My stock buying process

Market Share

First, I like to see a company’s market share above 50%.

Market share is a company’s sales divided by the total sales of the market it competes in.

So at least $1 of every $2 dollars customers spend in a category is spent with a single company.

This is a good sign that the company understands their customers and is delivering a product that their customers really want. Dare I say even love.

Let’s explore some examples.

Apple has over 50% of the premium smartphone market share in the United States. Premium is defined as people buying phones that cost over $600. Those phones often have better cameras, bigger screens and bigger batteries.

Another way people try to look at the smartphone market is all smartphones in the US or even all smartphones globally. I don’t think that way because customers don’t work that way. A person in the US who makes $200,000 a year doesn’t look at the same phones that a person who makes $40,000 annually does. Further, a person in Africa looking at smartphones who makes $9,000 a year is not the same as a person in the US who makes $90,000 per year.

Another example would be when Amazon was just a bookseller. In the late 1990s, Amazon owned 70% of all the book sales online. I did not worry about their market share of the overall book market. I knew based on how many books I bought I did not go to the store because they would not have the books I was interested in and even if they did it would be 30% more expensive. Amazon captured more than $1 of every $2 of web-based book sales.

One last example would be Tesla’s market share of fully electric vehicles in the US. In 2018 Tesla introduced the Model 3. The Model 3 was their less expensive, mass market car. It cost 40% less than their best selling model, the Model S. With its 3 models, Tesla collected $8 of every $10 spent on electric vehicles in the United States.

I was not focused on sales in other countries. And I considered hybrids like the Prius a gas car because they still required gas.

Market Growth

Second, the market each company is in has to be growing rapidly and that growth could continue for ideally two decades.

During the decade after the introduction of the iPhone, Apple went from selling 10m units a year to 200m units a year, nearly 40% growth year after year.

During the second decade of Amazon’s growth, it was growing 30% year over year.

During the years after Tesla introduced the model S, the market was growing 50% year over year for a decade.

The trick here is that the human brain can’t do compounding multiplication without paper. We aren’t even good at estimating the answer.

If a company’s market or revenue grows at 40% growth for 10 years, it is 29 times bigger. So all other things being equal if you put in $100,000, you have $2.9 million 10 years later.

If a company grows at 40% for 20 years it is 870 times bigger. So all other things being equal if you put in $100,000, you have $87 million 10 years later.

If something grows 29 times bigger over a decade it doesn’t matter if the stock is priced two times higher than it should be. You’re still going to have a chance of making 15x your money.

In essence, the growth potential simplifies the overall investment equation.

Now there are real complexities to understanding long stretches of extreme growth. It is insanely rare and hard to grow at those rates. Even small mistakes tend to multiply and spread very quickly when a company grows rapidly without breaks.

Critical Bottleneck

Solely based on these first two conditions, the beverage market would produce several great contenders. Starbucks, Red Bull and Monster all met these criteria. Unfortunately, I have zero intuition for things like coffee or energy drinks.

Often winners in this category are partially determined by distribution and I don’t understand how beverage distribution works either in the United States or globally. Distribution is the critical bottleneck to success.

I like markets where technology is the critical bottleneck of the business. The product itself does not have to be technology. For example, Amazon sold books but technology was how they handled and fulfilled orders.

In the world before AI, it was very hard to hire and manage elite, large engineering teams. At any one time, there were only a small number of places that were attractive for engineers to go work at and I have the background to watch YouTube videos of the senior leaders and tell whether they are likely to be able to do that well.

This essay builds on a recent essay about selling stock.

In future essays, we will talk about portfolio sizing, when to exit a stock and a variety of other topics.