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The Tipping Point!

|Includes: Apple Inc. (AAPL), GILD

When discussing an investment in BEV (Battery Electric Vehicle) technology on a recent SA article about Tesla TSLA, I asked a question to one commenter, "No one wanted a BEV except the most ardent environmentalist - then Tesla comes along and lots more people want one. I've wanted a hybrid for a while and when I could finally get a luxury car (not a Prius) that performed the way I wanted - I bought one.

In the end, both BEV and hybrid will save the owner money in the long run. I plan on owning my Lexus for 10 years. Even at today's gas price, I will save $18,000 over the decade just in fuel. I'm guessing Tesla's save more, which would have quite an impact on TCO (total cost of ownership).

As an investor, being too early or too late never works. Investing at the tipping point (like AAPL) in 2007 at $12 just before the iPhone is usually the best place to make money. Prior to that the company went from about $5 to just $12 in 30 years (split adjusted?).

So my question is - are we there yet? Is 50,000 BEVs enough to consider the technology far enough along to be considered mainstream in the next 3 - 5 years? Clearly the current shareholders have bid the price even higher than what Elon himself thinks it's worth and without batteries coming off the Gigafactory line, I'm guessing that we are still quite a ways from any tipping point where BEV becomes mainstream."

I realized that after I wrote this that it may be a good investment thesis and sought to prove it out. In my example of AAPL, it was really the introduction of the iPhone that has taken the world by storm. Smartphones have moved from innovation to staple in just seven years. For those that don't know, the iPhone was invented in 2007. It revolutionized the mobile phone business and made the company the largest market cap company on the planet.

This snapshot of AAPL from Google Finance shows the 25,000% return.

What is a tipping point?

Webster's dictionary defines tipping point as : the critical point in a situation, process, or system beyond which a significant and often unstoppable effect or change takes place.

The tipping point, as an investment thesis, is not when a product is invented but rather when a product reaches a point of distribution where it becomes the standard of choice. This process of reaching a tipping point starts with an invention, fine tuning the engineering through bringing a product to market and then market acceptance to replace whatever happened before. This process has happened in virtually every product we use today from horse drawn carriages to cars, from walkmans to iPods, from phone books to Google search.

Test the thesis!

It is not difficult to look at significant companies today and their history to see when the best time to buy might have been. Microsoft started in 1975, just one year before Apple. While not as dramatic as AAPL, the results are still impressive. You can see for yourself when the company started and when the stock price started it's meteoric rise. For those old enough, you will remember Windows 95.

Windows 95 was a watershed product for Microsoft, but also for computing in general. Microsoft sold 10M copies of the predecessor version Windows 3.0 in two years. Windows 95 sold 7M copies in only five weeks.

Future Tipping Points.

One company that I own is Visa V. I've only owned it for one year and my returns are north of 50%. It usually makes me nervous when a company stock price rises this fast, but when you step back and take a look, what do you see?

While not quite as dramatic as either MSFT or AAPL, it looks like V has been a great investment since it's IPO in 2008. You could have bought this company at any time after the IPO and it would have been a good investment. I contend that for companies that produce a product that creates a tipping point, there is plenty of time to start and grow your position.

Another household name, Google GOOGL began in 2004 at $85 and for the most part has only gone up.

There doesn't appear to ever be a bad time to buy the next best thing. There are definitely some ups and downs in all of these examples, but for these firms the end result of a rocky ride is up.

If the tipping point is the best time to invest - when does that occur?

Many companies are already underway when they go to public markets to raise money and monetize their earlier investments. But not all IPOs are the best investments.

Here's a good example of where the hype didn't match the actual performance.

Buying a company when it first goes public doesn't in any way guarantee success. Here's another example.

You can see the decline right after the IPO and then the quick leg up to the current price of $80. But is it too late to invest in Facebook FB? The question remains - is it at a tipping point?

What does a tipping point look like?

A tipping point follows a pattern where there's a large move in adoption in a short time frame. It looks like this.

But this movement isn't necessarily the stock price. A tipping point is when the "product" that the company offers get widespread market adoption. In the case of FB, the market adoption was very quick and they reached a billion users within a few years. Will that growth continue? If so, then we are only getting started. If it's peaked then it may not make a good long term investment.

GILD is another company that I own. Gilead manufacturers drugs in the biotech space that address critical illnesses such viruses. Much of our current medical advances have been in fighting infection with antibiotics and daily pill regimens for everything from headaches to heart attacks. Gilead GILD has recently invented a cure for Hepatitis C - or Hep C or rather acquired a smaller company that invented the cure.

Here's their chart.

You could have purchased shares in this company at any time since 1992 and done well, but look at what happens after early 2012. Sovaldi was released in 2014 but many knew that they were working on it in 2011 and 2012 with the acquisition of Pharmasset. Note that the market didn't realize what was happening until the product was close to release. And you could have bought the stock at any time up to now and still done quite well.

My initial conversation was about Tesla TSLA. Here's the stock over the entire history of the company.

While it's not clear to me the Tesla will be the absolute winner in the BEV space, it is very clear to me that we are quite far from a tipping point in market acceptance of electric cars. Tesla the company is clearly not profitable - losing money on every car. While this is not unique in business, it's a lot harder for shareholders to do well over time because the current shareholders will almost certainly face capital raises to fund growth, in my opinion. This is very different from all of the other examples above.

A company that is at a tipping point is one that is profitable with every sale. So like GILD, AAPL, GOOGL, V and others they fund their own growth through profits. You can clearly see that TSLA has not gone "parabolic" or "meteoric" just yet. It was flat for a few years and it's early success may have gotten ahead of itself. While it looks to have regained it's footing, it's success is far from assured.

GILD stock performance has done the same thing. It's success in the market was not guaranteed and the stock fluctuated between $85 and $115 for a long time, only recently haven broken out of that pattern as news of it's overwhelming success in the market filtered out. It's market share in Hep C cures is over 90%.

Picking future winners.

Products that have reached a tipping point in our lifetimes abound. Not every one of them makes a good investment. There are some common characteristics that I look for in companies which I invest:

1) Long operating history of success - maintaining a lead is difficult and nothing is better than experience.

2) Strong capital position from which to execute - many new companies run into cash flow problems due to rapid growth.

3) Positive cash flow - nothing kills a company faster than running out of cash. Just look at shale oil E&P players in 2015, even though the process they use is revolutionary, it doesn't mean that it is always a good investment.

4) The company profits are made from more than one line of business, but not more than a few. Focus is very important and concentrating your operation on a few strong things provides balance without diluting focus.

5) Trading a low PE for the next 3 - 5 years. While we often think that the world changes quickly (and it does), it rarely happens overnight. Credit cards have been around for decades, yet Visa V only became available as an investment in 2008. While the absolute level of PE is not as relevant as the forward PE, many stocks trading at 300x PE after IPO don't become good investments. The investment still has to make sense financially.

6) Share buybacks - returning capital after hitting a home run should be easy for companies that lead their industry. Reducing the share count leaves more earnings for shareholders when shares are canceled at fair value or below. The simple fact of reducing shares on it's own may not work, but I have found it to be a good use of corporate funds when the market doesn't agree on the company value.

7) Better to be early than late - investing is hard enough, but competition can be brutal. Every investor wants the same thing, so a company that is recognized as a tipping point is often priced beyond reasonable value e.g.: AMZN or NFLX. Information is shared around the world as easily as next door and many companies are bid up beyond any reasonable investment opportunity because of the next fad. Many of the best companies today actually suffered a bit after their IPO. There's a big difference between a company inventing something and it's product reaching a tipping point.

Using these criteria, I have selected the following as research candidates for investment at their current price.


Disclosure: The author is long QCOM, GILD.