB_all

Chart courtesy of StockCharts.com

All this is by way of saying that technology investments are unique. Economists speak often and loudly about how technology is the key to national productivity, which in turn is the only fuel for economic growth in advanced nations. These two facts are connected.

A new company replacing an old one does nothing to expand the economy, therefore its use to investors is limited. On the other hand, tech stocks like Facebook or Netflix create value where there was none before, giving us dramatically more upside.

Pimple-Faced Geniuses have a knack for working out these kind of problems because, well, they are geniuses. Little Zuckerbergs flock in droves to Silicon Valley from across the world to seek out funding for their ideas. If ever they reach the public market, we should continue to pay them mind. They are our ticket to the future.