investment thesis microsoft

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Should you buy, sell or hold microsoft (msft) before q4 earnings.

Microsoft MSFT is set to report fourth-quarter fiscal 2024 results on Jul 30. The Zacks Consensus Estimate for revenues is pegged at $64.13 billion, indicating growth of 14.2% from the figure reported in the year-ago quarter. The consensus mark for earnings has remained steady at $2.90 per share over the past 30 days, suggesting 7.8% year-over-year growth.

Image Source: Zacks Investment Research

In the last reported quarter, the company delivered an earnings surprise of 5.91%. The company’s earnings beat the Zacks Consensus Estimate in the trailing four quarters, the average surprise being 7.38%.

Microsoft Corporation Price and EPS Surprise

Microsoft Corporation price-eps-surprise | Microsoft Corporation Quote

Earnings Whispers

Our proven model does not conclusively predict an earnings beat for Microsoft this time around. The combination of a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) increases the odds of an earnings beat. This is not the case here. You can uncover the best stocks to buy or sell before they are reported with our Earnings ESP Filter. MSFT has an Earnings ESP of 0.00% and a Zacks Rank #3 at present. You can see the complete list of today’s Zacks #1 Rank stocks here.

Factors Shaping Upcoming Results

Microsoft's performance in the fourth quarter of 2024 is expected to have shown robust growth, primarily driven by its Intelligent Cloud and Productivity and Business Processes segments. The company's strategic focus on cloud services, particularly Azure and the Office 365 suite, is likely to have contributed significantly to top-line growth. In the Intelligent Cloud segment, the company anticipates revenues between $28.4 billion and $28.7 billion. Our model estimate for this segment is pegged at $28.54 billion, indicating growth of 19% from the figure reported in the year-ago quarter. In Azure, Microsoft expects revenue growth in the range of 30-31% at cc. Microsoft's Azure platform is spearheading the company's AI-driven growth strategy. A key factor in Microsoft's growth strategy has been Teams, its enterprise communication platform. Teams has been expanding its customer base and feature set, effectively competing against rivals like Zoom. The platform's growth is closely tied to the rising popularity of hybrid and flexible work models.  In the quarter under review, Microsoft announced that it is set to sell Teams separately from its Office product globally. The decision comes after the company unbundled the two products in Europe to avert a possible EU antitrust fine. Microsoft anticipates its Productivity and Business Processes segment to generate revenues between $19.9 billion and $20.2 billion. Our model estimate is pegged at $20.03 billion, indicating an increase of 9.5% year over year. This growth is underpinned by strong performance across various product lines. Office 365 Commercial is expected to see revenue growth of approximately 14% at constant currency (cc), which is in line with our model estimate. However, traditional Office Commercial products are projected to experience a decline in the mid-to-high teens range, highlighting the ongoing shift from on-premise to cloud-based solutions. The company's diversified portfolio continues to show promise, with Office Consumer products and cloud services expected to achieve revenue growth in the low-to-mid single digits. LinkedIn is projected to achieve mid-to-high single-digit growth. Our model estimate for LinkedIn is pegged at revenue growth of 6.6%. Dynamics 365, Microsoft's enterprise resource planning and customer relationship management platform, is another steady performer, with the company projecting revenue growth in the low-to-mid teens.  For the More Personal Computing segment, the company projects revenues between $15.2 billion and $15.6 billion. Revenues from Windows are likely to have been driven by steady traction seen in Windows Commercial products and cloud services growth amid improving personal computer (PC) demand. The Traditional PC market delivered its second quarter of growth following eight consecutive quarters of decline. According to preliminary results from the International Data Corporation (IDC) Worldwide Quarterly Personal Computing Device Tracker, worldwide shipments reached 64.9 million units in the second quarter of 2024, representing year-over-year growth of 3%. Among other major PC vendors, Lenovo (LNVGY) and Hewlett Packard (HPE) registered an increase in shipments. Lenovo's shipments increased 3.7% year over year to 14.7 million units, while HPE's shipments grew 1.8% year over year to 13.7 million units. Additionally, Apple (AAPL) registered a 20.8% year-over-year improvement in shipments, reaching 5.7 million units. Microsoft expects Windows OEM revenues to grow in the mid to low-to-mid single-digit range. In the Gaming segment, MSFT expects revenue growth in the low to mid-40s, including roughly 50 points of net impact from the Activision acquisition. Furthermore, Microsoft anticipates Xbox content and services revenue growth in the high 50s, driven by roughly 60 points of net impact from the Activision acquisition. In the quarter under review, Microsoft announced the renewal of a publishing agreement with NetEase, which will bring back Blizzard Entertainment's games like World of Warcraft to players in China.

Price Performance & Valuation

Shares of MSFT have returned 17.8% year to date compared with the broader Zacks Computer & Technology sector’s growth of 21.5%. Shares of HPE and AAPL have gained 21.3% and 16.3%, respectively, while shares of LNVGY have declined 2.8%.

Year-to-Date Performance

Now, let’s look at the value Microsoft offers investors at current levels. MSFT is trading at a premium with a forward 12-month P/S of 11.73X compared with the Zacks Computer - Software industry’s 8.13X and higher than the median of 10.05X, reflecting a stretched valuation.

MSFT’s P/S F12M Ratio Depicts Stretched Valuation

Investment thesis.

Microsoft presents a strong investment case with its dominant position in cloud computing (Azure) and productivity software (Office 365), driving consistent revenue growth. The company's strategic focus on AI integration and partnerships, like with OpenAI, positions it at the forefront of technological innovation. Microsoft's diversified portfolio, including gaming (Xbox) and professional networking (LinkedIn), provides stability and multiple growth avenues.  However, potential challenges include intense competition in the cloud market, particularly from Amazon and Google, and the cyclical nature of enterprise IT spending. Regulatory scrutiny over market dominance and data privacy concerns pose additional risks. Despite these challenges, Microsoft's strong balance sheet, consistent cash flow, and history of shareholder returns through dividends and buybacks make it an attractive option for investors seeking a balance of growth and stability in the tech sector.

Final Thoughts

Microsoft's strong performance in productivity and collaboration offerings is expected to drive substantial growth in the fiscal fourth quarter of 2024 despite a premium valuation and fierce competition in the cloud market. The company's strategic focus on cloud services, AI integration, and innovative product development has positioned it favorably in the competitive market. Maintaining a position in Microsoft appears prudent at present. Investors looking to buy the stock should, however, wait for a better entry point.

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Zacks Investment Research

Compounder Fund: Microsoft Investment Thesis

Compounder fund: microsoft investment thesis - 30 sep 2020.

Data as of 29 September 2020

Microsoft Corporation (NASDAQ: MSFT) is one of the 40 companies in Compounder Fund’s initial portfolio . This article describes our investment thesis for the company.

Company description

Founded in 1975 by Bill Gates and Paul Allen, Microsoft has grown to become a tech juggernaut and one of the largest companies in the world by market capitalisation. At its 29 September 2020 share price of US$210, Microsoft’s market cap was a staggering US$1.57 trillion. 

Much has changed about Microsoft’s business. In the past, the company was largely reliant on selling its productivity software tools to consumers and businesses, and its Windows operating system software to manufacturers of personal computers. Today, there’s so much more to Microsoft’s business. 

In its fiscal year ended 30 June 2020 (FY2020), Microsoft earned US$143.0 billion in revenue from its three operating segments: Productivity and Business Processes; Intelligent Cloud; and More Personal Computing. The revenue contributions from the three segments are evenly split, and they can be seen in the table below:

Each of Microsoft’s operating segments can be further split into multiple sub-segments. The following are brief descriptions of what these sub-segments are: 

• Office Commercial , which includes Office 365 subscriptions, the Office portion of Microsoft 365 Commercial subscriptions, and on-premise licenses of the Office software. You can think of these as software that improves personal, team, and organisational productivity. There’s an ongoing effort by Microsoft to shift Office on-premise licenses to Office 365 Commercial subscriptions.
• Office Consumer , which includes many of the above software, but with versions focused on individual consumer use. In a similar manner to the Office Commercial sub-segment, Microsoft is continuing to shift consumer Office software licenses to the consumer version of the 365 subscriptions (named Microsoft 365 Consumer). The Office Consumer segment also contains Skype, Outlook.com, and OneDrive services, which are driven by subscriptions, advertising, and the sale of minutes.
• Linkedin is a professional network on the Internet for people to display their professional experience (there are currently over 700 million members on LinkedIn) and for companies to share their profiles. LinkedIn provides paid subscriptions to (1) tools to help organisations hire and develop talent, grow skillsets, and sell better online, and (2) tools for individuals to manage their professional identity and grow their network. LinkedIn also provides a paid online marketing service.
• Dynamics , which provides cloud-based and on-premise software for financial management, enterprise resource planning (ERP), customer relationship management, supply chain management, and application development platforms for both large and small companies. The Dynamics sub-segment is also shifting from on-premise software products to its cloud-based Dynamics 365 solution.
• Server Products that include SQL Server, Windows Server, Visual Studio, System Center, and GitHub. These are mostly server software, integrated server infrastructure, and middleware designed to support software applications built on Windows Server operating systems. Github, which Microsoft acquired in 2018 for US$7.5 billion (paid in Microsoft shares), is an open-source collaboration platform for software developers. Revenue sources for the Server Products sub-segment include sales of volume licensing programs and licenses to OEMs (original equipment manufacturers).
• Cloud Services , which consists of Azure. Essentially, Azure is a cloud-computing service and it can be used for “computing, networking, storage, mobile and web application services, AI [artificial intelligence], IoT [internet of things], cognitive services, and machine learning.” Customers are charged based on consumption or number of users.
• Enterprise Services , where Microsoft helps its enterprise customers in deploying its server and desktop solutions, among other support services.
• Windows , which is the most widely used operating system (OS) on personal computers. This segment depends on the purchase of the Windows OS licenses by (1) device manufacturers to pre-install on the devices they sell, and (2) commercial clients.
• Devices , which involves the sale of devices that are designed and manufactured by the company, including the Surface product and other intelligent devices.
• Gaming , which houses (1) the Xbox family of video gaming consoles, (2) video gaming-related streaming services, (3) Xbox Game Studios, a creator of video games, and (4) Xbox Live, a platform for gamers to connect and share their gaming experience. Revenue from the Gaming sub-segment comes from subscriptions, sales of first- and third-party content, and advertising.
• Search , where Microsoft monetises its Bing online search engine through online advertising services. This sub-segment also houses the Microsoft Advertising online advertising service.

Here’s a more granular breakdown of Microsoft’s total revenue in FY2020 by product and service:

Microsoft groups all its cloud-related businesses under the Commercial Cloud banner. These businesses include Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and more (in the table just above, they are primarily included in Server products and cloud services, Office products and cloud services, and LinkedIn). In FY2020, Commercial Cloud’s revenue was US$51.7 billion, around 36% of Microsoft’s total revenue for the year.

Microsoft also has a fairly diversified business from a geographical perspective. In FY2020, 51% of the company’s revenue came from the USA while the remaining 49% originated from other countries across the world. 

Investment thesis

We have laid out our investment framework in Compounder Fund’s website. We will use the framework to describe our investment thesis for Microsoft .

1. Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market

As you saw in the “Company description” section of this article, Microsoft has a highly diversified business. In discussing Microsoft’s market opportunities, we will focus on three areas: (1) Azure, (2) Office 365, and (3) the video gaming business of Microsoft.

Azure is one of Microsoft’s fastest-growing products. Although Microsoft does not release revenue numbers for Azure, it does share the growth rates of the cloud computing business. The table below shows Azure’s impressive year-on-year revenue growth rates over the last few years.

Despite the heady growth Azure has experienced, we still see significant room for the cloud computing service to grow. The cloud computing market is expanding rapidly. According to market researcher Gartner, the cloud PaaS (platform-as-a-service) and cloud IaaS (infrastructure-as-a-service) markets are expected to collectively be US$132 billion in 2022, up 22% annually from US$59 billion in 2018. Azure currently participates in both the cloud PaaS and cloud IaaS markets. And importantly, Azure has been adept at winning market share. According to estimates from research outfit Canalys,  Azure held 20% of the global cloud computing overall infrastructure market in the second quarter of 2020, up from 18% a year ago, and up from 13.5% in 2017. 

In the global cloud computing overall infrastructure market, the top three players are, in descending order, AWS (Amazon Web Services), Azure, and Google Cloud. AWS has a commanding lead with its market share of 31% in the second quarter of 2020 according to Canalys; Google Cloud is a distant third with its market share of 6%. Azure is up against tough competition, no doubt. But we think a rising tide can lift some boats in this case, Azure included. The cloud computing infrastructure services providers with the largest scale are able to offer users lower costs and a better overall experience. Azure is one of the clear leaders in this space, and so should benefit from the growing need for cloud computing infrastructure services.

According to Bitglass, Office 365 reigns supreme in the cloud productivity software market. In 2019, Office 365 had a 79% adoption rate compared to key rival Google G-Suite’s 33% adoption rate. The number of consumer subscribers to Office 365 has also grown from just 7 million in the first quarter of FY2015 to 42.7 million in the fourth quarter of FY2020.

The market opportunity for Office 365 is still growing fast. According to Adroit Market Research, the productivity software market is expected to grow at 16.5% annually from 2018 to hit US$96 billion by 2025. Office 365 looks set to benefit from this growing addressable market.

Microsoft’s gaming business saw its revenue inch up by just 6% per year from US$9.2 billion in FY2016 to US$11.6 billion in FY2020. But the fourth quarter of FY2020 saw gaming revenue surge 64% from a year ago, with stay-at-home guidelines to combat the current COVID-19 pandemic boosting demand for Microsoft’s gaming products and services.

The opportunity ahead is intriguing to us. The global gaming market was US$109 billion in 2019, up 3% from US$106 billion in 2018, according to Nielsen’s SuperData Research Group. We won’t be surprised if Microsoft ends up pursuing a gaming-as-a-service strategy in the future. There are already early signs of this happening with Microsoft launching its game streaming service, Project xCloud, earlier this month. During Microsoft’s FY2020 fourth-quarter earnings conference call, CEO Satya Nadella also teased his ambitions for the company’s gaming business:

“This gaming TAM [total addressable market] is much more expansive than we participated in, even with all the success we have with Xbox. We think going forward, Xbox with the approach we are taking has much more of an ability to reach the 2+ billion gamers out there and we’re in the early days of building that out.”

2. A strong balance sheet with minimal or a reasonable amount of debt

Microsoft has a robust balance sheet that is flush with cash. As of 30 June 2020, it had US$136.5 billion in cash and short-term investments compared to US$63.3 billion in debt. This puts Microsoft in a net-cash position of around US$73.3 billion, which gives it massive financial firepower to continue investing in the business or return capital to shareholders through dividends and buybacks. It helps too that Microsoft has a great track record of generating free cash flow from its business for a long time, which we will discuss later. 

Microsoft’s strong balance sheet is made all the more impressive given the fact that the company has been very aggressively buying back shares and paying dividends. For perspective, Microsoft has spent a total of US$95.4 billion and US$74.4 billion to buy back shares and pay dividends, respectively, from FY2015 to FY2020.

3. A management team with integrity, capability, and an innovative mindset

On integrity

Microsoft is led by CEO Satya Nadella, who took over the hot seat in February 2014. The other key leaders in Microsoft include Amy Hood, Jean-Philippe Courtois, and Brad Smith. The table below shows more details on the four of them and there are two positive and striking things to note: (1) They are mostly all relatively young, and (2) each of them have long tenure with Microsoft.

We think that the compensation structure for Microsoft’s leadership demonstrates integrity. Here are a few key data points:

• In FY2019, Nadella was the highest paid executive in Microsoft and his total compensation was a princely US$42.9 million. But this is a rounding error when compared to Microsoft’s profit of US$39.2 billion in the same year.
• 69% of Nadella’s total compensation in FY2019 came from stock awards that vest over four years and performance stock awards (PSAs). The PSAs are based on (1)  three-year growth in Microsoft’s business metrics that make sense to us, such as Commercial Cloud revenue and Commercial Cloud subscribers, among others, and (2) Microsoft’s three-year total shareholder return compared to the other components in the S&P 500. So what this means is that the lion’s share of Nadella’s compensation in FY2019 depended on the long-term growth of Microsoft’s stock price as well as important business metrics.
• 25% of Nadella’s total compensation in FY2019 came from cash incentives that are based on the company hitting certain sensible goals, both financial (in terms of revenue and operating income) and qualitative (in areas such as product & strategy, customers & stakeholders, and culture & organizational leadership).
• The total compensation for Hood, Courtois, and Smith in FY2019 was US$20.2 million, US$15.1 million, and US$17.4 million, respectively. Around 75% of each sum came from stock awards and PSAs with the same features as Nadella’s. 

Moreover, there’s a high level of insider ownership at Microsoft, which strengthens our view that Microsoft’s leaders are in the same boat as the company’s other shareholders. As of 8 October 2019, Nadella owned 951,502 Microsoft shares and had an additional 1.457 million shares that vest over time. His directly-held stake alone is worth more than US$199 million at Microsoft’s 29 September 2020 share price of US$210 while his total stake is worth half a billion US dollars.

On capability and innovation

We rate Satya Nadella very highly on capability and innovation, and we think he has done a tremendous job at transitioning Microsoft from a company that mostly sells software licenses to one built for the cloud. There are a few things about Nadella’s tenure as Microsoft’s CEO that we want to discuss.

First is the transformation of Microsoft’s people culture under Nadella. In September 2017, Fast Company published an excellent feature on Microsoft’s CEO titled Satya Nadella Rewrites Microsoft’s Code . Here’re some relevant excerpts from the article:

“One of Nadella’s first acts after becoming CEO, in February 2014, was to ask the company’s top executives to read Marshall Rosenberg’s Nonviolent Communication , a treatise on empathic collaboration. The gesture signaled that Nadella planned to run the company differently from his well-known predecessors, Bill Gates and Steve Ballmer, and address Microsoft’s long-standing reputation as a hive of intense corporate infighting. (Programmer/cartoonist Manu Cornet crisply summed up the Microsoft culture in a 2011 org chart spoof that depicted the various operating groups pointing handguns at each other.) The reading assignment “was the first clear indication that Satya was going to focus on transforming not just the business strategy but the culture as well,” says Microsoft president and chief legal officer Brad Smith, a 24-year company veteran… …When I ask Nadella for his own account of working with his predecessors, he’s blunt. “Bill’s not the kind of guy who walks into your office and says, ‘Hey, great job,’ ” he tells me. “It’s like, ‘Let me start by telling you the 20 things that are wrong with you today.’ ” Ballmer’s technique, Nadella adds, is similar. He chuckles at the images he’s conjured and emphasizes that he finds such directness “refreshing.” (Upon becoming CEO, Nadella even asked Gates, who remains a technology adviser to the company, to increase the hours he devotes to giving feedback to product teams.) Nadella’s approach is gentler. He believes human beings are wired to have empathy, and that’s essential not only for creating harmony at work but also for making products that will resonate. “You have to be able to say, ‘Where is this person coming from?’” he says. “‘What makes them tick? Why are they excited or frustrated by something that is happening, whether it’s about computing or beyond computing?’” His philosophy stems from one of the principal events of his personal life. In 1996, his first child, Zain, was born with severe cerebral palsy, permanently altering what had been a pretty carefree lifestyle for him and his wife, Anu. For two or three years, Nadella felt sorry for himself. And then—nudged along by Anu, who had given up her career as an architect to care for Zain—his perspective changed. “If anything,” he remembers thinking, “I should be doing everything to put myself in [Zain’s] shoes, given the privilege I have to be able to help him.” Nadella says that this empathy—though he cautions that the word is sometimes overused—”is a massive part of who I am today. . . . I distinctly remember who I was as a person before and after,” he says. “I won’t say I was narrow or selfish or anything, but there was something that was missing.””

Microsoft’s excellent Glassdoor reviews also provide clues on the fantastic people culture that Nadella appears to have built. Nadella has a 99% approval rating on Glassdoor as CEO – far higher than the average Glassdoor CEO rating of 69% – and 95% of Microsoft’s employees who rated the company will recommend their friends to work at the software giant. The very first comment on Glassdoor we saw read, “Brilliant colleagues, incredible culture and a purpose-led mission that delivers impact.”

Second , on his first day as CEO of Microsoft, Nadelle sent an email to all of Microsoft’s employees. In it, he wrote that “our job is to ensure that Microsoft will thrive in a mobile and cloud-first world.” He’s doing great on this front. The table below shows the explosive growth in Microsoft’s Commercial Cloud revenue during Nadella’s tenure as CEO (Nadella became CEO in February 2014, which is in the second half of FY2014):

And earlier in this article, we also discussed the following positive aspects about Microsoft’s cloud-related business: (1) Azure’s stunning growth in the past few years; (2) Azure’s impressive market-share gains; and (3) the big jump in consumer subscribers to the cloud-based Office 365 productivity software. Nadella does not seem keen to rest on his laurels. Microsoft’s Project xCloud games streaming service which we mentioned earlier, works on Android mobile devices. And at Microsoft’s recent Build 2020 conference, Nadella said the following about Azure: 

“We’re innovating at every layer from edge to hybrid to data and AI. We’ve always led with hybrid computing. Azure Arc is the first control plane built for a multi-cloud, multi-edge world.”

Interestingly, Nadella’s decision to focus Microsoft on building for the cloud after he became CEO worried Microsoft’s directors: The cloud business had lower margins than Microsoft’s traditional software-sales business and the directors were not used to it. But Nadella’s decision proved to be right, and Microsoft is reaping the rewards. Nadella also has an audacious vision to make Azure the “world’s computer.” A key highlight of Azure’s progress happened in late 2019. The United States Department of Defence picked Azure over Amazon’s AWS to award a US$10 billion cloud computing contract. The contract, named JEDI (Joint Enterprise Defense Infrastructure), showed that Azure can compete with Amazon’s AWS and come out ahead.

Third, besides transforming Microsoft’s people culture, Nadella also drove a dramatic – and we think positive – change in the way Microsoft approached open-source software. Linux, an open-source coding system, was once described as “a cancer” by Steve Ballmer, Nadella’s predecessor as Microsoft CEO. But under Nadella, Microsoft is now a strong supporter of Linux and the company has been incorporating Linux into its own software. Here’s an excerpt from a July 2019 article from Wired that describes one instance of how it’s beneficial for Microsoft to be working with Linux:

“ Thanks to a feature called Windows Subsystem for Linux, you can already run Linux applications in Windows. WSL essentially translates commands meant for the Linux kernel—the core part of the operating system that talks to hardware—into commands for the Windows kernel. But now Microsoft will build the Linux kernel into WSL, starting with a new version of the software set for a preview release in June… … At first blush it may sound like a strange idea. But it makes perfect sense to programmers, especially web developers. Linux is the most common operating system for running web servers, but Windows is still king inside corporations. Making it easy to run Linux code in Windows is a boon for developers who need to use a Windows machine to write code that runs on Linux servers.”

Fourth, we’re impressed by the way Nadella has accelerated growth at Microsoft despite taking over the company when its business was already massive. For perspective, Microsoft’s revenue in FY2013 (remember, Nadella took over in the second half of FY2014) was US$77.8 billion. The table below shows the annualised growth rates in Microsoft’s revenue, net profit, and operating cash flow for various time periods to highlight the differences between the pre-Nadella and current eras. Note the significantly faster revenue growth rate for the FY2017-FY2020 time period – we think the growth rate achieved in FY2017-FY2020 show the fruits of the company’s transformation under Nadella’s leadership, and so they are a good indicator of Microsoft’s revenue growth over the next few years.

4. Revenue streams that are recurring in nature, either through contracts or customer-behaviour

Microsoft has multiple revenue streams, as we have shown earlier. The company does not breakdown exactly how much of its revenue is recurring in nature. But what we know for sure is that the Commercial Cloud business, which accounted for 36.2% of Microsoft’s total revenue in FY2020, is recurring. This is because the business relies on subscription and/or usage-based models. 

We also have a rough idea of how much of Microsoft’s Commercial Cloud business will return in the next fiscal year. Microsoft reports its remaining performance obligations (RPO), which consists of unearned revenue and amounts that will be invoiced and recognized in future periods. As of 30 June 2020, Microsoft’s RPO was US$111 billion, of which US$107 billion was related to its commercial business (this includes the Commercial Cloud business). Microsoft expects to recognise around 50% of the US$107 billion (roughly US$53 billion) as revenue over the next 12 months. This lends further weight to our view that the Commercial Cloud business is recurring in nature (for perspective, Commercial Cloud had revenue of US$51.7 billion in FY2020). 

We believe that there are significant recurring revenues in other areas of Microsoft’s business too. For instance, we think that Microsoft also enjoys fairly predictable revenue streams through the licensing of its Windows operating system (OS) software. First, the Windows OS dominates the OS market for personal computers with a 77% share as of August 2020. Second, we think there’s a sticky customer base as Windows OS users tend to continue with the Windows OS once they have learnt how to use it. These traits mean that software developers will be keen to write software and programs that are compatible with the Windows OS, increasing the OS’s value proposition. All of these then in turn cause computer manufacturers to prefer to pre-install the Windows OS in personal computers over other OS-es, leading to stable demand for the Windows OS. Indeed, revenue from the Windows business has displayed steady growth over the past few years as the table below illustrates.

In other examples of recurring revenues in Microsoft’s business:

• Microsoft has 42.7 million consumer subscribers to its Office 365 cloud-based productivity software
• The Gaming sub-segment has subscriptions and advertising services, both of which are recurring in nature
• The Search Advertising sub-segment is recurring because of customer behaviour, since companies have to continuously advertise to build awareness amongst their customers.    

5. A proven ability to grow

The table below shows Microsoft’s important financial numbers since FY2010. (We did not pick an earlier time period as the starting point because Microsoft’s business has gone through significant changes in the past few years, so more-recent data is better suited for us.)

A few key things to highlight from Microsoft’s financials:

• For the entire time period under study, Microsoft’s revenue has grown in nearly every single year. FY2016 was the only year there was a decline and even then, the fall was just 2.6%. From FY2010 to FY2020, Microsoft’s revenue compounded steadily at 8.6% per year. More recently, from FY2017 to FY2020, the company’s revenue increased at a significantly faster annual rate of 14.0%. As we mentioned earlier in this article, we think that the revenue growth achieved in FY2017-FY2020 shows the fruits of Microsoft’s transformation under Satya Nadella’s leadership.
• Net income has been consistently positive, although growth has not been smooth. From FY2017 to FY2020, net income has compounded impressively at 20.2%. There was a sharp drop in net income in FY2018, but this was due to a one-off US$13.7 billion charge recorded in the fiscal year because of changes to US tax laws that were enacted in December 2017. 
• Microsoft’s operating cash flow and free cash flow (net of capital expenditures and acquisitions) have both been consistently positive. There’s also a clear upward trend over the years for both metrics. The free cash flow in FY2017 was abnormally low because Microsoft acquired LinkedIn during the fiscal year (in December 2016 to be exact) for US$27 billion. From FY2010 to FY2020, operating cash flow compounded at 9.7% annually; the annualised growth rate had jumped to 15.4% for FY2017-FY2020. Meanwhile, free cash flow increased by 6.9% per year from FY2010 to FY2020. The growth rate in free cash flow from FY2017 to FY2020 was absurdly high at 98.8% per year, but that’s because of the low free cash flow in the base year. Shifting the base year to FY2016 will result in compound annual growth of 16.0% in free cash flow. We also want to highlight that Microsoft’s free cash flow has tracked its net income pretty closely.
• The balance sheet was rock-solid throughout the entire time frame we’re looking at with the amount of cash (including short-term investments) significantly outweighing the amount of debt. In fact, Microsoft’s net-cash position has increased from US$30.8 billion in FY2010 to US$73.2 billion in FY2020. We believe that Microsoft can afford to even be more aggressive with its share buybacks and acquisitions.
• Microsoft has not been diluting shareholders. Because of share buybacks, the number of shares declined by 1.5% per year from FY2010 to FY2020 and by 1.4% annually from FY2015 to FY2020. The buybacks have helped Microsoft’s existing shareholders to have a larger piece of the pie over time. For instance, the annual growth in Microsoft’s earnings per share for FY2017-FY2020 was 21.0%, compared to the net income growth rate of 20.2% per year.

The second half of FY2020 (1 January 2020 to 30 June 2020) was when COVID-19 started spreading across the world. Microsoft’s business performance in this period has been impressive, as shown in the table below. To a certain extent, the pandemic has benefited Microsoft, with Satya Nadella commenting in the FY2020 third-quarter earnings update that the company saw “two years’ worth of digital transformation in two months.”

6. A high likelihood of generating a strong and growing stream of free cash flow in the future

Ultimately, we want our portfolio companies to be able to generate a growing stream of free cash flow in the future because we believe this is what makes companies become more valuable over time.

We believe Microsoft scores well in this criterion for two reasons. First, Microsoft’s revenue is likely to continue growing at a healthy clip in the years ahead. In particular, revenue from Azure and Microsoft’s other subscription businesses will likely grow significantly as companies shift towards cloud-based software and solutions. Second, Microsoft has a fantastic track record in generating free cash flow. The company’s average free cash flow margin (free cash flow as a percentage of revenue) for FY2015-FY2020 was an excellent 23.3%. We see no reason why Microsoft’s free cash flow margin will shrink in the future. 

We like to keep things simple in the valuation process. In Microsoft’s case, we think the price-to-earnings (P/E) and price-to-free cash flow (P/FCF) ratios are appropriate metrics to value the company, since it has a long history of producing solid and growing streams of profit and free cash flow. 

We completed our purchases of Microsoft shares with Compounder Fund’s initial capital in late July 2020. Our average purchase price was US$205 per Microsoft share. At our average price and on the day we completed our purchases, Microsoft had trailing P/E and P/FCF ratios of 36 and 37, respectively. These ratios are on the wrong side of 30, and also high relative to their histories. The chart below shows Microsoft’s P/E and P/FCF ratios over the last five years.

But we believe that Microsoft deserves a higher multiple than what the market was paying for it back in late 2015. Microsoft has grown its Commercial Cloud business at rapid rates in the past few years, and this business currently makes up more than a third of the company’s overall revenue. Moreover, revenue from the Commercial Cloud business is nearly all recurring in nature. The growth of Commercial Cloud – not to mention the other subscription-based businesses – means that Microsoft is now a more robust and predictable business, and hence worth higher valuations. We also think that Microsoft will be able to compound its top-line in the low-teens rate, at the very least, in the next few years and this will be able to drive annual bottom-line and free cash flow growth in the high-teens range or more. For such growth, P/E and P/FCF ratios in the mid-30s do not seem high to us.

For perspective, Microsoft carried P/E and P/FCF ratios of 36 and 38 at the 29 September 2020 share price of US$210.

The risks involved

There are four key risks we are watching with Microsoft.

The first is key-man risk. Satya Nadella has been an immense transformative force at Microsoft. His foresight and ability to reinvent the company even when facing pressure from within has been instrumental to Microsoft’s recent successes. If there’s a change in leadership, it could impact Microsoft’s growth. The good thing is that Nadella is only 53 years old right now, so he likely still has plenty of years ahead of him to continue leading the company. 

The second is competition . Microsoft’s products and services have a host of competitors, big and small. In its annual report for FY2020, Microsoft name-dropped a who’s who of the technology sector as competitors. The list includes Alphabet (parent of search engine Google), Amazon, Apple, Cisco Systems, Facebook, IBM, Oracle, salesforce.com, SAP, Slack, Zoom, and more. Notably, Microsoft’s Azure lags behind Amazon’s AWS in the cloud computing space, although we believe that the cloud computing market is big enough for multiple winners. Nonetheless, we are still keeping an eye on Microsoft’s competitive landscape. 

The third is regulatory risk . Large technology companies in the USA have been under heavy scrutiny by the country’s regulators in recent years. For instance, in August this year, the CEOs of Alphabet, Amazon, Apple, and Facebook had to testify before US lawmakers on antitrust issues. Microsoft is currently not under the same level of scrutiny in the USA as its other large-tech peers, but the winds could change quickly, since the company had been fined by regulators in the more distant past. 

Summary and allocation commentary

We initiated a 4% position in Microsoft – a large-sized allocation – with Compounder Fund’s initial capital. Microsoft is a software juggernaut that we believe has years of reliable growth ahead of it. Its balance sheet is rock-solid, and it has an incredible leader in Satya Nadella. There are other strong positives going for Microsoft, including: A sensible compensation structure for its leaders; a high level of recurring revenue; a good track record of growth in revenue, profit, and free cash flow; and a high likelihood of being able to generate growing free cash flow in the future. 

There are risks to note for Microsoft, such as key-man risk, intense competition, and the potential danger of being subjected to heavier regulatory pressures. 

But after weighing the pros and cons, we’re comfortable to have Microsoft be one of the larger positions in Compounder Fund’s initial portfolio. We think highly of the company’s reliable growth prospects and we think the valuation is reasonable.

And here’s an important disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation; they are merely our thoughts that we want to share. Of all the companies mentioned in this article, Compounder Fund also currently owns shares in Amazon, Alphabet, Facebook, salesforce.com, and Zoom .

Ser Jing & Jeremy

M12 ventures down a new path

Jan 5, 2023 | Michelle Gonzalez - Corporate Vice President and Global Head of M12

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As we begin a new year, I am delighted to share some exciting changes we’ve made at M12 to better deliver value to our portfolio companies and to Microsoft. While I experimented with ChatGPT while writing this blog post, and have been impressed by its results, I decided on a traditional, human approach.

2022 was quite the year overall, with some exceptional volatility in the startup and venture capital ecosystem. We whipsawed from valuing speed of execution and growth above efficiency, to prizing diligence with guidance toward efficiency and profitability as valuations returned to pre-pandemic levels.

In the six years since M12 was founded, we’re proud to have invested in over 100 companies , including 15 unicorns and 6 IPOs. Millions of people rely on the products and services from M12 portfolio companies to protect them from identity fraud, ensure healthcare facilities have accurate patient data, engage in learning to help them do their jobs better and make their tasks easier though AI experiences. We are at our best when we partner early with teams and will continue to focus on investing in Series A and B startups.

However, over the last 12 months, we realized startups and Microsoft needed a new M12, and so we developed a more focused investment strategy tightly aligned to Microsoft. This has helped us create exceptional value through connections, customers and unique benefits for our portfolio. You might say we’ve leaned into the “M” of M12, where we tap more into Microsoft and the power of its network.

Our closer connection to Microsoft focuses our work and positions our portfolio companies to accelerate their growth, two things that are proving to be even more critical as we navigate the volatile macroeconomy. This approach is part of our new mission, and we’ve added additional experienced investors and operators to our team to make it a reality.

As we continue our work to build and nurture innovative early-stage startups, our goal is for our companies to have meaningful partnerships with us that empower them to win.

We’re thesis-driven and aligned to Microsoft stakeholders to support portfolio growth

Our core thesis areas are AI, cloud infrastructure, cybersecurity, developer tools and vertical SaaS (areas like retail and healthcare). Great companies in these spaces such as Innovaccer , a healthcare data platform, and At-Bay , a cyber insurance platform, often find success partnering with Microsoft on product integrations, growing their customer base, building out ecosystems and getting traction in our sales motions.

We also selectively make frontier investments in companies that innovate in autonomous systems and Web3, metaverse and gaming. These are spaces we think have the potential to influence the future direction of the industry, and we work to ensure they too can realize the power of having a deeper connection to Microsoft.

For example, Web3 is an emergent category we are paying close attention to and are partnering with Microsoft to support companies that are innovating here.

Space and Time , one of our latest investments in this area, is a decentralized database company. Their plans include an integration with Microsoft Azure to help customers access, manage and run analytics on blockchain-native data, a key driver of their growth goals. In this new era of ubiquitous computing, the comprehensive Microsoft Azure cloud platform and industry-leading identity and security capabilities provide a trusted set of services to develop and run Web3 applications, enabling Space and Time to build new and advanced use cases in Web3.

In addition to our work with Space and Time, we’ve seen our thesis-driven approach help create more value across the M12 portfolio.

Our new approach to stakeholder engagement and thesis-driven investment saw its biggest moment in recent months with our announcement of the M12 GitHub Fund . GitHub, which is part of the Microsoft family of companies, is all about empowering developers. With DevOps being one of our core thesis areas, our partnership created a fund managed by M12 to make investments in promising open source startups developing on GitHub’s platform. CodeSee , an open source platform that enables developer teams to visually understand their codebases, and Novu , open source notification infrastructure for developers, are our first portfolio companies to benefit from this effort. We see the establishment of this fund as a powerful proof point that Microsoft, M12 and our portfolio are all better together.

Leaning into the power of our platform to deliver value 

To deliver on the goal of bringing differentiated value to startups, we’ve leveraged our redesigned investment approach to better support our portfolio. Our investing and operating team members are now aligned to our specific thesis areas, which allows us to develop deeper expertise and partnerships in these domains.

Before every investment, we challenge ourselves to identify the unique value we can add. To meet that commitment, today more than half our team is dedicated to helping our portfolio companies realize their growth objectives. This support may take the form of a startup showcase with Microsoft’s CEO and most senior leaders; introducing our portfolio companies to new customers; a senior Microsoft executive formally advising a portfolio company; facilitating technology collaborations or engaging in co-selling or marketing activities. No matter the case, we’re always working to find creative solutions to deliver value for our portfolio companies.

Aqua Security has a strong history of working with Microsoft to include deep product collaborations, and co-selling and joint marketing activities to accelerate Azure deployments. In one example of this relationship, Aqua enables software licensing and procurement directly through the Microsoft Azure Marketplace, allowing customers to utilize existing purchasing methods in place for Azure services. This solution simplifies the process of building out a secure infrastructure for cloud applications, and customers deploying containers on Azure can utilize the solution to quickly complete their purchasing cycle.

Aqua and Microsoft have jointly conducted a series of regional marketing programs to educate customers on cloud native technologies and provided the opportunity to interact with local technical resources from both companies. As Aqua’s enterprise customer base and scale of their cloud deployments increase, Microsoft’s prime position as a cloud leader is a distinctive benefit to their success.

This type of collaboration and many others like it make us confident we can be a driver of innovation and an enabler of growth. By investing in areas where we have a unique ability to support our portfolio companies, we see a bright future for our work ahead and the technology that our fund will enable. We’re excited by what our approach can do for entrepreneurs, and we can’t wait to see what’s in store for 2023 and beyond.

Feel free to reach out to us or learn more about our team at m12.vc . We’re always looking to connect with interesting companies and partners to help accelerate the future of technology.

Tags: M12 , startups

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Jun 24, 2020, vc lab: vc investment thesis template.

In order to build a strong venture capital firm as a first-time fund manager, you need to start with a strong Investment Thesis. Find our worksheet here.

What is the Investment Thesis for a venture capital firm?

An Investment Thesis is the strategy by which a venture capital fund makes money for the fund investors, called Limited Partners or LPs. It identifies the stage, geography and focus of investments, as well as the unique differentiation of the firm.

What are Limited Partners?

Limited Partners, or LPs, are investors in venture capital funds, and there are a number of common categories, including family offices, pension funds, endowments, sovereign wealth funds and even corporates. LPs often have allocations for different stages of venture capital as an asset class, and these allocations are provided by their internal or external investment strategy managers.

Why is the Investment Thesis important for a venture capital firm?

An Investment Thesis is used to attract Limited Partners, and it guides the activities of the firm. Most LPs have investment criteria for their venture capital allocations that they are looking to meet, and a compelling Thesis allows LPs to see if a fund meets their desired allocation criteria.

What are New Managers?

New Managers are a category of venture capitalists that are launching a new venture capital firm. Even experienced venture capitalists get categorized as a New Manager if they are launching a new firm. Many categories of LPs are restricted from investing into New Managers, including pension funds, endowments, sovereign wealth funds and even corporates. This is because New Managers do not have a track record and because the new firms run into common problems of any new business.

What is the most common Limited Partner for a New Manager?

Most New Managers raise capital from family offices, which are the investment operations of wealthy individuals and families. Small to mid-sized family offices are often led by a wealthy individual, such as an entrepreneur that has had a large exit, and these individuals make the decision to invest into a fund. Family offices often have an agenda and a focus that can align with a compelling Investment Thesis, allowing New Managers to more easily get meetings. 

How do you write a compelling Investment Thesis?

There are multiple components to a compelling Investment Thesis that we have compiled into a simple to follow format. A good Thesis can often take months to develop, iterating on feedback from the market, advisors, and fund investors. In order to start this process, we have created a simple template for creating a venture capital Investment Thesis below.

“[Fund Name] is launching a [$x MM] [Stage] venture fund in [Country / City] to back [Geography] [Sector / Market Companies] [with Secret Sauce]”

Below you can see tips for each component in [brackets]:

• [Fund Name] When getting started, we recommend using a last name or color, like ‘Ressi Ventures’ or ‘Orange Fund,’ since the Thesis will evolve many times over the first months. After you feel that you have a final Thesis, then choose a name that represents your fund.
• [$x MM] This is the size of committed capital by LPs to the fund. You will be able to raise a fund that is 10 times the size of what you think you can easily close from contacts that you already have. So, if you think that you can easily raise $500,000 from friends, acquaintances and other contacts, then your first fund size maximum is $5 MM.
• [Stage] Stage is usually based on fund size, and, for New Managers, the options are angel (<$5 MM), pre-seed ($5 MM to $15 MM), seed ($15 MM to $50 MM) and Series A (>$50 MM). It is easier to have a larger fund doing an earlier stage, such as a $100 MM angel fund, than it is to have a smaller amount of money for a later stage, such as a $10 MM Series A fund.
• [Country / City] This is the city or country where the New Managers are living or plan to live while running the fund. Now, most funds have a life of at least 10 years, so make sure to pick a city or country where you and your fellow New Managers plan to be for some time. In addition, if you are living in a large country, then it is better to specify a city or region. “East Coast” is better than the United States.
• [Geography] This is the region where the fund will invest in portfolio companies. If the Geography is not specified, then it is assumed that the funding will be local. This is particularly important for New Managers, who often try to be too broad and then do not appear credible. For example, it is unrealistic to assume that a New Manager with a small fund will do cross border deals that require complex legal management. 
• [Sector / Market Companies] This is the type of companies that the fund will focus on investing in, such as FinTech, digital health, SaaS or marketplaces. Ideally, when choosing a sector or market in a geography, the opportunity will be obvious to the right LPs, such as "East Coast Fintech companies” or “German SaaS companies.” 
• [with Secret Sauce] ’Secret Sauce’ is your insight into a sector or market opportunity based on your in-depth experience. For example, “West Coast heath startups based on my 15 years leading the largest health tech angel group in San Diego while practicing neurosurgery.” The secret sauce needs to show why you are uniquely qualified to create this fund, and, if the market opportunity is not obvious, it should also show why the market opportunity is important right now.

What is a sample Investment Thesis?

Using the above template, here are some clear and concise thesis examples:

• “Purple Ventures is launching a $5 MM angel fund in Brussels to back European government technology startups that leverage the partner’s experience in various political and bureaucratic leadership roles across the EU.”
• “Found Capital is a $15 MM Seed fund in Lagos to back African mobile payment and fintech companies sourced from the partners network built while working as startup ambassadors at Google, PayPal and Microsoft in Africa.”
• “Sven Fund is a $100 MM Series A fund in Singapore to back blockchain startups in Asia that are building dynamic supply chain systems, which is a market segment where the partner had the largest recent exit in the region.”

How specific should your Investment Thesis be?

A compelling Investment Thesis is very specific about stage, geography and focus to align with the allocation requirements of Limited Partners. A common problem is that New Managers are often afraid to be specific, since they feel it will limit their ability to do hot deals. A Thesis states the intention of a firm to pursue certain kinds of investments, but often is not legally binding in the firm or in the fund agreements. So, an Investment Thesis has the effect of gravity. Venture capitalists often can do deals that are far away from the Thesis, but they have less attraction.

How do you refine your Investment Thesis?

You will be refining your Thesis heavily for the first few months when forming your fund. The measure of a great thesis is how easily it can attract meetings with LPs, but the first person that you need to satisfy with your thesis is yourself.

Here is an initial exercise to get started that should take about 30 minutes to an hour.

• First, use the template above and try to write three versions of a potential venture fund thesis. As mentioned above, be as concise and specific as possible.
• Next, read each of them aloud while recording a video of yourself. Speak conversationally (in the same way you might casually pitch the idea to someone in an elevator), and in one video "take". 
• Then, watch the videos and ask yourself if you would realistically invest in that thesis. How clear was the message? How confident was the delivery? What questions come to mind?
• Finally, revise the thesis and video until you are satisfied with your work. Resist the urge to make the one-sentence thesis a one-page thesis. Remember: brevity is the key. 

Download this VC Investment Thesis Worksheet

What are the next steps.

This is just one part of the first steps to starting a venture capital firm, which include: 

• Review Our VC Investment Thesis Template
• Determining Your Venture Capital Fund Size
• Selecting a Venture Fund Area of Focus
• Building a Strong Value Proposition for a VC Firm

We will be adding separate guides for each of these sections shortly on our main How to Start a Venture Capital Firm Guide . 

This content is provided by VC Lab, the YC for VC. Learn more about the industry-leading and free programs at: https://GoVCLab.com If you have questions about venture capital, ask the leading AI for VC, Decile Base. The Decile Base venture AI offers a fund lawyer, accountant, and tax specialist on demand. https://DecileHub.com/base VC Lab is a part of Decile Group. Decile Group is unlocking the potential of venture capital with a full-stack platform that empowers emerging managers to launch top-performing funds 3x faster through training, tools, and capital. https://DecileGroup.com

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VC Decision Making (Online): Developing an Investment Thesis

Navigate the changing trends in venture capital

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Create Your Own Venture Capital Strategy

Venture capital funding has experienced exponential growth in recent years. While the peak for venture capital in terms of dollar value has passed in the face of the global economic slowdown, the field continues to be one of tremendous opportunity — if you know where to find it.

In order to thrive in this fast-paced, volatile environment, venture capital professionals must stay abreast of trends and develop a solid investment thesis to help them navigate uncertainty and pinpoint viable opportunities.

Lead faculty Angela Lee is the founder of 37 Angels, an investing network that has evaluated 20,000 startups, invested in 90+ startups, and currently activates new investors through a startup investment boot camp. Join us to learn how to create a successful investment strategy and decision-making framework to improve venture fund performance and intelligently diversify your portfolio.

Global venture capital funding surged to $621B in 2021, two times more than in 2020, and around 10 times the level of 10 years ago.

Source: CB Insights

$132B invested in financial services in 2021, which is 169 percent year-over-year growth and 21 percent of total venture funding.

62 percent of all venture capital deals are early-stage deals.

Key Takeaways

By the end of the program, you will be able to:

• Determine the best investment strategy for your portfolio
• Establish your criteria for industries and business models to invest in
• Understand the risk/return trade-offs between investing in different stages
• Recognize and navigate trends that are transforming the venture capital market and uncover upcoming opportunities

Who Should Attend?

This advanced-level program is designed specifically for mid-career venture capital professionals interested in exploring the evolution of the venture capital landscape and identifying emerging startup trends and technologies in which to invest.

Program Modules

Get a refresher on the venture capital industry and self-assess your current knowledge. Identify the venture capital players, risks, rewards, and funding stages, and navigate the venture capital deal flow process.

Compare existing startup investment strategies and determine the investment strategy that works best for your portfolio.

Identify components of an investment thesis, evaluate real-world investment thesis examples, and build your own criteria for industries and business models in which you want to invest.

Understand the best stages in which to invest and how they benefits your portfolio. Compare methods used to mark up a portfolio.

Explore technology trends that have transformed the market and how to spot upcoming opportunities. Apply a framework to plan for uncertainties and decide on the trends that can add value.

Learn how to get — and stay — ahead of the curve with your investment strategies. Learn the differences between structural and cyclical changes, which help you make informed investment decisions.

Program Experience

World-Renowned Faculty

Learn from accomplished faculty, and industry experts whose diverse backgrounds encompass a broad range of disciplines

Guest Speakers

Accomplished academics and experts offer unique perspectives and the opportunity to put learning into practice

Live Faculty Sessions

Get actionable insights in live online interactions with faculty who are recognized leaders in their fields

Engaging Assignments and Activities

Hone business acumen and executive skills with try-it activities that help you redefine your potential

Program Faculty

Professor of Professional Practice in Finance, Faculty Director, the Eugene Lang Entrepreneurship Center, Columbia Business School

Angela Lee Professor of Professional Practice in Finance, Faculty Director, the Eugene Lang Entrepreneurship Center, Columbia Business School Angela Lee is an award-winning professor and former Chief Innovation Officer at Columbia Business School, where she teaches venture capital and leadership programs. She started her career in product management and then moved to consulting at McKinsey. She founded 4 startups and is also the founder of 37 Angels, an investing network that has evaluated over 20,000 companies and invested in over 90+ companies. She also serves as a venture partner at Fresco Capital, an early-stage venture fund that focuses on the future of work, digital health, and sustainability. She was awarded the Dean's Award for Teaching Excellence at Columbia Business School in 2020 and won the Singhvi Prize for Scholarship in the Classroom in 2022. Angela has spoken at the White House and NASA and is an expert in teaching online and making learning scalable. She is a sought-after expert on CNBC, Bloomberg TV, MSNBC, and Fox Business. She was recognized by Inc . as one of 17 Inspiring Women to Watch, by Entrepreneur Magazine as one of 6 Innovative Women to Watch, and by Crain’s as a Notable Women in Tech.

Elliott Robinson Partner, Growth Equity, Bessemer Venture Partners Elliott Robinson is a partner and co-founder of the growth investment practice at Bessemer, where he focuses primarily on cloud software investments, and is a board member of a number of organizations. Prior to Bessemer, he was a partner with M12, a vice president at Georgian Partners, and an associate with Syncom Venture Partners (where he led investments in organizations such as Canva, Forter, and Statespace). He earned his MBA from Columbia Business School and his BS from Morehouse College.

Hilary Gosher Managing Director, Insight Partners Since joining Insight Partners two decades ago, Hilary has played a role in some of the most exciting growth journeys in SaaS history. She founded and leads Insight Onsite, a team that accelerates growth at Insight's portfolio organizations. In addition, she is an adjunct associate professor at Columbia Business School. She holds an MBA from INSEAD in France along with a BA and LLB from the University of Kwa-Zulu Natal, South Africa.

Certificate

Upon completion of the VC Decision Making (Online): Developing an Investment Thesis program, you will receive a certificate of participation from Columbia Business School Executive Education — a powerful testament to your management capabilities — and add two days toward a Certificate in Business Excellence .

Your verified digital certificate will be issued in your legal name and emailed to you, at no additional cost, upon completion of the program as per the stipulated requirements. All certificate images are for illustrative purposes only and may be subject to change at the discretion of Columbia Business School Executive Education.

Other Recommended Programs

• Foundations of Venture Capital (Online) 6 weeks, online Learn the sources for deal flow and select the best organizations to invest in and identify key elements to consider when developing and managing a VC portfolio. Learn more

How do I know if this program is right for me?

After reviewing the information on the program landing page, we recommend you submit the short form above to gain access to the program brochure, which includes more in-depth information. If you still have questions on whether this program is a good fit for you, please email [email protected], and a dedicated program advisor will follow-up with you very shortly.

Are there any prerequisites for this program?

Some programs do have prerequisites, particularly the more technical ones. This information will be noted on the program landing page, as well as in the program brochure. If you are uncertain about program prerequisites and your capabilities, please email us at the ID mentioned above.

Note that, unless otherwise stated on the program web page, all programs are taught in English and proficiency in English is required.

What is the typical class profile?

More than 50 percent of our participants are from outside the United States. Class profiles vary from one cohort to the next, but, generally, our online certificates draw a highly diverse audience in terms of professional experience, industry, and geography — leading to a very rich peer learning and networking experience.

What other dates will this program be offered in the future?

Check back to this program web page or email us to inquire if future program dates or the timeline for future offerings have been confirmed yet.

How much time is required each week?

Each program includes an estimated learner effort per week. This is referenced at the top of the program landing page under the Duration section, as well as in the program brochure, which you can obtain by submitting the short form at the top of this web page.

How will my time be spent?

We have designed this program to fit into your current working life as efficiently as possible. Time will be spent among a variety of activities including:

• Engaging with recorded video lectures from faculty
• Attending webinars and office hours, as per the specific program schedule
• Reading or engaging with examples of core topics
• Completing knowledge checks/quizzes and required activities
• Engaging in moderated discussion groups with your peers
• Completing your final project, if required

The program is designed to be highly interactive while also allowing time for self-reflection and to demonstrate an understanding of the core topics through various active learning exercises. Please email us if you need further clarification on program activities.

What is it like to learn online with the learning collaborator, Emeritus?

More than 300,000 learners across 200 countries have chosen to advance their skills with Emeritus and its educational learning partners. In fact, 90 percent of the respondents of a recent survey across all our programs said that their learning outcomes were met or exceeded. All the contents of the course would be made available to students at the commencement of the course. However, to ensure the program delivers the desired learning outcomes the students may appoint Emeritus to manage the delivery of the program in a cohort-based manner the cost of which is already included in the overall course fee of the course. A dedicated program support team is available 24/5 (Monday to Friday) to answer questions about the learning platform, technical issues, or anything else that may affect your learning experience.

How do I interact with other program participants?

Peer learning adds substantially to the overall learning experience and is an important part of the program. You can connect and communicate with other participants through our learning platform.

What are the requirements to earn the certificate?

Each program includes an estimated learner effort per week, so you can gauge what will be required before you enroll. This is referenced at the top of the program landing page under the Duration section, as well as in the program brochure, which you can obtain by submitting the short form at the top of this web page. All programs are designed to fit into your working life. This program is scored as a pass or no-pass; participants must complete the required activities to pass and obtain the certificate of completion. Some programs include a final project submission or other assignments to obtain passing status. This information will be noted in the program brochure. Please email us if you need further clarification on any specific program requirements.

What type of certificate will I receive?

Upon successful completion of the program, you will receive a smart digital certificate. The smart digital certificate can be shared with friends, family, schools, or potential employers. You can use it on your cover letter, resume, and/or display it on your LinkedIn profile. The digital certificate will be sent approximately two weeks after the program, once grading is complete.

Can I get the hard copy of the certificate?

No, only verified digital certificates will be issued upon successful completion. This allows you to share your credentials on social platforms such as LinkedIn, Facebook, and Twitter.

Do I receive alumni status after completing this program?

No, there is no alumni status granted for this program. In some cases, there are credits that count toward a higher level of certification. This information will be clearly noted in the program brochure.

How long will I have access to the learning materials?

You will have access to the online learning platform and all the videos and program materials for 12 months following the program start date . Access to the learning platform is restricted to registered participants per the terms of agreement.

What equipment or technical requirements are there for this program?

Participants will need the latest version of their preferred browser to access the learning platform. In addition, Microsoft Office and a PDF viewer are required to access documents, spreadsheets, presentations, PDF files, and transcripts.

Do I need to be online to access the program content?

Yes, the learning platform is accessed via the internet, and video content is not available for download. However, you can download files of video transcripts, assignment templates, readings, etc. For maximum flexibility, you can access program content from a desktop, laptop, tablet, or mobile device. Video lectures must be streamed via the internet, and any livestream webinars and office hours will require an internet connection. However, these sessions are always recorded, so you may view them later.

Can I still register if the registration deadline has passed?

Yes, you can register up until seven days past the published start date of the program without missing any of the core program material or learnings.

What is the program fee, and what forms of payment do you accept?

The program fee is noted at the top of this program web page and usually referenced in the program brochure as well.

• Flexible payment options are available (see details below as well as at the top of this program web page next to FEE ).
• Tuition assistance is available for participants who qualify. Please email [email protected].

What if I don’t have a credit card? Is there another method of payment accepted?

Yes, you can do the bank remittance in the program currency via wire transfer or debit card. Please contact your program advisor, or email us for details.

I was not able to use the discount code provided. Can you help?

Yes! Please email us with the details of the program you are interested in, and we will assist you.

How can I obtain an invoice for payment?

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Writing a Credible Investment Thesis

by David Harding and Sam Rovit

Every deal your company proposes to do—big or small, strategic or tactical—should start with a clear statement how that particular deal would create value for your company. We call this the investment thesis . The investment thesis is no more or less than a definitive statement, based on a clear understanding of how money is made in your business, that outlines how adding this particular business to your portfolio will make your company more valuable. Many of the best acquirers write out their investment theses in black and white. Joe Trustey, managing partner of private equity and venture capital firm Summit Partners, describes the tool in one short sentence: "It tells me why I would want to own this business." 10

Perhaps you're rolling your eyes and saying to yourself, "Well, of course our company uses an investment thesis!" But unless you're in the private equity business—which in our experience is more disciplined in crafting investment theses than are corporate buyers—the odds aren't with you. For example, our survey of 250 senior executives across all industries revealed that only 29 percent of acquiring executives started out with an investment thesis (defined in that survey as a "sound reason for buying a company") that stood the test of time. More than 40 percent had no investment thesis whatsoever (!). Of those who did, fully half discovered within three years of closing the deal that their thesis was wrong.

Studies conducted by other firms support the conclusion that most companies are terrifyingly unclear about why they spend their shareholders' capital on acquisitions. A 2002 Accenture study, for example, found that 83 percent of executives surveyed admitted they were unable to distinguish between the value levers of M&A deals. 11 In Booz Allen Hamilton's 1999 review of thirty-four frequent acquirers, which focused chiefly on integration, unsuccessful acquirers admitted that they fished in uncharted waters. 12 They ranked "learning about new (and potentially related) business areas" as a top reason for making an acquisition. (Surely companies should know whether a business area is related to their core before they decide to buy into it!) Successful acquirers, by contrast, were more likely to cite "leading or responding to industry restructuring" as a reason for making an acquisition, suggesting that these companies had at least thought through the strategic implications of their moves.

Not that tipping one's hat to strategy is a cure-all. In our work with companies that are thinking about doing a deal, we often hear that the acquisition is intended for "strategic" reasons. That's simply not good enough. A credible investment thesis should describe a concrete benefit, rather than a vaguely stated strategic value.

This point needs underscoring. Justifying a deal as being "strategic" ex post facto is, in most cases, an invitation to inferior returns. Given how frequently we have heard weak "strategic" justifications after a deal has closed, it's worth passing along a warning from Craig Tall, vice chair of corporate development and strategic planning at Washington Mutual. In recent years, Tall's bank has made acquisitions a key part of a stunningly successful growth record. "When I see an expensive deal," Tall told us, "and they say it was a 'strategic' deal, it's a code for me that somebody paid too much." 13

And although sometimes the best offense is a good defense, this axiom does not really stand in for a valid investment thesis. On more than a few occasions, we have been witness to deals that were initiated because an investment banker uttered the Eight Magic Words: If you don't buy it, your competitors will.

Well, so be it. If a potential acquisition is not compelling to you on its own merits, let it go. Let your competitors put their good money down, and prove that their investment theses are strong.

Let's look at a case in point: [Clear Channel Communications' leaders Lowry, Mark, and Randall] Mayses' decision to move from radios into outdoor advertising (billboards, to most of us). Based on our conversations with Randall Mays, we summarize their investment thesis for buying into the billboard business as follows:

Clear Channel's expansion into outdoor advertising leverages the company's core competencies in two ways: First, the local market sales force that is already in place to sell radio ads can now sell outdoor ads to many of the same buyers, and Clear Channel is uniquely positioned to sell both local and national advertisements. Second, similar to the radio industry twenty years ago, the outdoor advertising industry is fragmented and undercapitalized. Clear Channel has the capital needed to "roll up" a significant fraction of this industry, as well as the cash flow and management systems needed to reduce operating expenses across a consolidated business.

Note that in Clear Channel's investment thesis (at least as we've stated it), the benefits would be derived from three sources:

• Leveraging an existing sales force more extensively
• Using the balance sheet to roll up and fund an undercapitalized business
• Applying operating skills learned in the radio trade

Note also the emphasis on tangible and quantifiable results, which can be easily communicated and tested. All stakeholders, including investors, employees, debtors, and vendors, should understand why a deal will make their company stronger. Does the investment thesis make sense only to those who know the company best? If so, that's probably a bad sign. Is senior management arguing that a deal's inherent genius is too complex to be understood by all stakeholders, or simply asserting that the deal is "strategic"? These, too, are probably bad signs.

Most of the best acquirers we've studied try to get the thesis down on paper as soon as possible. Getting it down in black and white—wrapping specific words around the ideas—allows them to circulate the thesis internally and to generate reactions early and often.

The perils of the "transformational" deal . Some readers may be wondering whether there isn't a less tangible, but equally credible, rationale for an investment thesis: the transformational deal. Such transactions, which became popular in the exuberant '90s, aim to turn companies (and sometimes even whole industries) on their head and "transform" them. In effect, they change a company's basis of competition through a dramatic redeployment of assets.

The roster of companies that have favored transformational deals includes Vivendi Universal, AOL Time Warner (which changed its name back to Time Warner in October 2003), Enron, Williams, and others. Perhaps that list alone is enough to turn our readers off the concept of the transformational deal. (We admit it: We keep wanting to put that word transformational in quotes.) But let's dig a little deeper.

Sometimes what looks like a successful transformational deal is really a case of mistaken identity. In search of effective transformations, people sometimes cite the examples of DuPont—which after World War I used M&A to transform itself from a maker of explosives into a broad-based leader in the chemicals industry—and General Motors, which, through the consolidation of several car companies, transformed the auto industry. But when you actually dissect the moves of such industry winners, you find that they worked their way down the same learning curve as the best-practice companies in our global study. GM never attempted the transformational deal; instead, it rolled up smaller car companies until it had the scale to take on a Ford—and win. DuPont was similarly patient; it broadened its product scope into a range of chemistry-based industries, acquisition by acquisition.

In a more recent example, Rexam PLC has transformed itself from a broad-based conglomerate into a global leader in packaging by actively managing its portfolio and growing its core business. Beginning in the late '90s, Rexam shed diverse businesses in cyclical industries and grew scale in cans. First it acquired Europe's largest beverage-can manufacturer, Sweden's PLM, in 1999. Then it bought U.S.–based packager American National Can in 2000, making itself the largest beverage-can maker in the world. In other words, Rexam acquired with a clear investment thesis in mind: to grow scale in can making or broaden geographic scope. The collective impact of these many small steps was transformation. 14

But what of the literal transformational deal? You saw the preceding list of companies. Our advice is unequivocal: Stay out of this high-stakes game. Recent efforts to transform companies via the megadeal have failed or faltered. The glamour is blinding, which only makes the route more treacherous and the destination less clear. If you go this route, you are very likely to destroy value for your shareholders.

By definition, the transformational deal can't have a clear investment thesis, and evidence from the movement of stock prices immediately following deal announcements suggests that the market prefers deals that have a clear investment thesis. In "Deals That Create Value," for example, McKinsey scrutinized stock price movements before and after 231 corporate transactions over a five-year period. 15 The study concluded that the market prefers "expansionist" deals, in which a company "seeks to boost its market share by consolidating, by moving into new geographic regions, or by adding new distribution channels for existing products and services."

On average, McKinsey reported, deals of the "expansionist" variety earned a stock market premium in the days following their announcement. By contrast, "transformative" deals—whereby companies threw themselves bodily into a new line of business—destroyed an average of 5.3 percent of market value immediately after the deal's announcement. Translating these findings into our own terminology:

• Expansionist deals are more likely to have a clear investment thesis, while "transformative" deals often have no credible rationale.
• The market is likely to reward the former and punish the latter.

The dilution/accretion debate . One more side discussion that comes to bear on the investment thesis: Deal making is often driven by what we'll call the dilution/accretion debate . We will argue that this debate must be taken into account as you develop your investment thesis, but your thesis making should not be driven by this debate.

Simply put, a deal is dilutive if it causes the acquiring company to have lower earnings per share (EPS) than it had before the transaction. As they teach in Finance 101, this happens when the asset return on the purchased business is less than the cost of the debt or equity (e.g., through the issuance of new shares) needed to pay for the deal. Dilution can also occur when an asset is sold, because the earnings power of the business being sold is greater than the return on the alternative use of the proceeds (e.g., paying down debt, redeeming shares, or buying something else). An accretive deal, of course, has the opposite outcomes.

But that's only the first of two shoes that may drop. The second shoe is, How will Wall Street respond? Will investors punish the company (or reward it) for its dilutive ways?

Aware of this two-shoes-dropping phenomenon, many CEOs and CFOs use the litmus test of earnings accretion/dilution as the first hurdle that should be put in front of every proposed deal. One of these skilled acquirers is Citigroup's [former] CFO Todd Thomson, who told us:

It's an incredibly powerful discipline to put in place a rule of thumb that deals have to be accretive within some [specific] period of time. At Citigroup, my rule of thumb is it has to be accretive within the first twelve months, in terms of EPS, and it has to reach our capital rate of return, which is over 20 percent return within three to four years. And it has to make sense both financially and strategically, which means it has to have at least as fast a growth rate as we expect from our businesses in general, which is 10 to 15 percent a year. Now, not all of our deals meet that hurdle. But if I set that up to begin with, then if [a deal is] not going to meet that hurdle, people know they better make a heck of a compelling argument about why it doesn't have to be accretive in year one, or why it may take year four or five or six to be able to hit that return level. 16

Unfortunately, dilution is a problem that has to be wrestled with on a regular basis. As Mike Bertasso, the head of H. J. Heinz's Asia-Pacific businesses, told us, "If a business is accretive, it is probably low-growth and cheap for a reason. If it is dilutive, it's probably high-growth and attractive, and we can't afford it." 17 Even if you can't afford them, steering clear of dilutive deals seems sensible enough, on the face of it. Why would a company's leaders ever knowingly take steps that would decrease their EPS?

The answer, of course, is to invest for the future. As part of the research leading up to this book, Bain looked at a hundred deals that involved EPS accretion and dilution. All the deals were large enough and public enough to have had an effect on the buyer's stock price. The result was surprising: First-year accretion and dilution did not matter to shareholders. In other words, there was no statistical correlation between future stock performance and whether the company did an accretive or dilutive deal. If anything, the dilutive deals slightly outperformed. Why? Because dilutive deals are almost always involved in buying higher-growth assets, and therefore by their nature pass Thomson's test of a "heck of a compelling argument."

Reprinted with permission of Harvard Business School Press. Mastering the Merger: Four Critical Decisions That Make or Break the Deal , by David Harding and Sam Rovit. Copyright 2004 Bain & Company; All Rights Reserved.

[ Buy this book ]

David Harding (HBS MBA '84) is a director in Bain & Company's Boston office and is an expert in corporate strategy and organizational effectiveness.

Sam Rovit (HBS MBA '89) is a director in the Chicago office and leader of Bain & Company's Global Mergers and Acquisitions Practice.

10. Joe Trustey, telephone interview by David Harding, Bain & Company. Boston: 13 May 2003. Subsequent comments by Trustey are also from this interview.

11. Accenture, "Accenture Survey Shows Executives Are Cautiously Optimistic Regarding Future Mergers and Acquisitions," Accenture Press Release, 30 May 2002.

12. John R. Harbison, Albert J. Viscio, and Amy T. Asin, "Making Acquisitions Work: Capturing Value After the Deal," Booz Allen & Hamilton Series of View-points on Alliances, 1999.

13. Craig Tall, telephone interview by Catherine Lemire, Bain & Company. Toronto: 1 October 2002.

14. Rolf Börjesson, interview by Tom Shannon, Bain & Company. London: 2001.

15. Hans Bieshaar, Jeremy Knight, and Alexander van Wassenaer, "Deals That Create Value," McKinsey Quarterly 1 (2001).

16. Todd Thomson, speaking on "Strategic M&A in an Opportunistic Environment." (Presentation at Bain & Company's Getting Back to Offense conference, New York City, 20 June 2002.)

17. Mike Bertasso, correspondence with David Harding, 15 December 2003.

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Investment Thesis Template

Create your own investment thesis slide with this free template

Prior to becoming a Founder for Curiocity, Hassan worked for Houlihan Lokey as an Investment Banking Analyst focusing on sellside and buyside  M&A , restructurings, financings and strategic advisory engagements across industry groups.

Hassan holds a  BS  from the University of Pennsylvania in Economics.

Currently, Adin is an associate at Berkshire Partners, an $16B middle-market private equity fund. Prior to joining Berkshire Partners, Adin worked for just over three years at The  Boston Consulting Group as  an associate and consultant and previously interned for the Federal Reserve Board and the U.S. Senate.

Adin graduated from Yale University, Magna Cum Claude, with a Bachelor of Arts Degree in Economics.

This template allows you to create your own investment thesis slide detailing your overall strategy.

The template is plug-and-play , and you can enter your own text or numbers. The template also includes other slide pages for other elements of a financial model presentation.

According to the WSO Dictionary ,

"An investment thesis aims to take an abstract idea and turn it into a functional investment strategy. An investment thesis helps investors evaluate investment ideas, ideally guiding them in selecting the best ideas that can help meet their investment objectives."

A screenshot below gives you a sneak peek of the template.

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Writing a Credible Investment Thesis

Only a third of acquiring executives actually write down the reasons for doing a deal.

By David Harding and Sam Rovit

• November 15, 2004

Every deal your company proposes to do—big or small, strategic or tactical—should start with a clear statement how that particular deal would create value for your company. We call this the investment thesis. The investment thesis is no more or less than a definitive statement, based on a clear understanding of how money is made in your business, that outlines how adding this particular business to your portfolio will make your company more valuable. Many of the best acquirers write out their investment theses in black and white. Joe Trustey, managing partner of private equity and venture capital firm Summit Partners, describes the tool in one short sentence: "It tells me why I would want to own this business."

Perhaps you're rolling your eyes and saying to yourself, "Well, of course our company uses an investment thesis!" But unless you're in the private equity business—which in our experience is more disciplined in crafting investment theses than are corporate buyers—the odds aren't with you. For example, our survey of 250 senior executives across all industries revealed that only 29% of acquiring executives started out with an investment thesis (defined in that survey as a "sound reason for buying a company") that stood the test of time. More than 40% had no investment thesis whatsoever (!). Of those who did, fully half discovered within three years of closing the deal that their thesis was wrong.

Studies conducted by other firms support the conclusion that most companies are terrifyingly unclear about why they spend their shareholders' capital on acquisitions. A 2002 Accenture study, for example, found that 83% of executives surveyed admitted they were unable to distinguish between the value levers of M&A deals. In Booz Allen Hamilton's 1999 review of thirty-four frequent acquirers, which focused chiefly on integration, unsuccessful acquirers admitted that they fished in uncharted waters. They ranked "learning about new (and potentially related) business areas" as a top reason for making an acquisition. (Surely companies should know whether a business area is related to their core before they decide to buy into it!) Successful acquirers, by contrast, were more likely to cite "leading or responding to industry restructuring" as a reason for making an acquisition, suggesting that these companies had at least thought through the strategic implications of their moves.

Not that tipping one's hat to strategy is a cure-all. In our work with companies that are thinking about doing a deal, we often hear that the acquisition is intended for "strategic" reasons. That's simply not good enough. A credible investment thesis should describe a concrete benefit, rather than a vaguely stated strategic value.

A credible investment thesis should describe a concrete benefit, rather than a vaguely stated strategic value. This point needs underscoring. Justifying a deal as being "strategic" ex post facto is, in most cases, an invitation to inferior returns. Given how frequently we have heard weak "strategic" justifications after a deal has closed, it's worth passing along a warning from Craig Tall, vice chair of corporate development and strategic planning at Washington Mutual. In recent years, Tall's bank has made acquisitions a key part of a stunningly successful growth record. "When I see an expensive deal," Tall told us, "and they say it was a 'strategic' deal, it's a code for me that somebody paid too much."

And although sometimes the best offense is a good defense, this axiom does not really stand in for a valid investment thesis. On more than a few occasions, we have been witness to deals that were initiated because an investment banker uttered the Eight Magic Words: If you don't buy it, your competitors will.

Well, so be it. If a potential acquisition is not compelling to you on its own merits, let it go. Let your competitors put their good money down, and prove that their investment theses are strong.

Let's look at a case in point: [Clear Channel Communications' leaders Lowry, Mark and Randall] Mayses' decision to move from radios into outdoor advertising (billboards, to most of us). Based on our conversations with Randall Mays, we summarize their investment thesis for buying into the billboard business as follows:

Clear Channel's expansion into outdoor advertising leverages the company's core competencies in two ways: First, the local market sales force that is already in place to sell radio ads can now sell outdoor ads to many of the same buyers, and Clear Channel is uniquely positioned to sell both local and national advertisements. Second, similar to the radio industry twenty years ago, the outdoor advertising industry is fragmented and undercapitalized. Clear Channel has the capital needed to "roll up" a significant fraction of this industry, as well as the cash flow and management systems needed to reduce operating expenses across a consolidated business.

Note that in Clear Channel's investment thesis (at least as we've stated it), the benefits would be derived from three sources:

• Leveraging an existing sales force more extensively
• Using the balance sheet to roll up and fund an undercapitalized business
• Applying operating skills learned in the radio trade

Note also the emphasis on tangible and quantifiable results, which can be easily communicated and tested. All stakeholders, including investors, employees, debtors and vendors, should understand why a deal will make their company stronger. Does the investment thesis make sense only to those who know the company best? If so, that's probably a bad sign. Is senior management arguing that a deal's inherent genius is too complex to be understood by all stakeholders, or simply asserting that the deal is "strategic"? These, too, are probably bad signs.

Most of the best acquirers we've studied try to get the thesis down on paper as soon as possible. Getting it down in black and white—wrapping specific words around the ideas—allows them to circulate the thesis internally and to generate reactions early and often.

The perils of the "transformational" deal. Some readers may be wondering whether there isn't a less tangible, but equally credible, rationale for an investment thesis: the transformational deal. Such transactions, which became popular in the exuberant '90s, aim to turn companies (and sometimes even whole industries) on their head and "transform" them. In effect, they change a company's basis of competition through a dramatic redeployment of assets.

The roster of companies that have favored transformational deals includes Vivendi Universal, AOL Time Warner (which changed its name back to Time Warner in October 2003), Enron, Williams, and others. Perhaps that list alone is enough to turn our readers off the concept of the transformational deal. (We admit it: We keep wanting to put that word transformational in quotes.) But let's dig a little deeper.

Sometimes what looks like a successful transformational deal is really a case of mistaken identity. In search of effective transformations, people sometimes cite the examples of DuPont—which after World War I used M&A to transform itself from a maker of explosives into a broad-based leader in the chemicals industry—and General Motors, which, through the consolidation of several car companies, transformed the auto industry. But when you actually dissect the moves of such industry winners, you find that they worked their way down the same learning curve as the best-practice companies in our global study. GM never attempted the transformational deal; instead, it rolled up smaller car companies until it had the scale to take on a Ford—and win. DuPont was similarly patient; it broadened its product scope into a range of chemistry-based industries, acquisition by acquisition.

In a more recent example, Rexam PLC has transformed itself from a broad-based conglomerate into a global leader in packaging by actively managing its portfolio and growing its core business. Beginning in the late '90s, Rexam shed diverse businesses in cyclical industries and grew scale in cans. First it acquired Europe's largest beverage—can manufacturer, Sweden's PLM, in 1999. Then it bought U.S.-based packager American National Can in 2000, making itself the largest beverage-can maker in the world. In other words, Rexam acquired with a clear investment thesis in mind: to grow scale in can making or broaden geographic scope. The collective impact of these many small steps was transformation. 14

But what of the literal transformational deal? You saw the preceding list of companies. Our advice is unequivocal: Stay out of this high-stakes game. Recent efforts to transform companies via the megadeal have failed or faltered. The glamour is blinding, which only makes the route more treacherous and the destination less clear. If you go this route, you are very likely to destroy value for your shareholders.

By definition, the transformational deal can't have a clear investment thesis, and evidence from the movement of stock prices immediately following deal announcements suggests that the market prefers deals that have a clear investment thesis. In "Deals That Create Value," for example, McKinsey scrutinized stock price movements before and after 231 corporate transactions over a five-year period. The study concluded that the market prefers "expansionist" deals, in which a company "seeks to boost its market share by consolidating, by moving into new geographic regions, or by adding new distribution channels for existing products and services."

On average, McKinsey reported, deals of the "expansionist" variety earned a stock market premium in the days following their announcement. By contrast, "transformative" deals—whereby companies threw themselves bodily into a new line of business—destroyed an average of 5.3% of market value immediately after the deal's announcement. Translating these findings into our own terminology:

• Expansionist deals are more likely to have a clear investment thesis, while "transformative" deals often have no credible rationale.
• The market is likely to reward the former and punish the latter.
• The dilution/accretion debate. One more side discussion that comes to bear on the investment thesis: Deal making is often driven by what we'll call the dilution/accretion debate. We will argue that this debate must be taken into account as you develop your investment thesis, but your thesis making should not be driven by this debate.

Sometimes what looks like a successful transformational deal is really a case of mistaken identity. Simply put, a deal is dilutive if it causes the acquiring company to have lower earnings per share (EPS) than it had before the transaction. As they teach in Finance 101, this happens when the asset return on the purchased business is less than the cost of the debt or equity (e.g., through the issuance of new shares) needed to pay for the deal. Dilution can also occur when an asset is sold, because the earnings power of the business being sold is greater than the return on the alternative use of the proceeds (e.g., paying down debt, redeeming shares or buying something else). An accretive deal, of course, has the opposite outcomes.

But that's only the first of two shoes that may drop. The second shoe is, How will Wall Street respond? Will investors punish the company (or reward it) for its dilutive ways?

Aware of this two-shoes-dropping phenomenon, many CEOs and CFOs use the litmus test of earnings accretion/dilution as the first hurdle that should be put in front of every proposed deal. One of these skilled acquirers is Citigroup's [former] CFO Todd Thomson, who told us:

It's an incredibly powerful discipline to put in place a rule of thumb that deals have to be accretive within some [specific] period of time. At Citigroup, my rule of thumb is it has to be accretive within the first twelve months, in terms of EPS, and it has to reach our capital rate of return, which is over 20% return within three to four years. And it has to make sense both financially and strategically, which means it has to have at least as fast a growth rate as we expect from our businesses in general, which is 10 to 15% a year.

Now, not all of our deals meet that hurdle. But if I set that up to begin with, then if [a deal is] not going to meet that hurdle, people know they better make a heck of a compelling argument about why it doesn't have to be accretive in year one, or why it may take year four or five or six to be able to hit that return level.

Unfortunately, dilution is a problem that has to be wrestled with on a regular basis. As Mike Bertasso, the head of H. J. Heinz's Asia-Pacific businesses, told us, "If a business is accretive, it is probably low-growth and cheap for a reason. If it is dilutive, it's probably high-growth and attractive, and we can't afford it." Even if you can't afford them, steering clear of dilutive deals seems sensible enough, on the face of it. Why would a company's leaders ever knowingly take steps that would decrease their EPS?

The answer, of course, is to invest for the future. As part of the research leading up to this book, Bain looked at a hundred deals that involved EPS accretion and dilution. All the deals were large enough and public enough to have had an effect on the buyer's stock price. The result was surprising: First-year accretion and dilution did not matter to shareholders. In other words, there was no statistical correlation between future stock performance and whether the company did an accretive or dilutive deal. If anything, the dilutive deals slightly outperformed. Why? Because dilutive deals are almost always involved in buying higher-growth assets, and therefore by their nature pass Thomson's test of a "heck of a compelling argument."

As a rule, investors like to see their companies investing in growth. We believe that investors in the stock market do, in fact, look past reported EPS numbers in an effort to understand how the investment thesis will improve the business they already own. If the investment thesis holds up to this kind of scrutiny, then some short-term dilution is probably acceptable.

Reprinted with permission of Harvard Business School Press. Mastering the Merger: Four Critical Decisions That Make or Break the Deal , by David Harding and Sam Rovit. Copyright 2004 Bain & Company; All Rights Reserved.

David Harding (HBS MBA '84) is a director in Bain & Company's Boston office and is an expert in corporate strategy and organizational effectiveness.

Sam Rovit (HBS MBA '89) is a director in the Chicago office and leader of Bain & Company's Global Mergers and Acquisitions Practice.                                              

10. Joe Trustey, telephone interview by David Harding, Bain & Company. Boston: 13 May 2003. Subsequent comments by Trustey are also from this interview.

11. Accenture, "Accenture Survey Shows Executives Are Cautiously Optimistic Regarding Future Mergers and Acquisitions," Accenture Press Release, 30 May 2002.

12. John R. Harbison, Albert J. Viscio, and Amy T. Asin, "Making Acquisitions Work: Capturing Value After the Deal," Booz Allen & Hamilton Series of View-points on Alliances, 1999.

13. Craig Tall, telephone interview by Catherine Lemire, Bain & Company. Toronto: 1 October 2002.

14. Rolf Börjesson, interview by Tom Shannon, Bain & Company. London: 2001.

15. Hans Bieshaar, Jeremy Knight, and Alexander van Wassenaer, "Deals That Create Value," McKinsey Quarterly 1 (2001).

16. Todd Thomson, speaking on "Strategic M&A in an Opportunistic Environment." (Presentation at Bain & Company's Getting Back to Offense conference, New York City, 20 June 2002.)

17. Mike Bertasso, correspondence with David Harding, 15 December 2003.

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An Investment Thesis: The Key To Making More Money Long Term

In general, the longer you stay invested, the greater your chance of making money. To help you maintain a long-term investment approach, it's imperative to develop an investment thesis.

Drawing from my experience in investing since 1995, it's sometimes easy to get shaken out of a particular investment. Or it’s easier for some people to just keep their money sitting in cash out of fear of financial loss. I get it. I’ve lost plenty of money before because there are no guarantees when you take risk.

I observed panic selling during the 2000 dot bomb and 2008 global financial crisis, affecting both stock and real estate sellers. More recently, I witnessed panic selling at the beginning of the global pandemic in 2020. The events lead me to try and allay fears with the post, “ How to Predict the Stock Market Bottom like Nostradamus .”

Having a solid investment thesis, as long as it remains intact, will provide you with the courage and confidence to hold on for the long term.

The Importance Of Developing An Investment Thesis When Investing

Let me go through some examples of how having an investment thesis has helped me hold long-term and make more money overtime. Coming up with an investment thesis also helped me make a significant decision on a recent dilemma. At the end of this post, I'll also share what makes a good investment thesis.

If you are just starting out and are fearful of investing your hard-earned money, developing an investment thesis will help you take action. To beat inflation , you must continuously invest over the long term. If you don’t overcome your fear of investing, then you will likely fall way behind over time.

Please know that you don't have to be a great investor to make money. You just need to be a good-enough investor to significantly outperform a large part of the population that does not save and invest aggressively.

1) Heartland Real Estate Investment Thesis

In 2016, I published my post titled “ Focus on Trends: Why I'm Investing in the Heartland of America .” My investment thesis was based on the anticipation that more people would relocate to lower-cost areas of the country due to advancements in technology and the increasing ability to work from home. Additionally, I believed that Trump's victory would contribute to increased interest, funding, and expansion in red states.

Given the uncertainty of which specific real estate investment deal to pursue, I opted to invest in a couple of funds that focused on acquiring real estate in the heartland of America. Now, eight years and $954,000 later, I have generally witnessed positive returns on my investments. Texas properties, in particular, have performed quite well since 2016. However, as I shared in my post on private real estate investing after eight years , there have also been some duds as well.

Investing for such an extended period has been relatively straightforward. In the realm of private funds , the expected distributions typically span between 5-10 years.

Based on my investment thesis of a demographic shift to the heartland, I logically looked for real estate investment firms that had the same investment thesis. And I found one in 2016 in Fundrise. Fundrise predominantly invests in the Sunbelt region where valuations tend to be lower and rental yields tend to be higher.

2) San Francisco Real Estate Investment Thesis

When I arrived in San Francisco in 2001, I was amazed by the affordability of real estate compared to New York City. Properties were priced 20 to 30% lower, offering more space for the same cost or a similar property for less.

At that time, compensation in the finance industry was comparable between the two cities at my level. My investment thesis was that prices in SF would catch up to prices in Manhattan due to a better quality of life and the growth of technology.

Didn’t Want To Miss Out On The Tech Boom

My firm played a role in taking Facebook and Google public in the early 2000s. As a result, I anticipated a resurgence in Web 2.0. Lacking the skills or connections to enter the tech industry, I opted to invest in tech stocks and acquire rental properties instead.

Overall, San Francisco property prices have shown positive performance. The excitement of living in a big city attracts billions of people. However, the city's reputation suffered post-pandemic due to hesitancy by officials to address criminal activities and remove drug dealers downtown.

Thankfully, to stay in power, politicians must address corruption, tackle crime, clean up the city, and provide tax incentives for businesses to thrive. Citizens discontented with criminal activities are likely to vote out ideological politicians and judges who harm the community. Consequently, there is potential for the city's image to be restored post 2024 election, leading to a recovery in real estate prices.

Deja Vu With Artificial Intelligence

Since 2023 there has been an extraordinary surge in tech stock prices. Fueled by substantial bonuses and robust portfolios, I anticipate that a portion of this wealth will flow back into San Francisco Bay Area real estate. Redfin reports that luxury home prices are reaching all-time highs , attracting a significant number of all-cash buyers .

The rise of artificial intelligence (AI) is evoking a sense of déjà vu, reminiscent of 25 years ago when the internet promised to revolutionize the world. Today, it is equally apparent that AI will shape the world in the next two decades.

Despite the likelihood that most of us won't secure lucrative AI jobs due to intense competition, there's an opportunity for ordinary individuals to invest in AI companies. Beyond public companies like Nvidia, Microsoft, Google, and Facebook, private investments can be made through open-ended venture capital funds like the one offered by Fundrise.

Fundrise launched its venture capital product at the end of 2022, which was great timing given private company valuations had corrected. The investment minimum is only $10, so everybody can participate. You can see the holdings, and the fees are much lower than closed-end venture capital funds.

I am personally adopting this approach by investing in both public and private AI-related companies. My goal is to allocate $500,000 to these companies over the next five years. This strategy not only positions me for potential gains but also serves as a hedge against the challenges AI might pose for our children in terms of job opportunities.

AI Facilitated My Property Decision

In my previous post, “ Rent out, sell, or create a wellness center, ” I detailed my dilemma regarding what to do with my old house. At 46 years old, with two young children and already managing four rental properties, the prospect of overseeing another rental didn't appeal to me.

Being a landlord can be burdensome, particularly when dealing with challenging tenants or constant maintenance issues. Such responsibilities take away time that could be better spent on more enjoyable activities, like playing tennis or spending quality moments with my kids.

After reading through the comments on my post, which provided diverse opinions on the course of action, I weighed the options and arrived at a decision to rent out the house and hold it for the long term. The deciding factor was the formulation of an investment thesis.

Why Renting Out Is Better For Now

My investment thesis revolves around the belief that owning a single-family home on the west side of San Francisco is a sound decision. Local economic catalysts, including the opening of a large school in the fall of 2024 and the $4 billion renovation of the UCSF Parnassus Hospital by 2030 (expected to create 1400 new jobs), indicate a positive trajectory for real estate on the west side.

Remote work is here to stay. In addition, there is a demographic transition from downtown on the east side to the west side. The final catalyst for my decision to rent out is the anticipated wealth generated by Artificial Intelligence (AI) for employees and investors. As a result, I will suck it up as a landlord for the next 3-5 years and then reevaluate. The earliest I'd relocate to Honolulu, Hawaii is in 2030.

I spoke to Ben Miller, CEO of Fundrise , and he believes we're past the real estate market as do I. As a result, holding onto my property and renting it out makes even more sense.

3) The Vision Pro Investment Thesis For Apple

I've owned Apple stock since 2012 and it has done well. With the S&P 500 surpassing 4,900, I've faced increasing challenges in finding compelling stock investments. However, when the Vision Pro was unveiled on February 2, 2024, my interest was piqued.

At that time, Apple had just reported somewhat soft quarterly results, causing a dip in the stock. I contemplated whether this could be the opportunity to further invest in the company. After dedicating several hours to researching the Vision Pro, I concluded that the answer was affirmative.

Apple's new Vision Pro is a significant accessibility tool for the visually impaired . Approximately 2.2 billion people worldwide experience some form of visual impairment. While an estimated 237 million face moderate to severe impairment. Among them, 40 million are considered legally blind or completely blind. This figure is expected to rise to 115 million by 2050.

Consequently, I believe the Vision Pro holds the promise of greatly assisting a substantial portion of the global population in enhancing their vision and interaction capabilities. Considering the critical importance of sight, the demand for this product should be relatively inelastic for the visually impaired. Furthermore, Apple is likely to enhance the product over time and reduce its retail cost. I can’t wait for version 2 and 3.

An Example Of How The Vision Pro Can Help The Visually Impaired

If you have regular sight or can correct your myopia or hyperopia with glasses or contact lenses, then you might take for granted your vision. Seeing a small screen on your phone or the 10-point font size on a menu is usually not a problem. For for those with visual impairments, it can be.

This Vision Pro commercial succinctly captures one of its many benefits for the visually impaired.

Apple is already an outstanding company with intelligent employees and an impressive product line. Further, it is cash flow positive with substantial cash reserves and a dividend payout. My confidence in investing in Apple stock aligns with my confidence in the S&P 500. However, I anticipate additional upside potential, particularly with the introduction of the Vision Pro and how Apple with integrate artificial intelligence with all its products.

Note: The definition of legally blind means the inability to correct your visual accuity to at least 20/200 with corrective lenses. Most people can correct their visual acuity to 20/20 to 20/40 with glasses or contacts. Legally blind usually does not mean complete blindness, as many people who are legally blind still have some vision.

America The Great: The Ultimate Investment Thesis

I harbor a home country bias as an American patriot. I've resided in this country since 1991 and have payed six figures in taxes annually since 2003. My children were born on American soil. In addition, I've crafted over 2300 personal finance posts aimed primarily at aiding Americans in achieving financial freedom sooner. These experiences have fostered my deep connection and commitment to this nation.

I envision my final days in America, leaving behind a positive legacy . Consequently, my long-term outlook is bullish and biased on owning American assets.

The greatness of America, in my belief, stems from:

• Entrepreneurial spirit
• Strong work ethic
• A stable democratic government
• A robust legal system safeguarding intellectual property and individual rights
• A formidable defense industry ensuring citizens' protection
• A stable world currency
• Generally thoughtful and kind people aspiring to assist others globally in attaining freedom
• A history of unity during times of crisis, exemplified by events like 9/11 and the pandemic

While acknowledging America's challenges—crime, poverty, socioeconomic injustices—I consider it unwise to bet against its long-term excellence. The collective willpower of our nation, I believe, will drive ongoing positive improvements.

I advocate that everyone, globally, should find a way to own a piece of America . You can do so by buying the S&P 500 or U.S. physical real estate or private real estate.

In 50 years, when our grandchildren become adults, they will appreciate our foresight in investing in America today. Despite inevitable economic fluctuations, with a well-defined investment thesis, we stand to accumulate wealth beyond our current imagination.

What Makes A Good Investment Thesis

A good investment thesis is a well-researched and articulated rationale behind an investment decision. It serves as a comprehensive guide that outlines the reasons and expectations for choosing a particular investment. Here are key characteristics of a good investment thesis:

• Clear and Concise: The thesis should be easily understandable and to the point.
• Supported by Research: Ground your thesis in thorough research, including fundamental analysis, technical analysis, and an understanding of relevant economic and market trends.
• Alignment with Goals: Clearly state how the investment aligns with your overall financial goals and objectives. Whether it's capital appreciation, passive income generation , or risk mitigation, the thesis should reflect your goals.
• Identifies Investment Opportunity: Specify the investment opportunity or opportunities you have identified. This could involve a specific asset class, industry, sector, or individual securities.
• Analysis of Risks: Acknowledge and assess the risks, challenges, and uncertainties associated with the investment.
• Time Horizon: Clearly define your time horizon for the investment. Specify whether it's a short-term trade, a long-term hold, or something in between.
• Competitive Advantage: Understand what sets it apart from competitors and how it plans to sustain or enhance that advantage.
• Financial Metrics: Include relevant financial metrics supporting your investment decision. This may include valuation ratios, growth rates, profitability, and other key financial indicators.
• Scenario Analysis: Consider different scenarios and outcomes. A well-thought-out thesis anticipates how the investment might perform under various circumstances.
• Adaptable and Dynamic: Recognize that market conditions can change. A good investment thesis is adaptable and allows for adjustments based on new information or changing circumstances.
• Exit Strategy: Clearly outline your exit strategy. Know under what conditions you would sell or reduce your position.
• Communication: Share your thesis with others to find any blind spots, like I am with this post. Others should be able to understand your rationale and analysis.

Keeping updating your investment thesis over time

Having a good investment thesis won't guarantee success, but it's like a roadmap for your investments. Keep updating it based on what's happening in the market, and make sure you invest for the long term.

For example, after the failed assassination attempt on July 15, 2024, Trump will likely become the 47th president of the United States. As a result, there may be further upside with your investments in 2025 and beyond. Here's a detailed article on what Trump's presidency means for your money .

Investment theses can vary in quality, and sometimes you might get the investment right with the wrong thesis. The main thing is to have a good reason why you're investing, so you stick with it over time.

In 10 years, you'll probably end up with more money who keeps investing for the long haul, compared to someone who doesn't invest or tries to time the market. Decide which situation you want to have in the future.

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35 thoughts on “an investment thesis: the key to making more money long term”.

Folks investing should have an Investment Policy Statement (IPS).

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Research the subject and find a Financial Advisor (RIA) firm that prepares such IPS reports and go over your situation with them. Ron Delegge at ETFguide can prepare an IPS for you for a reasonable fee. You can find his firm online.

your quote sums up our last 40+ years of heavy real estate investing vs investing in equities.

“Since 1996, I’ve discovered that having a well-defined investment thesis increases the likelihood of consistently investing and holding onto investments during challenging periods. As the old saying goes, ‘time in the market is more important than timing the market.’ This lesson came to me the hard way during the first 10 years of my investing career.”

We were told many times that we would lose it all, go bankrupt, have to grovel to return to work & suffer the never ending torment of bad tenants & damages. We could write a book on it all, as it definitely was not easy, but since 1998 (& retired) we have been free & clear on every property since, have no debt since & live comfortably between three homes during the year after selling our 4th, a FL home of 31 years, just before H. Ian hit. love your articles & financial insight.

My California real estate thesis is this:

Despite numerous rent control efforts and the State’s (and most coastal counties’) hostility towards landlords, I think California residential real estate will be very lucrative for landlords assuming they have sufficient cash on hand to withstand vacancies, evictions, cash for keys, etc.

This is because rent control decreases landlord and developer participation in providing housing and thus leads to fewer units on the market. Fewer units on the market will increase rental prices.

Hi, like you I own and manage a few rental properties in the city, which is our primary income. Although the rental market here isn’t great, at least it’s stabilized. It’s like survive until 2025 and hopefully things will turn around in SF. These upcoming city elections, with a swell of moderate candidates will hopefully make a tangible difference in quality of life issues, which of course have hurt SF’s reputation worldwide.

I’m also bullish on the potential for the AI industry. But work from home is pervasive and I think downtown and soma are going to be challenged for several years. Also tech firms are less concentrated in the Bay Area now and getting more distributed in 2nd tier cities. The saving grace for SF is that many local neighborhoods are now more cleaned up and also have thriving foot traffic, if it’s the mission, inner sunset, etc. So I feel good about the future of good and established SF neighborhoods, which is where I own properties.

SF has roughly doubled in value every 10years, which is amazing. The first chart in this report is a good visual, https://www.bayareamarketreports.com/trend/3-recessions-2-bubbles-and-a-baby The main thing I need to wrap my head around is that I think the next 5-10 years will not have the amazing appreciation that we’ve had since the mid-late 90’s when I started investing. I honestly got used to that phenomenal rate growth, but I’m trying to set more modest expectations going forward.

How bullish are you on future SF appreciation? Do you think it will be anything like the last 30 years?

The market may simmer this year. But I think it’ll eventually go up again by a rate of 3.5 to 5% a year. If you look at the historical cycles, there’s generally about 4 to 5 years of flat lining.

Given we’re already at a high base, the growth rate of appreciation won’t be as high as in the past. That said, I think there’s gonna be another renaissance of Wealth being created over the next 10 to 20 years with new tech / AI.

What the cost of building materials, labor, and restrictive building should help push real estate prices higher.

Yeah 3.5-4.5% SF real estate returns over the next 5-10 years is probably realistic. 7% is unlikely, which is what we’ve gotten used to :) Without that outsized 7% equity return, and holding my properties debt free (no leverage), keeping them long term vs selling and going into the stock market becomes a much closer call.

My cash on cash on my RE is 3.5-4%, plus 3.5-4.5% expected appreciation totals 7-8.5% total returns, which is roughly in line with s&p 500 long term returns. Tax treatment favors RE, but then again with stocks you don’t need to deal with tenants and repairs. But of course the main issue is transferring my RE equity into stocks is bloody expensive, with sales expenses and capital gains of about 37%. So I’m still better off holding the RE. My only issue is that I’m heavily RE weighed, with only a small stocks portfolio. My plan has been to dollar cost average excess RE profits into stocks to better balance my portfolio.

I’ll just have to see what transpires over the next 2-3 years to our fair city, plus evaluate the macro economic picture. I guess this “sell RE, buy stocks” dilemma isn’t such a bad problem to have. But nevertheless it’s nice to have a “safe space” (sic) such as this blog where wealthy people can freely cry about their problems…IRW anytime I bring this up to people it’s like, “wait, let me get the worlds smallest violin to play for you” :)

Innovation Fund vs going after AI public companies like the following that are already established and surging YTD. Thinking the latter might be more attractive and with less risk.

Nividia TSMC Arm SoundHound

I don’t have thesis, only several points: -Only buy S&P 500 index with lowest fee. -No trading, hold for LONG time. – Maximize all tax deferred accounts. – No investment in a single company since I have no control over management. I bought and didn’t look at my account for years . I just recently checked and saw that it has 13% compounding interest making me millionaire.

Well done. Don’t forget to capitalize on your investments by selling on occasion to buy things you want and improve the quality of your life. Otherwise, there’s really no point to investing in stocks.

Is there a fundrise equivalent for non-US citizens? Thanks in advance. Dave

Hi Dave, I’m not aware of one. You can just invest in a public real estate ETF like VNQ or one of the publicly-traded REITs like O. Just know they are more volatile.

Just to clarify, Innovation Fund is not currently open to new investors but has a “waitlist.”

Also what is happening with publically traded companies in the AI thesis seems to me to mean that not really necessary to take on added risk of start-ups. just look at recent performance of ARM SMCi and NVDA. and that is just a few. i will continue inverting in a broad 10-12 public stocks and sure to gain solid and not massive returns. i look at it this way, if a start up here or there will do 10x and some will bust, leaving you with overall 3-4 times return, then i am likely to better with the established companies in a sector where the revolution has just begun. smci is up 3x in just a month.

That’s weird. I just checked with Fundrise and the Innovation Fund is open to investors.

“The Innovation Fund is OPEN to new investors. It is possible this person is unable to make a direct investment into the fund if they are an existing investor who is not a Pro member. This is something we’re working on.

But to reiterate the fund is open to new investors.

If you select the Venture Capital investment plan during signup you can invest in the Innovation Fund.”

I’m an existing investor and don’t believe I’m a pro member. I’m able to invest in the Innovation Fund.

i’m an existing investor but not a pro member and i am not able to invest in Innovation fund so must fall into that segment. it is not provided as an option when i select “browse investments” in my account. i then read a review of the fund from late 2023, i will try to post, and it did say that it wasn’t open to all yet. it did said all you needed was $10 to start.

You should reach out to them and let them know.

ASH01 – What are the 10-12 AI public companies you are targeting besides Nividia, smci and ARM? Thoughts on TSMC & SoundHound? I tend to agree with your thesis. Why take on the private risk when the public companies should still be in their infancy in terms of AI growth.

As discussed earlier, here is my investment thesis which could be quite controversial:

1. A portfolio of 50/50 real estate vs. stock. The stock portion should not be lower but could be much higher. Holding real estate is mostly for pleasure/need and rent. Rental properties are all places i would want to live. Once pleasure part of real estate is no longer needed, should graduate to stocks or to rental units.

2. Stocks is a mix of SP500 and Tech i.e. Nasdaq 100, XLK, VOOG and also exposure to single high performing stock. No international stock. No bonds. Mostly automated invested to cost average. Real estate rental income is the security in case stock market crashes.

3. Flexible and nimble approach. Whenever the market is down, try investing more and don’t withdraw funds.

4. No investment in private funds, real estate funds, bitcoin and other cryptos which i dont understand and have no transparency. No need to complicate.

Sounds good. What’s your investment thesis though for your tech stocks?

It’s a good mantra to not invest in what you don’t understand.

I really enjoy investing private funds (VC, VD, real estate) as it forces me to invest for the long term ~10 years. The capital calls also keep me investing even when I might not want to.

I am excited about building out, my artificial intelligence exposure, and I have one from the invested in Ripple, which has turned out to be maybe a 20-40X return. Maybe I can cash out just in time to buy a new car in 2027, when my current car is 12 years old.

Here’s an example of an AI company one of my private funds (Kleiner) is investing in. I’m pumped! https://techcrunch.com/2024/02/06/ambience-healthcare-raises-70m-for-its-ai-assistant-led-by-openai-and-kleiner-perkins/

I’m also excited about the AI investments in the Fundrise Innovation Fund , like Databricks.

Sounds good. As for tech, i have a single stock exposure due to my employment which is doing better than market and is a great company that does good work. So thesis for that is don’t fix what is working. As for the rest, my strategy is similar to most here – i Invest in 15-20% of stock portfolio in QQQ and lesser to XLK and VOOG which are Apple, Microsoft heavy – i believe i get enough AI and other exposure through these since i dont know what the next big thing will be.

One last point. I am very bullish about US Stocks for the following reasons:

1. European markets are not performing. On surface, it appears cheap to buy however not a single tech company in the top 100 European companies. 2. China stock market is not performing. Significant decline and volatility. Could be the beginning of a Japan like deflation and decline. 3. US is the center of AI and innovation. 4. Stock ownership, although at historical highs is still low among Americans being at approx 56%.

In couple years, i think everyone will want a piece of the US companies. Already evidenced by the fact that Shiller CAPE after 80s is much higher than historically has been. Could this lead to a bubble? Definitely – but it could well last 10-20 years and the fundamentals could also catch up in the meanwhile either due to AI generated earnings or something else and optimism pays when investing!

My best thesis was investing in semiconductor stocks. Roughly 5 years ago I noticed how almost everything needed a chip. My thesis proved itself out during the pandemic. You couldn’t get a car, dishwasher or any smart device because chips weren’t available. I bought AMD, NVDA, and Intel. 2 of them worked out pretty good. I was banking on the cloud and data centers to boom. That part worked out okay. I didn’t see any of the AI craze coming which has been hugely beneficial. Decent thesis and a ton of luck!

Nice! But what about the future?

Take a little profit and hold the rest for another 5 years. I realize we’re right in the middle of AI mania but everything I read and watch tells me we’re still in the early days of AI.

No matter what happens we’re still going to need more chips to power all our future ambitions

so interesting how almost nobody but nvda saw the AI craze coming. that one earnings report by them set this whole thing off about a year ago. such an interesting phenomenon. AI has been talked about for many years but then suddenly companies decide to try to make a product of it in a massive scale. nvda explosion in earning was because companies suddenly ordered their chips.

Yup, I spend hours a day watching cnbc, reading blogs and doing research and I truly didn’t know what AI could do or how much money companies could make off it. Luck is definitely a factor.

VTI + VXUS + long haul = chill

Agree, but it’s hard to retire earlier by just investing in the total stock market. There are two levels of wealth , the top-tier wealth did not get there by investing in ETFs or index funds.

100% agree with you on that front! BUT I do personally believe that 95% of people will accumulate more wealth through regular and automated index investing over time vs. active investment strategies such as picking 1:1 stocks. I would guess you also have a sizable audience base that loves the content but also leans toward simple investing strategies over the long haul and not constantly stressing about achieving the top tier of wealth. The content here can sometimes make you feel behind, overly stressed that you’ll never have enough, and stuck stressing about the future. I personally have to step back and remember it’s really about regular investing (in your strategies of choice) + time in the market and not timing the market. Which I personally think is a sound investment thesis! Love the content though to be clear. It’s really helped me think about allocation percentages and mortgage payoff strategies.

Yes, good points. For most people, buying a primary residence and regularly investing in an S&P 500 index fund is a great long-term strategy.

Personally, I like to always be challenged bc it’s fun. Even if I fail, I will likely have accumulated more than if I hadn’t pushed myself.

From my coaching days, the players who advance the most are pushed the hardest.

But good reminder to press the easy button once in a while for readers who may be burning out or feeling behind.

I love your clear and specific convictions in your investment thesis. That’s something I need to work on. Very cool on the Apple Vision Pro. I don’t have anything specific in my own investments. Although I do believe in long term real estate, stock, and tech exposure. Thanks for the list of steps on creating an investment thesis.

I’ve been investing since the mid-1980s. Every time I’ve evaluated my portfolio against a portfolio of index funds using backtesting of 5 years and more, the index funds (with expenses deducted) have beaten my portfolio’s performance over a 5+ year time horizon. I’ve finally realized that I have a lot more money today if I’d purchase a mix of three low-cost, passively managed index funds. My latest lesson occurred during the latest 5 year period in which my portfolio performed well. It did what it was designed to do (mitigate losses during down markets like 2022). I was only down 2% that year. Unfortunately, if I had invested in a mix of SCHD (50%), SCHG (25%), and SWPPX (25%), that portfolio would have crushed my performance by a wide margin. Yes, it lost more money in 2022 (around 14.75%) but dramatically exceeded its performance in the other four years. I’m done trying to be smart. I’m buying a mix of passive ETFs and accepting the market risk.

Thanks for posting that. You basically stated my “investment thesis”:

1. My assets must grow in order for me to keep up with long term inflation 2. Over the long haul it’s very difficult for me to outperform the market 3. Figuring out my my risk tolerance and indexing accordingly is probably my best bet

No different than you, it’s taken since the mid 1980’s for this reality to really set in…

Those are great points Vaughn. Keep the focus and stay invested for the long term!

Active funds underperform their benchmark passive index >95% of the time after 10 years. With retail investors its over 99% with average underperformance by 4% *annually*. The 1% that crush due to lucky pick with concentration are the reason people still do it, but I’d rather have a 99x higher chance to have a +4% CAGR *and* barely think about it.

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We also talk about how to write an investment thesis and how a journal can help when markets get choppy.

In this podcast, Motley Fool host Ricky Mulvey and analyst Tim Beyers discuss:

• Toast 's quarter and its move into convenience stores.
• Shopify 's impressive profitability and what could put a damper on the e-commerce platform's growth story.

Then, Motley Fool host Mary Long and analyst Asit Sharma discuss how to write an investment thesis.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center . To get started investing, check out our quick-start guide to investing in stocks . A full transcript follows the video.

This video was recorded on August 08, 2024.

Ricky Mulvey: Toast isn't playing ball, but you're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by Tim Beyers. Tim. How you doing?

Tim Beyers: Doing well, fully caffeinated, ready to go.

Ricky Mulvey: I'm going to ask you that question a second time because, the market's been a little nuts this week, and Mary and Asit are going to talk about mindset later in the show. How are you right now as an investor? How's this past week been for you?

Tim Beyers: This is the market that is great for me. I know it's not good for a lot of people, and I will not dismiss that, Ricky. But for me, this is when I am at my absolute best as an investor. I get nervous and anxious when the market is going up into the right for reasons that I cannot explain. When we have irrational sell offs, I'm great, man. I've bought two stocks, new positions this week, which I can't talk about because of our disclosure rules. You can ask me about that another time, maybe next week. This is when I am at my absolute best. I love it when the market decides to do full Kermit and run around with its hands in the air and just cannot figure out which way is up.

Ricky Mulvey: Have also been buying. I talked about it with Gillies a couple of days ago. Let's dive into some individual companies you can talk about. One of them your favorites, I should say. I don't know if it's your favorite.

Tim Beyers: That's still my favorite.

Ricky Mulvey: That is the payment software that asks you a question after you check out and get your cup of coffee. Tim, before I get into the numbers, there was a moment in the Q&A, where an analyst asked the CEO, basically, about the international and retail expansion. I was hoping you could touch on that and maybe use a baseball analogy. What inning are we in in terms of building out the platform for these new verticals? I think that's a fair question. I'm not going to use a baseball analogy. Yep. Then described what was happening. Let me throw that at you, Tim. When you look at Toasts quarter, how would you describe it using a baseball analogy?

Tim Beyers: I would say it's very early innings. I'd say, you know, first or second inning. I think to Aman Narang's credit, he's one of the co founders, said, I'm not going to use a baseball analogy, but I will say that, our core business is 11-12 years old, we're one, not even really two years in, so you could draw a similar conclusion here. We've barely talked about the first 10% of the opportunity here, and we may be even earlier than that. I think in terms of their expansion opportunity outside their core business, we've barely scratched the surface. Overall, remember, this is a company that originally targeted 800,000 US restaurant locations as its core market. That's an immediately serviceable market. Now they have said, and I know we're going to get to this a little bit later. There are some other areas they can expand into that open up another 220,000 locations to them. Now we're talking over one million. Right now they're at 120,000 locations. Are we in the earliest of early innings? Yes, we are. Absolutely.

Ricky Mulvey: Let's look at some of the highlights from the quarter, adding 8,000 new locations, so the total now stands at $120,000 positive gap operating income by a SMIG, $5 million, but that's enough to make it positive Tim, and annualized recurring revenue at $1.5 billion. That is a 30% increase from last year. Sounds like good numbers to me, but what from the quarter really stands out to you?

Tim Beyers: Toast has said that one of the ways you want to measure them is on their core profitability metric. Their core profitability metric. I'm going to say this twice so you can do this math for yourself because they report all of these numbers. They take adjusted EBITDA. That is the numerator. Adjusted earnings before interest, taxes, depreciation, and amortization, they report that on every press release. This quarter, it was $92 million. You take that and divide it by the sum of their subscription gross profit. That's a core piece of their business. They sell subscriptions to the core Toast software, the platform that restaurants subscribe to, and then the FinTech gross profit, which is their share of the business that they help process at all of their restaurant customers. They believe they can get that margin, Ricky up to somewhere between 30 and 35%. They said they can get that stable at that level over the long term. In the latest quarter that is now up to 27.88%. That was a year ago at 5.79%. This is one of those businesses where Toast is saying, here's our target, here's where we think we can get to, and they have unrelentingly marched toward that goal. They haven't slowed down. It's interesting to me that the market says, we don't care about that.

Ricky Mulvey: What is that I heard the formula for it? What is that profitability metric? What's the story behind it?

Tim Beyers: The story behind that profitability metric is, let me put it this way. When Toast goes into a new restaurant group, They will essentially add a loss. They'll do this as a loss leader. They will deploy a bunch of people to help you install their software, and they'll put hardware in your hands, those little tablets that you have seen, if you've gone to a restaurant and you've checked out with Toast, and a server has come up and had a little tablet in their hand, and it says Toast on it. That's all stuff they sell at a loss. Then on the back end, they believe that they will make a significant long term profit, by doing right by you and getting their software and hardware into your hands and helping you do more business at your restaurant group over time. The subscription gross profit and the FinTech gross profit reflect that belief. That the more that you use our products, the more subscription gross profit, the more you will make inside your restaurant group, FinTech gross profit, and for us, once you strip out all of the things that we spend in order to put all this stuff in your hands, the core profits, the adjusted EBITDA, we're going to make a lot of money and so are you. Everybody's going to win here. It's a metric that's designed to reflect what that win, win, win dynamic of the Toast business actually looks like financially.

Ricky Mulvey: One of the stories we got in the earnings call was Taziki's, and they explained how they're able to help them, essentially with the Toast Point of Sale system. They upsell different food items that go well with different drinks. Tim sounds like you're pretty happy with Toast right now, but it doesn't seem like the market is happy with Toast after this earnings release. You said they were unrelentingly going toward this profitability goal. That's usually a good sign for a company. What's the market so unhappy with?

Tim Beyers: I have no idea. The market seems like a teenager that you cannot say anything right like, we're going to get pizza tonight. I'm a vegetarian, and all you ever do is order pepperoni pizza. It's that sort of thing. It feels ridiculous. I do not understand it. I think the guidance was reasonable. It was in line. They didn't beat guidance by any means, Ricky. But the last two quarters, when they have issued guidance on adjusted EBITDA, they've smashed it. They have absolutely smashed their guidance numbers. I don't get it. I don't know why there's so much angst here, but I will say this. I do think this is a good sign for anybody who has not yet opened a Toast position because the market has not yet chosen to believe that what Toast says defines value inside the business. The market is not valuing the company according to those metrics. They're just ignoring it. What I told you about, that core profitability metric, the market doesn't care. They're not paying attention to it. That is not how the market is valuing this business. They're using something else. I don't know exactly what else they're using, Ricky, but they are using that core profitability metric. The institutional investors, do not believe that Toast can scale up its free cash flow margins to much higher than they are today. They just don't believe it. If it does happen, which I believe it will, then I'm going to get paid, and other Toast investors are going to get paid quite well.

Ricky Mulvey: I hope so as a Toast investor. Let's talk about the new verticals. Toast is trying to move into grocery convenience stores, bottle shops. So far, they've got 1,000 new customers in this space. I think of Toast as a restaurant company, but what do you think about this move, and does it affect your thesis for the company?

Tim Beyers: It doesn't affect my thesis yet. It's way too early. I like the idea, especially the idea of putting Toast into liquor stores, because liquor stores have something in common with small restaurant groups that have dedicated owners, because that's really where Toast sweet spot is. It's not in the one, like, somebody who has a bakery shop in one location. That's not Toast score market, nor is it like RBs? It's not that, either. It's in the middle, sit down restaurant, Bistro restaurant group of, 5-20 locations. Liquor stores are like this. Liquor stores, like in a regional area, you might have a group that owns, 5-8 liquor stores. That's actually a great market for Toast, and they tend to use really old Point of Sale technology, and they could benefit. They have to manage a lot of logistics inside those liquor stores because that's a high turnover business. People come in, and they're buying wine, beer, hard liquor, they're buying it all the time. You have lots of supply chain logistics. You have payroll and inventory, just like anything else. You have the other common things that are, areas of interest and or pain for a retail business. I think it's a very smart idea. Regional grocery stores, small markets, local liquor store groups, I think that's an excellent place for Toast to strategically expand.

Ricky Mulvey: Let's move on to Shopify where we are getting a free cash flow story. Yesterday was some welcome relief for Shopify Investors. Last quarter, shop told investors to expect some margin pressure, and this quarter it beat expectations handedly. Free cash flow is up about 250% from the prior year. Tim, I know you like talking about unit economics. That's a unit economic story. What's going on at Shopify?

Tim Beyers: We hope so. It does seem like it. I think it's more a cost management story. I think they've done a really good job of getting on the other side of selling the logistics business and getting back to core principles, so in that sense, sure, it absolutely is a unit economic story here. But what we're seeing is that Shopify is expanding its influence and it's doing good things to capture a larger market. There's just more business being done on Shopify. As they scale up, they do get the benefit of it. As long as they keep their unit economics relatively steady, they are going to get that benefit of rising cash flows, rising margins, as their customers take them up on, just give more responsibility to Shopify overall. You could certainly see that. The gross merchandise volume was up substantially to $67.2 billion, I believe. Now you are at, what is that? $252 billion in annualized gross merchandise volume. That is that's serious business, Ricky.

Ricky Mulvey: Shopify crossed 1 trillion total in gross merchandise volume. President Harley Finkelstein would like us to reflect on that. I think there's another number you want to reflect on. You're giving me a shrug of emoji right now, Tim.

Tim Beyers: Harley Finkelstein is a terrific salesperson, and he he is a brilliant hype man for Shopify. I think you need to know that that he's a brilliant hype man and not take him exactly at his word. He's very good, though. He's a really good servant for Shopify. I don't think that one trillion metric matters all that much. What I will say is that the value that, Shopify can compound value for investors is when that gross merchandise volume number grows, and with it, the attach rate. As really the way that Shopify goes up into the right and gets real hockey stick growth for investors is if there's more business being done on the platform, more sales, more payments processed. Then more of that activity accrues to Shopify. It's roughly stayed stable, though, Ricky. The attach rate isn't going up. It's going down, but I would say it's largely flat. In the latest quarter, that attach rate was 2.98%. The way you get that is two billion in revenue. Divided by 67.2 billion in gross merchandise volume. It's about 2.98%. A year ago, it was at 3.09%. Down a little bit. I would call that roughly flat. The way that Shopify from here at its valuation. If you want today's valuation to look cheap, get that attached rate up to 3.5%, get it up to 4%. If you have vendors, shoppers, the entire ecosystem of people that are participating in the Shopify experience. If they are giving more dollars to Shopify, look out. Today's valuation will look very cheap. If the attached rate doesn't move that much, Ricky, then I think you could make an argument that Shopify is maybe not outrageously priced, but probably at least fairly priced. You need that attached rate to go up.

Ricky Mulvey: You're saying you need them to flex their pricing power a little bit for some hockey stick growth?

Tim Beyers: Yes, I need them to be involved in more parts of the transaction. Yes.

Ricky Mulvey: Any yellow or warning flags in Shopify's quarter. You said Harley Finkelstein is a great salesperson, but, this is also a company where less so to do with the company, more to do with the valuation. It's gotten ahead of its snowboard before. Any signs of caution stand out to you.

Tim Beyers: I don't know that this is a cautionary note, but it is something to be aware of. Payments are now 61% of gross merchandise volume. The business that's being done on the Shopify platform, all of those dollars, a lot of it that, Shopify gets credit for is there, not because there's a lot more commerce being done on the platform. Although there is, there is more commerce being done on the platform. The growth is coming from Shopify being involved in more of the payments, more of the transactions. That's not necessarily a bad thing, but it is at least a risk because it puts Shopify at conflict with payments processors. They do need to not forget their roots. Shopify needs more commerce to happen on its platform, not just more involvement in payments on its platform. I think that'll happen. They are talking about, greasing the skids for things like international sales. That would be good. You need that. You need more commerce on the Shopify platform, and you need Shopify getting involved in more of those payments transactions. If those things happen, and they don't need to happen overnight, Ricky. This can be slow and steady wins the race here. A little bit at a time. We're expanding the reach of the commerce platform. We're seeing more commerce from more regions on the Shopify. That's a good thing. Then if there's more payments, and there's more Shopify involvement in those payments, that is also a good thing. You don't need much. Like, little incremental improvements will generate big leaps in cash flows. I am cautiously optimistic about the way that Shopify is going about its business. Let's not pretend that this is, smooth sailing from here. There's work still to do.

Ricky Mulvey: Good place to end it. Tim Beyers. Appreciate coming on, and thank you for your time and your insight.

Tim Beyers: Thanks for Ricky.

Ricky Mulvey: As we wrap up, just wanted to note our latest premium podcast launched this week. It's called Epic Opportunities. This is available to members of Epic and the Motley Fools advanced investing services. You can catch the show on Spotify by linking your Motley Fool account or through the Motley Fool App. We'll put links to all of those in the show notes for today's episode.

Ricky Mulvey: All right, up next. We've got a volatile market, and Motley Fool Senior Analyst Asit Sharma joined my colleague, Mary Long to discuss how to write an investment thesis and how a journal can help when markets get choppy.

Mary Long: Asit, it won't come as any surprise to you when I say that this week opened with a whole lot of market turbulence. For today, we're going to focus less on what happened, why that happened, and more talk about what do you do when this stuff happens? Because whether the market stays in correction territory, reverts, re corrects, goes up, goes down, what have you. The fact of the matter is that when you're investing, there will be times when the stock market gets spooked. There will also be times when it gets unspooked, and then spooked again. With all that in mind, what do you do when volatility and uncertainty seem to be everywhere you turn.

Asit Sharma: Mary, there are a few things that I do. One is just totally related to the investing side of it. I try to double down on businesses that I like. Few reasons for this. One is the obvious. If volatility is in full swing, prices are all over the map, then maybe you get some buying opportunities for companies that you already have conviction in. It pays to go back to your watch lists or businesses that you've studied. The second is more of a mindset thing. The market's going crazy. Where do you want to focus your attention on like the flashy news sites that are trying to draw you into more angst? Or do you want to go to a safe place, which is like let me go back to that transcript where Satya Nadella talked about how Microsoft was going to destroy its competition. He didn't use those exact words, but he talked about all that great CapEx investment. That's a place where my mind should be, I think, in times of volatility, focusing on what's going to make money. It's the business results, not the share price.

Mary Long: Fair point, but I have to hone in on something. Is Satya Nadella really your happy place? The Microsoft Earnings call transcript is your happy place?

Asit Sharma: Not really, but this is an investment focus podcast. People don't want to hear about the mundane ways that I get to my happy place. Which is this zig zagy route. Sometimes it starts with just cleaning the inside of my grill. I think I'm starting to resonate here with some people. It may end in a paperback novel, I don't know. This is off topic for us. This is not what folks want to talk about. The market is so volatile You want to hear about that investing happy place. [laughs] That's why I went first.

Mary Long: The investing happy place. We can bring it back to the investing happy place. Here, I'll make a smooth segue. You mentioned Paperback Novels. The other day, on our Members only Live Stream, right in the midst of this Monday, market, mania, whatever we want to call it. You talked a bit about keeping an investment journal and the importance of that and how the idea was that, when times are tough, you've got this written record of why you believe in a company that you can return to. Talk to us a little bit about your investment journal and what goes into it. How do you write an investment thesis right off the bat?

Asit Sharma: So many great questions. First of all, an investing journal it means different things to different people. For some of us, it's a place to deal with our emotions when the markets are really coasting and we see our wealth expanding. It could be a way to just keep ourselves grounded. Just jot down those emotions. I feel really great, but I'm scared at how well this is going, or it could be the opposite. It could be a time like this where you see so much volatility in the markets, and you just want to document that it's unsettling. Maybe just write down what those long term goals are, the ones that got you into your whole investing journey, that's always helpful. For other people, these aren't exclusive sets. It could be more about trying to document why you like a company, what you think its characteristics are that are going to advance it past other competitors in the business world and that's the share price should follow why the share price will rise versus other companies or the market in general. That's always fun to return to, which gets us to your third question here, which is, how do you write a business thesis? What is it? I will tell you when I started in this game, I thought it was about a lot of facts and figures. In fact, if you'd asked me to write a business thesis or an investment thesis about a company, I don't know 10, 15 years ago, I probably would have returned you three pages to prove a point. What's that point? I'm Smart.

Mary Long: I'm smart. Look at your numbers.

Asit Sharma: Exactly. You should listen to me. Look at all this stuff. Look at these reams of data. I'm supporting my points. Sharma, what are your points? I don't know. [laughs] Stocks are going to go up. I learned over time that an investment thesis is really simple. There was a great investor who used to work at the Motley Fool. Some of you may know him if you are in the gaming world. His name is Aaron Bush. At one time he posted on Twitter now X, really succinct bullet pointed list of things you should do as investor. One of the main tenets of that list is like, just narrow it down, dial it down, make it more succinct. Don't overthink this. That is very true as I've come across other investors and learned from so many great investors here at the Motley Fool. An investment thesis should be simple, easy to grasp. You and I should be able to explain in this conversation, Mary, before people stop listening, two or three investment theses to each other, because what you're trying to identify is the crux of why a company should succeed, and that usually is pointing to two or three advantages in the marketplace, how that company is going to capitalize on them. If there are a gazillion advantages that a company has, I will tell you that's too good to be true. There's something on the other side of that coin you may not have looked at. In my mind, it is something very simple.

Mary Long: In preparation for this conversation, I had asked you if there was a company or a stock that maybe you were revisiting in light of all the ups and downs over the past few days. If you wouldn't mind sharing the thesis of that company with us, you took what should have been maybe a simple request, and you challenge yourself because you picked a company that's hard to explain. Let's see if you can do it. Could you share that thesis with us that you drafted up before this?

Asit Sharma: Sure. I want to talk about Lam Research . This company is a leader in the semiconductor industry. It makes machines that make silicon. You need complex machines to build integrated circuits. Lam sells these machines to companies that manufacture integrated circuits. I like this company because it's yes, somewhat cyclical. Mary most of its equipment is used to make electronics. Computers, memory, etc. It's cyclical, but it has a tailwind and an advantage in this economy, which is shifting toward Gen AI products. There are really a few things behind that. One is that Generative AI is increasing demand for a type of storage called N-A-N-D flash storage. That's a type of memory that Lam's tools specialize in. Also, Generative AI is pushing up demand for something called high bandwidth memory. This is really stacking memory on a chip that often surrounds the compute functions of the chip. It's something that NVIDIA is requesting more of and AMD is requesting more of. Companies that make this type of memory or the tools to make this type of memory are going to benefit. Lam is going to benefit from that. It's trading at really attractive forward multiples. The stock is down due to this volatility and a few other factors. I don't know, Macro economic acceleration, more angst in the market, and some slacking off of Generative AI demand, which is going to happen at some point could push shares down further. Maybe they're not such a bargain here. Also, I should note this geopolitical picture we have with China and the semiconductor back and forth between our two countries is going to catch some companies, perhaps like Lam in the middle, Lam has about 39% of its latest revenue [laughs] out of the greater China region. With that, I think my initial thought right now for Lam Research is actually to buy a few shares to dollar-cost average in. I don't own any shares right now.

Mary Long: My next question was going to be, has your mind changed on this, but it sounds like maybe it's a newer idea that's been on your watch list for a minute that now makes sense to jump into.

Asit Sharma: Yeah I think my mind is changing because I've had it on a watch list for a long time. I've studied this company. It is a recommendation in Stock Advisor. There's some free IP for those of you who aren't members of Stock Advisor. We like this company very much. I've looked at it for other services. For me personally, I'm warming to it. The thesis is changing somewhat. Probably the price falling a bit is pushing that. Also, the more I learn about the trends within the Gen AI industry, the more I see that Lam is an essential player. It's not that it doesn't have competition, it does. I wouldn't put it quite on the level of companies like ASML . Another specialized company which has literally no competition right now, but not a bad one to look at.

Ricky Mulvey: As always, people on the program may have interests in the stocks they talk about. The Motley Fool may have formal recommendations for or against buyer sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.

Asit Sharma has positions in Advanced Micro Devices and Microsoft. Mary Long has positions in Shopify. Ricky Mulvey has positions in ASML, Shopify, and Toast. Tim Beyers has positions in Shopify and Toast. The Motley Fool has positions in and recommends ASML, Advanced Micro Devices, Lam Research, Microsoft, Shopify, and Toast. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy .

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Why Microsoft’s Earnings Miss Won’t Stall the A.I. Boom

Investors are worried about how much companies are spending on artificial intelligence, but the tech giant is sure that its efforts will pay off.

By Andrew Ross Sorkin Ravi Mattu Bernhard Warner Sarah Kessler Michael J. de la Merced Lauren Hirsch and Ephrat Livni

Big Tech’s big spending

The technology sector is facing another rough patch, after Microsoft reported mixed quarterly earnings and its shares tumbled. The company’s results are fueling more concern among investors about whether hefty spending on artificial intelligence will pay off, and how long that might take.

But analysts say that Microsoft is on better footing than its rivals, and that investor enthusiasm for all things A.I. will remain strong over the long term.

Microsoft missed earnings expectations for its cloud business by a hair. The company said on Tuesday that its Azure division grew 30 percent in the most recent quarter, just short of the 31 percent that the company had forecast.

Shares in the tech giant were down 3 percent in premarket trading on the results, echoing a similar market reaction to Alphabet last week, when Google’s parent company disclosed the scale of its ever-growing A.I. bills.

Other A.I.-related stocks are down, too. Shares in Nvidia , the dominant A.I. chipmaker, closed down 7 percent on Tuesday, wiping about $250 billion off its market value, while those in Arm, the SoftBank-controlled chip design company, fell 6 percent.

The costs of the A.I. boom are hanging over Big Tech. Microsoft has invested $13 billion in OpenAI, the company behind ChatGPT, and a number of other partnerships with A.I. start-ups to meet soaring demand. On Tuesday, the company revealed more mind-boggling numbers behind its effort to win the A.I. race:

It spent almost $19 billion in capital expenditure last quarter, up almost 80 percent year-on-year and more than twice as much as it invested two years ago.

Spending on new building and data center improvements rose to $35.4 billion for the fiscal year that just ended, up from $13.5 billion in the previous year.

Microsoft isn’t going to pull back. Satya Nadella, the company’s C.E.O., told analysts the investments were key to “capture the opportunity of A.I.” Amy Hood, its C.F.O., said that spending would rise this year, adding that the investments in data centers would be monetized “over 15 years and beyond.”

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More From Forbes

Go small to go big: small wins prove ai isn’t a bubble.

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SAN FRANCISCO, CALIFORNIA - NOVEMBER 06: OpenAI CEO Sam Altman speaks during the OpenAI DevDay event ... [+] on November 06, 2023 in San Francisco, California. Altman delivered the keynote address at the first-ever Open AI DevDay conference.(Photo by Justin Sullivan/Getty Images)

The overarching narrative of AI being a bubble is rooted in the idea that behind all the NVIDIA GPUs shipping to hyperscalers there is a nearly non-existent demand for AI.

At first glance, the idea that Meta Platforms Inc., Alphabet Inc.’s Google, Amazon.com Inc., Tesla Inc., and other companies would spend more than $100 billion in capex on AI infrastructure (sell-In) without a clear view of what customers are going to do with it (sell-out) is almost absurd. However, there are very smart people in Venture Capital and financial services at firms like Sequoia and Goldman Sachs that are suggesting AI, at least at this current juncture, is a bubble .

Is there an AI Bubble?

The answer depends on the timetable by which you measure AI and its impact on industries.

First, historically speaking, AI algorithms are more than four decades old, and the tech industry has been investing heavily in variants of artificial intelligence such as machine learning, deep learning, neural networks, and more extensively for at least 10 to 15 years.

Generative AI, and its late 2022 arrival, changed the timeline and gave a glimpse of what felt like a more prescient type of AI that generated text, images, then video, and now a variety of outputs — providing a sneak peek at what we refer to as Artificial General Intelligence, the holy grail or end of days depending on whom you talk to.

Today, the market is seeking to better understand how the sell-in of GPUs and XPUs at a pace of more than $100 billion in 2024 , and growing, is going to convert to value outside of the tech industry.

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For instance, AI is showing up at banks, hospitals, hotels, manufacturing plants, transportation, retail, and more. The bear thesis is AI is mostly hype, with limited evolution from the data optimization tactics of the past 15 years and that customers aren't going to pay more for SaaS services with Generative AI capabilities or new PCs and smartphones with AI features.

Our intelligence data suggests otherwise. What many aren’t accounting for in the AI calculus is the timeline that AI will be digested and deployed, and how that will vary across industries and lead to a variance in time-to-value for many business use cases.

Our data is also showing triple-digit percent increases in multimillion-dollar proof of concepts (POCs) in 2024 and mid- to high- double-digit percentage growth of AI use in key industries like financial services, healthcare, and telco growing near 40% CAGR over the next five years. Use cases like object detection and conversational AI are also seeing more than 35% growth (five-year CAGR), which means the silicon investment and infrastructure build out will have to convert to software and industry use cases. However, it is more of a drip right now. And once the dam breaks, it will become a waterfall.

I've regularly referenced the three AI network effects, and I’ll refer back to them here once again. We are seeing most of the AI impact on the economy in the n0 and n1 effects with increasing small wins for the n2 node. All of this provides a big opportunity for the System Integrator community that is building these POCs and supporting the buildout of AI within the enterprise chip design and manufacturing network (NVIDIA, AMD Inc., Synopsys Inc., TSMC, Arm Holdings, Intel Corp., etc.)

Network One Infrastructure buildout (Dell, Lenovo, Super Micro Computer Inc., AWS, Microsoft Azure, Google Cloud, Oracle Corp., etc.)

Network Two Enterprise Software and SaaS + Devices at the edge (Salesforce Inc., Microsoft Corp. apps, Palantir Technologies Inc., SAP, Oracle, ServiceNow Inc., IBM Corp., HP Inc., Dell Inc., Samsung Electronics, Apple Inc., etc.)

Network Three Industry Adoption and Implementation (financial services, manufacturing, healthcare, etc.)

In conclusion, AI and mega cap tech have a different horizon for AI than most investors and certainly traders.

Businesses have been extracting value in AI for years, and generative AI has accelerated demand, increased data volumes, and increased pressure on enterprises to implement AI faster to stay competitive. But the expense of build out and the complexity of the data estate are substantial challenges for most companies, and the tech industry does have an important point to make that AI features are incremental. Customers and consumers are willing to pay for AI features, especially those that have free (often open source) alternatives.

There isn’t really a bubble around AI, but there also aren’t enough big wins for analysts and investors to fully see the economic impact beyond the data center.

I see that changing in the next 18 months. Some may think that is too long, so we’ll have to settle for small wins that keep on coming or perhaps another way of looking at it is when it comes to AI implementations it will be slow at first, and then (nearly) all at once.

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Microsoft: Roadblocks In GenAI Based Growth Can Lead To Near-Term Price Deterioration

• Microsoft's stock outperformance is attributed to its Generative AI leadership, however may face near-term challenges.
• The incorporation of niche data is crucial for the development of Large Language Models (LLMs) and commercializing Generative AI.
• New York Time's recent lawsuit against OpenAI and Microsoft highlights the potential roadblocks LLM developers will face.
• We expect near-term risk for Microsoft meeting its growth expectations, which can create an opportunity for long term investors to take a position on any repricing of the stock.

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Investment Thesis

Microsoft ( NASDAQ: MSFT ) is one of the most impactful global businesses of our time. While the company has solid fundamentals backed by a large runway for growth in its area of focus, namely Cloud and Commercial Software, we believe the market is pricing in an unreasonable amount of near-term growth from the recently announced GenAI initiatives. We believe there are several challenges to GenAI initiatives coming to the forefront and moving the needle for large tech players such as Microsoft. This can lead to a near-term price deterioration from any performance miss compared to market expectations which long term investors can benefit from to take a position in the stock. We see potentially 15-20% downside from today's valuation with limited margin for safety.

Perceived GenAI Impact on MSFT's Growth

It should now be obvious to everyone that Generative AI (GenAI) is a significant contributor to Microsoft stock's recent outperformance compared to its peers. While the first mover advantage created by Microsoft through its partnership with OpenAI and other GenAI based initiatives it has undertaken (and announced) is impressive, it is not immune to the complex challenges accompanying the deployment of its AI strategy. Recent developments have shed light on some of these challenges, most notably the recent news around New York Times ( NYT ) suing OpenAI and Microsoft for use of copyrighted work . This event highlights two important themes:

• The importance of incorporating niche data in the development of Large Language Models (LLM) in order to bring GenAI closer to commercialization
• Potential access to data challenges LLM developers (who are basically all backed by the large tech companies) will face going forward

In this article, we will discuss these themes and the overall impact these will likely have on the GenAI world where Microsoft is currently the leader. We believe this impact will have implications on how the market is currently valuing Microsoft's stock and its growth trajectory and we will provide our perspective on the company's valuation.

MSFT Recent Stock Performance (Seeking Alpha)

The Importance of Data in LLM Development and the Quest for Niche Data

The development of LLMs such as OpenAI's GPT models and Google's ( GOOG ) Bard (among others) depends heavily on vast amounts of data. This data is generally sourced from various sources such as scraping the internet, public data sets, crowdsourcing and even synthetically generated data. The more extensive the dataset, the more comprehensive the language model's understanding of human language becomes. At the same time, the variety in the data set ensures a broader grasp of different contexts, styles and use cases. Currently, all LLM developers are focused on incorporating various data sets into their models and we are seeing the concept of model convergence emerge. This essentially means that the various models will eventually perform at a similar level simply because they have been trained on the same data. Therefore, the key differentiator in the future will be the availability of niche data on which each LLM is trained.

Comparison of various LLMs ( source )

LLM developers, including OpenAI (backed by Microsoft), are encountering hurdles in accessing niche data crucial for training their models. The most high profile example of this is NYT's claim of copyright infringement by OpenAI/Microsoft. While NYT's move to sue is likely a negotiating tactic in getting OpenAI/Microsoft to agree to a higher licensing fee and more favorable terms (based on news reports , negotiations have been ongoing for quite some time), it highlights the challenge which all LLM developers will face in the near term in getting access to niche data. The landscape is likely to shift as data owners, such as journalism organizations and artists, recognize the financial potential behind GenAI and the fact that big tech's deep pockets are up for grabs. Note that OpenAI and other developers have already struck deals with several data owners as evidenced by OpenAI's deal with Axel Springer and Apple's licensing deals with various organizations.

Financial Implications for Microsoft and other Tech Companies Counting on GenAI Monetization

General impact on llms.

The financial implications of this issues should be fairly clear. LLM developers will have to pay a substantial amount of fees to content owners in order to further develop their models. It is important to understand that these are not expected to be one-time expenses. AI models require refreshing on a regular basis; according to McKinsey , one-third of AI models needs to be refreshed at least monthly, and one in four require a daily refresh. The cost of data will vary depending on the uniqueness associated with it. For example, in the case of New York Times, OpenAi will likely be looking at other sources who produce similar type of content (e.g. Washington Post and other publications) however more niche data (such as customer information and spending habits) will come at a much greater cost.

Furthermore, we are likely to see an increase in legal costs, not just in fighting off copyright claims, but also indemnifying customers who are subject to copyright claims due to their use of output from LLMs. Anthropic recently updated their service terms to include:

Our Commercial Terms of Service (previously our services agreement) will enable our customers to retain ownership rights over any outputs they generate through their use of our services and protect them from copyright infringement claims.

Ultimately, this will elongate the LLM development cycle and likely slow down the monetization benefits expected from this new technology and developers strike deals with individual data owners. Additionally, margins will be suppressed for an extended period which will impact the bottom lines of large tech players.

Microsoft Specific Impact

While Microsoft's efforts to date in progressing its GenAI strategy are commendable (certainly industry leading), it should be noted that we are in the very early innings of this long game. The future growth which has been underwritten by the market in determining Microsoft's current valuation will require substantial enhancements to GenAI's capabilities. While the current capabilities are great at generating text and image based content, it is currently limited to a few use cases which present limited opportunities for monetization for Microsoft's customers. Microsoft has announced its intention to incorporate GenAI into its Copilot offerings however given the limited use cases to date, the uplift which Microsoft will receive from these offerings will be nowhere near sufficient in meeting its underwritten growth targets. Consider the fact that OpenAI, which we believe is currently generating the bulk of global GenAi based revenue, is expected to hit ~$1.3b in revenue this year. While this is impressive growth given the hype around GenAI was only created roughly 1 year ago, this barely moves the needle for a company such as Microsoft which needs to grow its revenue in its next fiscal (FY25) year by ~$34b to meet analyst consensus forecast while its most recent fiscal year (FY23) saw revenue growth of ~$13b. The expectations for FY24 growth is ~$32b which is expected to primarily be driven by Microsoft's cloud division however we believe there is a fair bit of risk in at least a slight miss in this year's expectations which could cause a meaningful decline in share price (further discussed in section below). It is clear that future growth expectations for the company is building in a substantial amount of revenue from GenAI based initiatives which may not arrive as quickly as the market expects due to themes such as access to niche data and regulatory scrutiny.

Additionally, consensus targets expect margin uplift at Microsoft which as we explained previously will be challenged as GenAI developers will need to share a portion of their revenue with data owners.

MSFT Financial Performance (Capital IQ)

Microsoft currently trades well above its large tech peers. While a premium is justified given higher margins, lead in GenAI and a capex light model; the difference in forward growth rates (which we believe have the highest correlation with valuations) don't warrant today's extended lead. Consider the fact that Meta is expected to grow at the same rate but is trading at half the revenue multiple. Furthermore, all the other tech peers have their own GenAI initiatives and while we believe there will be a lot to go around for everyone to share, the timing and magnitude of the GenAI prize is still uncertain

MSFT Peer Comps (Capital IQ)

Based on the table above, the average peer comp is ~5.3x forward revenue. Keep in mind that estimates of forward revenue (which are essentially from analyst consensus forecasts) can be overstated as we believe most analysts react to update their estimates on good/bad news vs. proactively scrutinizing management provided estimates. Nonetheless, we will take Microsoft's consensus forward TTM revenue of $251.3b in arriving at our valuation. We will attribute Microsoft a generous 70% premium on average peer comps and use a 9x multiple. This implies a potential 15-20% downside on today's valuation.

We believe there is elevated risk for near-term price deterioration on a slight miss to consensus financial metrics or growth expectations for the remainder of FY24. Microsoft's CFO noted on the last earnings call that the impact of GenAI and Copilots will be weighted towards the second half of the year, implying that there is revenue built in from this source for the remainder of the year's projections. Keeping in mind the themes we have noted to GenAI development, we believe this revenue could be at risk or at least may spill into the next fiscal year.

Investor Takeaways

To be clear, we believe Microsoft is a fantastic business which should be in everyone's portfolio for the long run. This article is by no means meant to persuade existing investors to sell however we do caution anyone looking to take a long position at today's prices to take into account the risks we have laid out above with regards to GenAI benefits accruing in Microsoft's growth trajectory.

A near-term re-pricing can create an opportune time for long term investors to take a position in the stock or for existing investors to average down. There could of course be a materialization of upside risks (i.e. faster growth on the cloud unit) which could mitigate any revenue miss from GenAI however on an overall basis, we believe the margin for safety is currently limited.

This article was written by

Analyst’s Disclosure: I/we have a beneficial long position in the shares of MSFT either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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