Four Lessons From a Recovering Value Investor

My friends often ask me if it was hard making the change from being a value investor to becoming an early-stage startup investor.

I reply with a shrug and two words: “What change?”

They think I’m kidding. I am just a little, but not as much as you’d think.

At first glance, value stocks and companies just getting out of the gate have little in common.

Value stocks have track records. Their growth and profitability is subject to analysis.

Not so much with startups. What these pups offer is POTENTIAL.

“Potential” breakthrough technology, products or business models…

Potential isn’t a concept value investors use. Actually, it’s pretty much a dirty word.

As a value investor, track record trumps potential… ALWAYS.

I used to look for companies whose prices were skewed much lower than they should have been when compared to sales, profits, cash flow and net asset value (among other metrics).

When I do have metrics to analyze these days, it feels like old times. Granted, the numbers are different – lifetime value, churn rates, conversion rates (to upselling), customer acquisition cost.

But the feeling of arriving at insights through number-crunching is still exhilarating.

Early-stage investments typically highlight a few of these numbers, but not always. Often they’re pre-revenue and pre-final product. When they do have them, they don’t go back that far. Patterns are difficult to discern. Hard and fast conclusions very rare.

Old-Fashioned Value Investing vs. Newfangled Early Investing

I’ve had to develop a different skill set. With that said, I’ve also found myself leaning on my past experience as a value investor more than I anticipated. Much more.

Some of the reasons why:

  • Keeping the herd at a distance. It’s at the heart of value investing. You won’t find bargains with companies whose hype is drowning out rational analysis. There’s a similar dynamic in early investing. The market or technology that’s killing it today is irrelevant to your timeline. Rather, it’s the technology/market/business model that will be coming into its own two to 10 years down the road that counts – 3-D printing, marijuana-related products and Google-like glasses (augmented reality) are good examples. They’re in a bit of a lull these days. But I think all will become forces to be reckoned with. It’s just a matter of time.
  • Less tied to present macroeconomics. A global slowdown? Sluggish stock market? Threat of deflation? Bubbles bursting? Value investors often get lower prices in such an environment. Early investors also get better prices and terms. And the upside remains fully intact. By the time these startups are ready to scale (or consider an IPO), today’s economic storms are ancient history.
  • Time and patience. In both investment realms, it takes great patience and many years before you see any rewards. The psychology of the market has to change to recognize the true value of an underpriced company. That could take years. Likewise, a startup needs several years of development before it has “made it.” In either case, the payoff makes the wait worthwhile. (More so, however, with startups!)
  • Thriving vs. surviving. The better value companies have lower costs, bigger margins and higher efficiency than their peers. When the going gets tough, they tend to outperform. For early-stage startups, the best ones aren’t trying just to survive an economic downturn. They will be taking advantage of some of their competitors dropping out. Picking up the talent that will be available. And even buying startup companies selling cheaply under duress.

Been There, Done That

As a value investor, I’ve lived through several bull/bear cycles. I’ve seen that bulls don’t last forever. Neither do bears.

This is certainly no time to panic. Listen, I don’t want the markets to crash. I’m not rooting for the economy to tank. But, without a doubt, this is a great time to be an early-stage investor.

The only two numbers that should matter to you is the price you buy and the price you sell. As early investors, we could benefit at both ends. Young startups are getting lower valuations. And the better ones will be positioning themselves to take advantage of less fierce competition.

As a former value investor, this feels like going home again.

All in time for the launch of equity crowdfunding in May…

Invest early and well,

Andrew Gordon
Founder, Early Investing