How to find the next Apple, Microsoft or Netflix

Editor’s note: Yesterday I introduced Whitney Tilson, an investment analyst friend of mine who has a fantastic track record. As I mentioned, we are teaming up for a 2 legends predict 2023 event. (You can click here to register if you haven’t already.)

Today I want to share a great article by Whitney, where he explains how to find big stock winners. Check it out below.

First let me take a moment to thank my good friend Louis Navellier. Yesterday in this space, Louis was kind enough to introduce me to you – the InvestorPlace readership.

I really appreciate that.

In this article, Louis told you how I discovered Amazon.com, Inc. (AMZN) before it became the trillion-dollar monster we know today.

And how I bought…

• Apple Inc. (AAPL) In 2000…
• Microsoft Corporation (MSFT) in 2010…
• And Netflix, Inc. (NFLX) in 2012.

These investments were one of the reasons I was able to grow my hedge fund from $1 million in assets in 1999 to over $200 million at its peak.

In today’s essay, I’ll show you exactly how I spotted these moonshots long before they became the mega-cap blue chips we know them today.

Let’s look at Apple first.

The “network effect” at work

When I bought shares at $0.35 adjusted for distribution, legendary founding CEO Steve Jobs had just re-entered the struggling company, which had recently launched its iMac desktop computer. It was years before the iPod, iPad, iPhone, AirPods and App Store existed.

But I knew that Apple was special at the time for several reasons:

• It had (and continues to have) a fiercely loyal user base.
• At the time, 50 million American households in the United States did not have a personal computer (not to mention hundreds of millions of households abroad). These people were significantly less technologically sophisticated than average, which played into Apple’s strengths: its products are easy to configure and user-friendly.
• Apple had a long history of developing sleek and innovative products that set it apart from competitors and allowed it to charge a premium price. This is still the case today, and we continue to see it with every new product that Apple creates.
• The company’s balance sheet was pristine, with huge cash, little debt, and a “lean” business model with low inventory and capital expenditure.

At the time, Apple had more than $4 billion in cash and short-term investments, and $819 million in long-term investments, offset by only $300 million in long-term debt. This represented more than two-thirds of its share price.

Plus, Apple had the ultimate “wildcard” in the form of Jobs, who was a genius and a visionary…and who deserved the lion’s share of the credit for engineering Apple’s comeback.

Jobs sadly passed away in 2011, but Apple continues to perform brilliantly.

The iPhone basically put the nail in the coffin of its main competitor, BlackBerry Limited (BB), which has seen its market capitalization drop from $64 billion when Apple launched the first iPhone in 2007 to around $3 billion today.

The iPhone was a complete game-changer, putting computers in the pockets of millions of Americans, enabling them to use social media, email, stream videos, and play games. games where they wanted.

Apple is the perfect example of the “network effect” at work: the value of its products and services increases as the number of people who use them increases.

Consider the App Store. Rather than hiring hundreds of thousands of developers to build apps, Apple has incentivized outside developers to build apps for its users, expanding its ecosystem exponentially.

The more users there are to download apps, the more developers want to create apps for those users, and so on. That’s why App Store revenue has grown from $39 billion in 2017 to over $85 billion in 2022.

It is what i mean when i say these companies are hyper scalable.

It was the same case with Microsoft…

How MSFT unlocked hyperscalability

I first bought Microsoft in mid-2010 before it became a 17-bagger.

Despite controlling more than 90% of global operating systems and rising profits, the stock had fallen sharply.

Investors feared that Microsoft would lose to Google in search engines and lose market share in personal computing to Apple. In addition, its hardware business was struggling.

But by withdrawing its nearly $40 billion in cash, shares of MSFT were trading for just eight times earnings. As I told a Reuters reporter at the time, “It’s incredibly cheap for a company of this caliber and this position in the market.”

A few years later, Microsoft moved to a software-as-a-service (SaaS) model, which meant it charged a few dollars a month in perpetuity for access to the Microsoft Office suite.

This allowed Microsoft to become extremely scalable: It didn’t really cost the company anything extra, whether it had 1,000 subscribers or 1 billion subscribers.

And like Apple, as more people used Word and Excel, other people wanted to share compatibility, taking great advantage of its network effect.

These powerful forces propelled shares of MSFT higher, and in 2019 Microsoft joined Apple in the $1 trillion market cap club.

Netflix took the same path to stardom as Microsoft…

I Was Wrong On NFLX…Before I Was Right

At the turn of the century, Netflix had just 400,000 subscribers. Today, that number has exploded to almost 233 million…a staggering increase of almost 58,000%. Look at…

In the process, Netflix completely bankrupted Blockbuster Video. (Ironically, Blockbuster had the opportunity to buy Netflix for $50 million in 2000 but passed. A decade later, Blockbuster filed for bankruptcy.)

But as we’ve seen with Apple and Microsoft, Netflix hasn’t been smooth sailing either. In an unfortunate strategy, the company spun off its DVD-to-email business from its streaming business in 2011 and gave it a new name – Qwikster – forcing people to subscribe to it separately.

Netflix customers revolted – the company lost 800,000 subscribers in that quarter alone – and within a month CEO Reed Hastings reversed his decision. But the damage was done… Netflix went from growing 30% year over year to just over 10% for three quarters. Shares fell from $43 to under $10.

I was out of Netflix at the time and even posted an article titled “Why We’re Out of Netflix”…

Which prompted Hastings to publish her own article, titled “Whitney Tilson: Cover Your Short Position.” NOW.”

Hastings and I connected via email, and he invited me to brunch at his California home where he helped me realize I was watching Netflix with a completely wrong purpose.

I was looking at how many people were paying $8 a month and trying to figure out how much each subscriber was worth. Instead, Hastings explained that Netflix’s streaming platform was already built…and now it was taking advantage of the network effect as more and more people were using it.

Because Netflix paid a fixed amount for its content, it costs Netflix virtually nothing to add a new subscriber. Every new subscription was almost pure profit.

I immediately closed my short position and, after the stock fell sharply, supported the truck on Netflix stocks. I went on CNBC on the exact day Netflix hit rock bottom after the stock market crash in 2011 and predicted it would be Amazon in the decade to come, whose shares have risen 1,000% over the past decade .

Turns out I was way too conservative: NFLX shares rose 90 times over the next nine years!

A common trait

Apple, Microsoft and Netflix all share a common trait: they are extremely “hyperscalable”.

To see what I mean, take a look at the following table…

As you can see, this hyper-scalable model has resulted in massive revenue growth for all three companies over the past few years…

This, in turn, has resulted in massive returns for shareholders over the same period…

I talk to people all the time who blame themselves for not investing in Amazon, Apple, Microsoft and Netflix…

Everyone wishes they had the opportunity to invest in these stocks back then. But I believe that right now investors have a similar opportunity to make a fortune in the markets.

I think people who come into the LAW stocks today will regard this volatile market of the past two years as one of the best things that has ever happened to their portfolio.

That’s why I join my friend Louis Navellier, an industry legend and billion-dollar fund manager who has found 18,100 different baggers in his career. We’re putting the finishing touches on a presentation where we’ll explain how an upcoming event could create a wave of millionaires in the markets.

Louie and I will share the details of our big prediction – and how you can profit from it – during our 2 legends predict 2023 event on tuesday 23 may. Since you are already registered, you don’t have to do anything. We’ll send you a link to the event as soon as it’s available.

Louie will be back in touch tomorrow with a special essay in which he discusses the first-quarter earnings season and a big catalyst that could lift two tech giants.

Sincerely,

Whitney Tilson

Editor, Empire Investment Report