The Zen Innovation Investor Volume 15

The purpose of this weekly is to sharpen my thinking by sharing thoughts about industries and companies that fit into powerful long-term investment themes. It is also a place to share insights into decision-making, takeaways from the past week, and random thoughts that arise. Thank you for reading this piece! Feedback is welcomed. 

This week: 

  • Profits in Vogue 
  • 2021 – The No Profits Bubble 
  • A Miss, Then a Realization 

Profits in Vogue 

Investors and the market overall value different things at different times. This can be hard to reconcile in the short term as we all are wrapped up in our day-to-day business. One thing that the market does love consistently is growth, and it loves profits. The combination of growth in revenue and profits has proven over long periods to be the formula for increasing intrinsic value and in turn increasing market value.  

We have written in prior posts about the divergence of the so-called Magnificent 7  and the rest of the market. This is well documented and on the minds of many active managers and allocators. The thing that really stands out about this divergence is how discerning the market has become over the last 18-24 months regarding profitability. We will touch on the 2021 no-profits bubble later, but with interest rates rising rapidly in 2022, the market quickly shifted to rewarding profitability.  

We are struck by a few examples of just how important profits are to investors right now. Meta and Salesforce are companies with a profile of strong historical growth, a very good margin structure, and good historical returns on capital. Both companies had seen their growth rates decelerate a bit in the later part of the pandemic, and made the decision to invest more heavily, reducing near-term profitability. The market punished their equity valuations more than the average company in the 2022 selloff. Both companies decided to take their feet off the 

spending pedal and show more profitability in late 2023. As a result, their stock returns have been strong versus the bottom and have recovered the declines of  2022 or, in the case of Meta, made new all-time highs. 

2021 2022 High Low % chg Today % chg 

Meta META 378 93 -75% 501 439% Salesforce CRM 311 126 -59% 316 151% 

Source: FactSet 

There are obviously more factors that cause large swings in stock prices as you see here. The point that we are making is that right now, the market is rewarding not only profitability but also higher levels of profitability.  

More evidence of this effect is the underperformance of many of the darlings of the pandemic that had no profitability then and still do not now. What is striking about this group of companies is both the level of declines in their share prices and how little they have rebounded as the broader market has risen in 2023 and Q1 2024.  

In these three company cases, they all were unprofitable before, during and after the pandemic. As we like to say, you can run the business without profits and proof of the leverage in the model for only so long. Eventually, the bill comes due. 

2019 2022 % chg % chg % chg 

Close High Low Today from high from 2019 from low 

Peloton PTON 30 171 6 5 -97% -84% -22% Wayfair W 92 368 32 60 -84% -35% 88% Teledoc TDOC 84 308 22 15 -95% -82% -32% 

Source: FactSet

So, the takeaway is that this market values profitability, especially those showing more profitability. This is the formula for long-term value creation, as evidenced by the market values of the most valuable global companies. They have compounded revenue and profit growth at high rates of return, thus earning their place as the most valuable. 

2021 – No Profits Bubble 

In recent history, we have seen an instance where the love in the market was for companies with high growth and no profits. In the height of the pandemic,  companies that were considered beneficiaries of being at home or remote work were some of, if not the best, performers in the market.  

We have written about signs of a bubble to watch out for in the AI craze, and now that I reflect more, we had a no-profits bubble in 2021. Not only did the valuations rise much more than the revenue and profits, there was a lot of behavior that also gave it away. Some VCs and Technology Hedge Funds that had gotten into Private  Equity were writing checks to companies with little to no due diligence. SPACs were a craze, with 613 going public in 2021 alone. This was up from an already high level in 2020 of 283. 

In retrospect, it is hard to know where the collective enthusiasm was aimed. In the dot com boom and bust, it was all about transformational change. My best explanation is that interest rates were basically zero and people were in the mood to take risks. 

In the aftermath of any bubble or craze, the pattern is that the companies that were swept up in it endure punishment in the form of a crash in valuations and take a while to recover, or do not recover at all.  

As we discussed earlier, companies with proven business models that had chosen to invest more in the near term to maintain or accelerate growth had the option to reverse course, and those that did were rewarded. 

A Miss, then a Realization 

In 2002, I was at the Allen and Company Arizona conference, which was, and I  believe still is, a group of internet-related companies. The dot com fallout was still working its way through the markets. The conference was in the late winter, so we didn’t know that the valuation declines would continue through the end of the year.  

Reed Hastings, founder and CEO of Netflix, presented one of the days and detailed how the business that he was in at the time, DVD rentals, was going to be replaced by streaming. Because the internet was still early in its broad adoption, it was hard 

to see that from where I sat. There was also a giant incumbent (Blockbuster) that would likely have something to say about the shape of the industry, or so I thought. 

I dismissed what Hastings had to say, and I did not buy into the vision that he had.  I made two mistakes in retrospect. First, I didn’t do my job, which is to listen and learn about where pioneers see the future going. Second, I never updated my view even after it was established that streaming was the way of the future. 

Putting aside any details about the company, my error was not made in not investing. It was in not making a conscious effort to understand or learn about the company and the change occurring. I can live with doing the work and making the incorrect decision, it is a part of the job. 

But I did learn from that lesson. Years later, I was researching The Trade Desk  (TTD) and noticed that it had a very powerful combination of revenue growth and high profitability. I learned more about the company and its niche in the industry.  After some early work, I did what I like to call “short-cutting” and dismissed the idea of investing because I foresaw too much competition coming. 

I watched as the company posted strong results, and the market reacted favorably. I  had reflected on other times, like the Netflix example, and decided to dive in deeper. Upon further research, I was amazed at what a great company it was and how open-ended its opportunity was. From the time that I first looked at the company, the valuation had risen from $1.5B to $3B.  

Investing is a constant exercise in mind management, and this is certainly the case when you have a company double in value and are not involved. 

“I missed it.” 

“It has to be really expensive now.” 

“These results can’t continue.” 

These thoughts and more crept into my mind. Luckily, I tried to look at the company and its prospects objectively. As difficult as it is to do this, it is equally challenging to take the ego hit that comes with admitting that I didn’t really do the work the first time.

When dealing with companies that are driving change and exhibit a powerful combination of growth and profitability, even on a stock that has appreciated, you may still be early. In this case, Trade Desk has gone on to post revenue growth of  32% compounded over the last 5 years plus stock appreciation of 34% over that same timeframe. 

So, I remember Netflix fondly as a reminder to do the work, even if you need to revisit a prior decision. 

For readers: ArrowSide Capital holds positions in The Trade Desk. My story 

I am an investor and entrepreneur, having started two investment companies. I am the Founder and CIO of ArrowSide Capital (, based in Boston, MA. I have more than 30 years of experience in the investment business, investing in companies geared toward innovation and growth. The blog is named 

The Zen Innovation Investor because I believe it is so important to remain calm and focused during the rapid pace of change in the world today. I am keeping a view of the long term while also keeping abreast of developments in the world of innovative companies. I view this as a place to sharpen my thinking and provide some insights that are thought-provoking. 


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