Podcast Audio | Posted by Phil Leigh on November 8, 2012
Woody Allen once made a science fiction movie parody entitled Sleeper. His character is awakened two hundred years after being cryogenically frozen in 1973. Although initially groggy, once he becomes alert he happily comments, “You know, I bought Polaroid at seven. It must be up millions by now.”
Despite an early 1970s triple digit stock price and a CEO with a captivating personality later emulated by Steve Jobs, Polaroid Corporation went bankrupt in 2001. Along with a great many 1970s-era investors, Allen failed to realize that the chemical process of film imaging was near a technological dead end. In the rearview mirror, Polaroid’s fate should not have been a surprise as underscored by the amplifying evidence of Kodak’s demise a decade later.
The first rule of technology stock investing is to accurately identify the current state-of-the-art within the applicable industry’s life cycle. For example, in the 1970s Kodak and Polaroid could make picture taking incrementally more convenient, but film technology was unlikely to ever reduce the consumer’s cost-per-snapshot or provide the versatility promised by the future of digital photography. In contrast, it was simultaneously becoming evident that semiconductor integrated circuits were beginning to comply with Moore’s Law whereby the cost-per-function dropped by half every eighteen months. Furthermore, the underlying miniaturization processes to manufacture the chips could be repetitively improved thereby implying the Law would last for years, if not the decades that it has actually persisted.
As a consequence of Moore’s Law, 1970s-era companies with leading edge capabilities in electronics, computers, and communications held the potential to grow 10-to-100 fold, or more. Examples include Intel, Cisco, Apple, and Microsoft. Upon mapping the pertinent industrial life cycles, a 1970s investor would likely have put Kodak and Polaroid in a category of “stocks to avoid” whereas Intel, Cisco, Apple, and Microsoft would likely have ended-up in a group of companies meriting further analysis.
Unfortunately, as difficult as industrial life cycle analysis can be, it is less challenging than the merciless subtleties involved in selecting the long-term winners within a truly infant technology sector. For example, in the early 1970s it was evident that the solid-state electronics industry was at the threshold of long term growth. Yet integrated circuits evolved through various esoteric designs, – bipolar, MOS, CMOS, silicon gate, etc. – which created opportunities for new companies to gain leadership at each stage. Since only a highly dedicated and skilled shareholder can remain current on such developments, investors may be tempted to rely upon a subject company’s management credentials as a proxy for technological leadership status.
Unfortunately, well-credentialed management alone is not a sufficiently reliable indicator. For example, just as the transistor market was taking-off in the 1950s, one of the Bell Labs transistor co-inventors and Nobel Prize winners named William Shockley formed his own company to capitalize on the market opportunity. He was well funded by a California instrument maker and hired the best talent. One example was Robert Noyce who later invented the planar integrated circuit, which is the basis for everything in computers and communications that has since followed. But Shockley was a bad manager and his team left to eventually form Intel in the late 1960s.
For a time in the 1950s an upstart competitor named Transitron appeared as though it would hijack Shockley’s destiny. The company was founded by David Bakalar who was another Bell Labs scientist with physics pedigrees from Harvard and M.I.T including a PhD. Transitron issued public stock in the 1950s and was an investor favorite for about a decade. It went out of business in 1984.
Unfortunately the picture that emerges from each additional layer of investigation resembles never-ending fractals – fascinating but practically unanalyzable. Consequently, prominent venture capitalists admit their investment decisions are eventually based upon visceral instinct. To paraphrase, “we invest in people, not businesses”. But how can the passive investor identify a Robert Noyce among a group of Shockley, Noyce, and Bakalar? And surely Polaroid’s Edwin Land would have successfully passed a gut-instinct-about-the-man test from a venture capitalist, yet Land remained wedded to a dying technology.