When I evaluate companies for my US portfolio – which consists only of tech companies that I think I understand – I am forced to think of how many companies I want in my portfolio. There are quite a few good bets. But adding too many of them dilutes individual holdings without adding much by way of diversification. As things stand now I’m pushing myself to think harder about my thesis – which we have written about before – so I can split it into two portfolios. Perhaps we will write about this as and when this pans out.
In this regard, at one point I was thinking about whether the portfolios would naturally align by size of company: one with older, more established companies like Apple or Microsoft. And the other with newer ones like Twilio and Square. Of course, this is lazy. In the economy at large age, size and stability are all mostly positively correlated, lending themselves to large-cap and small-cap fund strategies.
But they are anything but in tech. Network effects are much stronger and available to a lot more companies than in other sectors. Barriers to innovation by startups are much lower and switching costs for people are low, meaning disruption is vastly more common. Also, acquisitions of such companies by large companies for IP, talent and/or customers happen often, at very high valuations. And speaking of valuations, they can soar even for public companies, making them larger than much older competitors.
This may not always hold true in the future. Over time there are platforms emerging in many areas that are controlled by older, larger tech companies. Amazon’s AWS, Google’s Cloud Engine and Microsoft’s Azure for building internet applications are well known. Apple’s device-first strategy of building a platform around health and fitness (Fitness+) is less obvious. Platforms like these raise the barrier for newcomers. But we have also seen such platforms fail or die out – Facebook’s applications platform is one such. Its decline took along with it entire public companies like Zynga.
It’s exciting watching these platforms emerge and investing in companies that dominate them – for instance Cloudflare is building a new platform for the Internet that’s a lot more small-business-friendly and privacy-conscious. And Shopify is building a platform that gives merchants an independent presence online, unlike the Amazon model which subsumes their identity.