Optionality: The Key to Antifragile Investing in the Tech Age
The world promised us jet packs, flying cars, disintegration, and hoverboards (that actually hover). Instead, all we got was 24/7 access to work emails, distorted views of reality from social media, and fake news. That's how some people see the state of technology. While not entirely wrong, it’s a very pessimistic view and demonstrates how poorly we predict the future.
Innovation drives economic growth, but it's seldom the innovations we see coming that change the world. It's even harder to identify companies that will emerge victorious in developing and scaling disruptive technologies.
Instead of selecting investments solely based on the development and commercialization of one innovative technology, look for companies optimized for optionality — that is, the ability for a company to generate additional revenue streams based on their current business success.
In essence, optionality creates new investment opportunities from previous ones.
Nassim Taleb, the author of the book, Antifragile, wrote:
“An option is what makes you antifragile.”
Antifragile companies can survive, even during times of utter chaos.
To simplify this concept, let's consider a fictional company with little optionality, One Co. Imagine they produce a specialty widget sold exclusively to one automaker. Their entire revenue relies on continued purchases by that customer. Should something happen to that automaker, the widget-maker is in big trouble.
It's not only troubles with the customer that could derail One Co. If the auto industry is disrupted, as we're seeing with the emergence of electric vehicles, their widget may become obsolete. If One Co. isn't prepared to pivot, they'll vanish into the abyss of failed companies.
What if their customer decides to vertically integrate and produce the part themselves to lower their costs and increase their profit margins? Disastrous. If One Co. wants to thrive in the future, they might want to start thinking about building on their existing success.
It's easy to see that a company with few options and numerous risks might not be an ideal long-term investment. On the flip side, let's see how optionality can be an X factor.
You're probably familiar with Amazon — you know, the online bookstore. It's comical to think of Amazon as a book retailer today because we know the behemoth they've become. Not only did Amazon branch out from selling books to damn near everything — they've also created new businesses, most importantly Amazon Web Services (AWS).
How did an online bookseller become the largest e-commerce marketplace and a cloud computing giant? Optionality.
In the early days, Amazon was a first-party retailer. They bought goods and resold them at a higher price for a profit. Amazon still has a first-party retail business, but their business boomed when they allowed third parties in on the act, becoming the world's largest marketplace. That pivot was one example of optionality in action, but not even their most famous.
In the early days of internet commerce, Amazon leadership recognized a problem — there wasn't an effective and affordable way to store data online. The internet was growing a warp speed, and companies were using more and more data to operate their businesses—eventually, even small companies needed server space, a significant burden for companies with few resources.
Realizing that the internet was experiencing exponential growth and correctly predicting that many businesses wouldn't have the know-how or the resources to manage their own storage solutions, Amazon created what would eventually become part of their suite of cloud tools, AWS. In 2021, AWS generated over $62 billion in revenue for the bookseller. Not too shabby for a bookstore.
Consider Amazon's path had Jeff Bezos's vision stopped at selling books? They'd be competing with brick-and-mortar bookstores and countless online bookshops. While they'd likely be successful, they wouldn't be the Amazon we know (and both love and hate) today.
How do you find optionality?
Understanding optionality is one thing; identifying it is another. You won't find optionality listed in a company's profit and loss statement or balance sheet. Most people view investing more science than art, but in a field lacking creativity and originality, thinking outside the box can go a long way.
Leadership: some leaders are focused on not sinking the ship. Other leaders are creating a fleet of the most innovative ships at sea. Coasting and thriving are two different objectives, and leaders that have an unrelenting drive can propel a company in good times and bad. Steve Jobs, Jeff Bezos, and Elon Musk are all known for their steadfast commitment and unwillingness to settle. Look for companies with leaders whose ambitions are bigger than their net worth (ironically, these folks often end up at the top of the net worth list).
Mission Statement: Tesla has the best mission statement of any company I know of: "to accelerate the world's transition to sustainable energy." Short, understandable, and powerful. But do you notice anything missing? The mission statement doesn't say anything about cars, despite being known predominately as a maker of electric vehicles. In just eight words, Tesla managed to say a whole lot. "To accelerate" implies forward movement, not stagnation. "The world's transition" means the disruption of the entire global market, and "sustainable energy" demonstrates Tesla's commitment to thinking bigger than vehicles. A company culture of thinking big can lead to an array of options in the future.
Employees: being innovative and flexible requires more than a strategic vision and a strong leader. It requires creative employees with a knack for problem-solving and a curious mind. Top performers like to work with like-minded people, so the world's best engineers are attracted to a small number of magnetic companies. If you can find out where these problem-solvers congregate, you have a good chance of finding a company with the intellectual capital to generate optionality.
Optionality is Not a Substitute for Fundamentals
Optionality is an X factor, not the only factor. Countless companies have failed despite having abundant options and a thirst for innovation because they lacked the financial capital or other resources to execute. In a quest to find antifragile and innovative companies, optionality is worth exploring, and it could prove to be very rewarding when you find it.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from James Vermillion, and all rights are reserved.
