By Christopher Lochhead, Dave Peterson, and Al Ramadan
FORTUNE -- Savvy technology investors seek potential, not performance. They identify companies leveraging technology to build and dominate new market sectors that show promise for significant growth. Because elite tech investors know two things that others don't: First, there is no such thing as a legendary company in a dying sector. And second, the technology business is a winner-take-all game, where companies that dominate specific markets in tech, such as Google (GOOG), Facebook (FB) and Salesforce.com (CRM), often gain upwards of 50% market share over time.
Most financial news and analysis are a blizzard of historical numbers: Revenue, sales, backlog, margins, earnings, etc. This spreadsheet-based, historical analysis is often void of context.
Legendary investors look to the future. They study the potential. Wrapping your brain around potential is a lot harder than analyzing an existing space. A mature sector like search advertising has a market that is relatively easy to measure. But, making a bet on an emerging space like "content marketing" requires non-traditional examination and a leap of faith.
"Smart investment choices require understanding the potential size and importance of the market category. We seek mission-driven founders who can build a great company and category at the same time," Sequoia Capital partner Jim Goetz says. He should know. His early investment in WhatsApp turned into the $19 billion transaction heard around the world. Facebook didn't just buy WhatsApp's revenue, technology or its 450 million active users. Facebook wanted WhatsApp's leading position in a strategic, massively growing new market called mobile messaging. The transaction was reported to be the largest acquisition in venture history.
All technology markets fall off over time. Understanding the growth prospects for mature companies starts with examining how much, if any, erosion they face.
This is Dell's problem. Server, desktop and laptop demand is stagnating. The companies leading new markets for cloud, smartphone and tablet are neutering their future. The same way the personal computer crushed the typewriter. That's why Dell is pivoting to software and services. They are trying to access new potential because their current categories are eroding.
Traditionally, companies fight for market share within existing sectors. Think Coke vs. Pepsi or Eight Minute Abs vs. Seven Minute Abs. As new technologies create new markets, customers shift dollars from the old to the new.
Firms that currently dominate their sectors, such as SAP (SAP) and Oracle (ORCL), are staring at this demon now. Workday grew revenue over 71% last year, Salesforce.com (CRM) is now a $4 billion company, growing at over 30% with a market cap of $34 billion. Additionally, Dropbox, Box, ServiceNow, Netsuite and many more, continue to ascend. These new players are not competing with conventional weapons. They are driving customer spending away from on-premise apps to new cloud apps. As oxygen leaves the space, everyone suffocates.
This type of risk is the biggest threat technology companies face. As history shows, slow kills companies fast. The trick to understanding if the old leaders can grow again is examining how much erosion they face and how quickly they are pursuing new potential.
Big players always have outsized stock prices because potential plus execution equals a premium. This explains why Amazon's (AMZN) market cap is $155 billion with $75 billion in revenue, while Wal-Mart (WMT) is worth $245 billion on $476 billion in revenue. The tough question is what premium should high-growth companies that dominate their sectors have? Answering the question lies in what you believe about a given company's strategy to make money off of their category potential.
Tesla (TSLA) was founded 100 years after the Ford Motor Company (F). Today, Tesla has a market cap of $26 billion vs. Ford at $61 billion. How much potential do you think the electric car space has? According to Zachary Shahan, director of CleanTechnica, it's growing at 300%.
"If the category is big enough and the category king is dominant enough, current valuation is almost irrelevant. The key to making investment decisions is understanding category potential and the ability of the category king to define, develop and dominate the space over time," says Jason Maynard, managing director at Wells Fargo Securities.
As technology innovation accelerates so do new sectors. That opens new opportunities to make and lose money more quickly. Sector analysis should be as strategic as financial analysis if you want to make money in tech.
Christopher Lochhead, Dave Peterson, and Al Ramadan are co-founding partners at Play Bigger Advisors, a San Francisco-based firm that coaches technology executives to build market-leading companies. Follow us @playbiggeradv)
The software giant soon will name a new leader after a tumultuous seven months of drama. A look back at the upheaval Microsoft's next CEO must address.
By Geoff Colvin and Adam Lashinsky, senior editors-at-large
FORTUNE -- Bill Gates was the star attraction at a private event that included some of Silicon Valley's young luminaries in San Francisco last October, but his planned topic, philanthropy, wasn't the most prominent topic on their MOREFeb 3, 2014 7:00 AM ET
Ex-Peoplesoft execs successfully founded Workday after Oracle's hostile buyout. But can they successfully make a profit?
FORTUNE -- The technology industry loves an underdog, especially when a scrappy startup makes breakfast of a bloated incumbent. In enterprise software, Workday (WDAY) has emerged as just such an underdog, using a cloud-based business model to handle human-resources software and take on giants like Oracle (ORCL) and SAP (SAP).
Workday was founded in 2005 by MOREKevin Kelleher - Dec 16, 2013 3:44 PM ET
Not much. Still, the actor brings star power to a dense enterprise technology subject.
By Michal Lev-Ram, writer
FORTUNE -- What was Alec Baldwin doing at a cloud computing conference in San Francisco?
Delighting fans (and getting paid to do so) in an effort to smooth over his most recent public relations flap in which the 30 Rock actor was accused of yelling a gay slur at a photographer. Baldwin disputes the account, MOREMichal Lev-Ram, writer - Nov 21, 2013 3:44 PM ET
The Facebook COO and Lean In author offers frank advice to Salesforce.com's chief executive at its annual customer conference.
FORTUNE -- Facebook (FB) COO Sheryl Sandberg has a lot of advice for women who want to advance in their careers. This week, she also took her Lean In message to Salesforce.com (CRM) CEO Marc Benioff and the throngs of conference-goers at the cloud computing company's annual Dreamforce conference in San Francisco.
Sandberg, one of MOREMichal Lev-Ram, writer - Nov 21, 2013 10:28 AM ET
We report from the company's annual Dreamforce conference in San Francisco.
By Michal Lev-Ram, writer
FORTUNE—Salesforce.com (CRM) CEO Marc Benioff knows how to put on a good show. On Tuesday morning, the outspoken executive kicked off his company's annual Dreamforce conference in San Francisco with a nearly three-hour-long keynote that featured music performances from Huey Lewis and the News plus appearances by actor Sean Penn, supermodel Petra Nemcova and Haitian prime MOREMichal Lev-Ram, writer - Nov 20, 2013 5:10 PM ET
As customer relationship management finds itself at a crossroads, Nimble aims to take a bite out of Salesforce and others.
By Andres Vaamonde
FORTUNE -- "CRM" looks like yet another jargony business acronym -- it stands for "customer relationship management," which just doesn't sound all that sexy.
Lack of appealing acronyms aside, the CRM industry is booming. CRM companies create software that helps businesses manage contact with current and future clients MOREJul 30, 2013 5:00 AM ET
There's no shortage of HR software to track employee goals. The next step is to get workers to actually follow them.
FORTUNE -- Stodgy human resources software is getting a reboot. Over the past year enterprise giants IBM (IBM), Oracle (ORCL), and SAP (SAP) have collectively shelled out some $6 billion to acquire companies that make recruitment and compensation tools. Salesforce's new Work.com product lets managers and employees track their goals. MOREMichal Lev-Ram, writer - Oct 17, 2012 5:00 AM ET
Ariba's co-founder is back - and he's trying to change the way you sign on the dotted line.
FORTUNE -- It's a boast you don't hear too often from CEOs: "I'm doing it for sport." Yet that's precisely what Keith Krach says drove him last year to become chief executive of DocuSign, a company that offers electronic-signature technology for transactions and document verification. "I never thought I'd go back and do MOREMiguel Helft, senior writer - Oct 9, 2012 5:00 AM ET
Ahrendts is making Burberry (yes, Burberry) into an innovation machine.
By Beth Kowitt, writer
FORTUNE -- Last May, Burberry CEO Angela Ahrendts flew to California from her London headquarters to introduce herself to an executive she thought could be critical to the future of her business: Salesforce.com CEO Marc Benioff. When the two met at the Ritz-Carlton in Half Moon Bay, they stood in the hall batting around ideas for 15 MOREJun 5, 2012 5:00 AM ET
|GM's recalled Cobalt was a failure from the start|
|Michaels hack hit 3 million|
|Ousted Yahoo exec gets $58 million golden parachute|
|Canadians arrest a Heartbleed hacker|
|Detroit pension cuts hit civilian workers hardest|