Against the Herd: Value Investing & Internet-Related Businesses

As an investor I believe value investing is the only kind worth any trouble, that highly concentrated portfolios provide an advantage, and that time horizon should be massively flexible with a long-term focus. Generally, however, I find that these principles are rarely mentioned in the context of investing in Internet-related businesses or other technology-focused sectors. For that reason I enjoyed a recent article in Barron’s that profiled Mario Cibelli, the founder of Marathon Partners. According to the article, Cibelli “likes companies with disruptive, usually Internet-based business models that have the potential to change industries.”

Lately, the press would have you believe that if you are investing in disruptive Internet-based business models with the potential to change industries you are buying in at high valuations. This touches on a theme I mentioned not too long ago, identifying an area of interest and then waiting for the right buying opportunity. The article provides examples of how Cibelli does this quite well:

The best example is Netflix (NFLX), which Cibelli bought for $10 a share in late 2004 and sold for $100 in late 2011; he repurchased it in 2012 between the mid $60s and high $80s and last year sold it for more than $200.

In addition to being patient in a space where it is perhaps more difficult to avoid “herd mentality,” Cibelli also defines his valuation approach without mention of metrics like the number of users / exchanges per day / etc.

To figure out what a stock could sell for in three to five years, he calculates its enterprise value, at times varying his metrics. Although he usually bases enterprise value on earnings before interest, taxes, depreciation, and amortization (Ebitda), he will use free cash flow or earnings before taxes or revenue if he believes that’s more appropriate. Then he adds excess cash and subtracts debt. Next, Cibelli works with his two full-time analysts to estimate how fast the company’s earnings or cash flow will grow in coming years. That lets him estimate the future enterprise value per share. Then he applies a multiple that he believes an outside investor would pay to own a fast-growing, well-run business.

I realize that is fairly straightforward. For those new to investing, I included it because the passage is a well-written concise summary of an approach to valuation. If you are experienced then maybe it’s just reassuring to hear that not everyone is paying millions / user for apps with no revenue to speak of.

My favorite aspect was the way Cibelli responded to portfolio concentration and volatility. In this space (Internet / Tech) the idea of investing small sums in a plethora of up and coming ventures is what comes to mind most immediately. But Cibelli has 50% of his assets invested in just 5 companies. His response to the volatility realized on account of this approach resonates strongly with me:

“ But if you are long-term-oriented, the volatility is not that important.”

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