"Above 30%, the market doesn't value growth."
The Idea of the Week, from David George
To ring in the new year, we’re launching a new weekly series: the Idea of the Week. These are short but powerful ideas that really make you stop and think; from founders, a16z partners, or other leaders. Our first one is from David George, who leads the Growth fund at a16z.
If you look at the last year of our activity in the a16z growth fund, our dollar-weighted portfolio is growing 112%1 and we entered at 21 times revenue. I recognize that revenue multiples can be flawed, especially for traditional investors. But if I could invest for the rest of my career in really great 112% growing companies at 21 times revenue, I would do it in a heartbeat. I think that’s way less risky than buying a 12% grower in PE for 15 times EBITDA. Because growth just takes care of so much for you.
I think above 30% growth, the market still doesn’t fully value the growth rate. Why is that the case? I think it’s just because it’s hard to model. I’ve studied all these companies that we call “modelbusters”, and even after seeing all of these success stories, it’s hard for any investor to build a five or ten year model where high growth persists. It’s just not natural. No one built a financial model for Google or Visa that had them still growing 15 or 20% after 20 years of existence. It would just be totally unnatural to do.
Let’s take the iPhone. If you looked at consensus estimates in 2009 for where Apple would be in 2013, and then compare them to actual performance, the consensus estimates were off by 3x. That’s a massive number. And this was one of the most covered companies in the world. You can be surprised by growth. I really get a kick out of when this happens, and learn as much as I can when it does.
Again, it’s unnatural to model any company with that kind of growth rate. If you observe a company growing 80%, the natural model you build is to say, Okay, they’re going to grow 65%, then 50, then 40, then 30, and ultimately some terminal growth rate. But what if that 80% growing company persists at 75, 65? That’s a 3x difference in your valuation. This is why I love high growth. The math behind it is so simple and obvious. But it’s hard to appreciate it, just because it’s not natural to build a model that way.
I tell the team that we can make a lot of mistakes on forecasting margins and business models and unit economics and all that stuff, and furthermore, there are lots of people out in the world who know how to do that analysis. So where can you actually get edge? You can get edge from product insights, market insights, and people insights.
If I were to summarize it in one line, “My style and taste is that I like to pay fair prices for great companies.” But everyone would say they would like to do that, right? The art is in recognizing where greatness may lie, and which other people may not recognize. I’ve studied the history of technology companies and why they outperform. In growth stage investing, it’s always on the growth side. The growth side is where you get things really right.
For more on how DG thinks about growth, watch his conversation with Patrick O’Shaughnessy a few months ago:
Figure represents revenue growth.
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Super insightful, and I’d love to look at the specific companies you studied in more depth. Two reactions. First, if you really believe in compounding at north of 30% for a decade or longer, it becomes very hard to anchor on value today, because almost anything can look like a good price in hindsight.
Second, it’s interesting to think about how many things have to go right to compound at that rate for that long, market size, moat, and whether the business ultimately needs an Act 2. Visa and Google are notable in that core Payments and Search have compounded at that rate largely on their own. But many of the other great compounders have had to extend into an Act 2, like Veeva moving beyond core CRM, or companies like SAP, ServiceNow, Salesforce, and HubSpot expanding their product surface area.