Bronte Capital's John Hempton recently blogged an excerpt from his letter to clients about why he's short First Solar (FSLR). It's not the FSLR thesis itself that I find valuable - I do not now have a position, nor have I ever had a position in FSLR or any of the other stocks Hempton mentions, but there are essential tidbits to be gathered from his piece.
"Investing in technology stocks has lots of traps for neophytes – and by-and-large we are neophytes so we do not do very much of it. We however spend a lot of time thinking about it primarily because we are scared of what technology can do to other businesses. (The demise of many low-tech newspapers provides a good demonstration of why – as investors – we should think about technology.)"
Even if you don't understand the technology in question, you need to make an effort to understand the effects of the technology on your other businesses and investments.
"We do however have a framework to hang around our (limited) technology investments. A technology, to be a really great investment, must do two things. It must change part of the world in a useful way – a big part of the world is better of course – but you can be surprisingly profitable in small niches. And it must keep the competition out."
It's this second trait - "it must keep the competition out," that I think is an interesting epiphany that could help many investors. He continues:
"Surprisingly, changing the world looks like the easy bit. Plenty of companies do it. The problems are in keeping the competition out. Only a few do that (Microsoft, Google are ones that seem to). Hard drive makers changed the world (they allowed all that data storage which made things like digital photography and internet multi-media possible). But they never made large profits – and they trade at small fractions of sales.
The limited technology investments we have are not driven by any real understanding of the technology. Sure we try – but if you ask us how to improve the laser etching on a solar panel then we will not be able to help. The driver of our investment theses in almost all cases is watching the competition."
Hempton comes back to the main point:
"To make money in technology you need to do two things. Firstly you need to change the world (which First Solar clearly did) and secondly you need to keep the competition out. Alas very few businesses manage the second trick."
I'm not going to get into the competitive position of FSLR - I have no value to add with that regard, although interested parties would do well to read Hempton's thoughts on the stock. In any case, everyone can take away the lesson regarding the essential for a competitive edge.