Amazonit is (AMZN -0.68%) meteoric rise will be studied in business schools around the world for decades to come.
There are obviously a number of factors that have contributed to the company’s success, such as its customer-centric obsession, its ability to scale its supply chain, and the founding genius, Jeff Bezos, at its helm.
But there’s a less-discussed attribute that’s at the heart of Amazon’s rise, and it just might be a key indicator for predicting the next wave of generational businesses.
To truly understand this secret ingredient, we need to look at Amazon’s origin story.
A brief history of Amazon
The company opened its doors in 1995 in Bellevue, Washington, and was very successful from the start. Within months, he was selling books in over 40 countries and raising $80,000 in monthly income.
Immediate success coupled with market fervor for internet stocks led Bezos to take the company public just two years after its founding, raising a whopping $58 million. The company used this new capital to expand into selling other products, eventually selling just about anything you could think of.
While the dot-com crash crushed the stock in 2000, the company was still performing well and reinvesting heavily in its logistics network. This led to the launch of two-day shipping with Amazon Prime, which at the time was mind-blowing for customers and the competition.
In 2007, Amazon did something awesome. He acknowledged that businesses of all sizes, anywhere in the world, would likely prefer to rent web servers rather than buy and maintain them in-house. This sparked the launch of Amazon’s most profitable product, Amazon Web Services (AWS).
Over the next decade, Amazon would launch its own streaming service and acquire companies like Whole Foods, Zappos, IMDB, Audible, Alexa, MGM, and Ring, to name a few.
The secret ingredient
Amazon is a story of expansion. The company has continuously invested considerable sums in new markets and products. And even if it all didn’t work out (remember the Fire Phone?), Bezos created a culture of risk-taking and accepting failure. For all the products that didn’t work, Amazon created AWS.
The investment term for this is “optionality”. It’s not a metric you’ll see on financial statements or something you can model in a discounted cash flow, but it’s at the heart of the vast majority of multibaggers. Think of it as the possible number of paths in the company’s overall growth story.
Amazon’s early investors could never have predicted that they would one day own the world’s largest cloud computing company. But listening to the statements from the management team and seeing the massive investments they were making, the first few investors who had held the stock so far probably knew they were buying something special.
How to recognize optionality
The optionality will not appear during a stock review. There is no single ratio or financial metric that will indicate many potential avenues for growth.
But if you listen to the words the management team uses on conference calls and in shareholder letters, you can get an idea of potential future expansion.
The mission statement is a great starting point. Amazon’s mission statement for years was to be “the world’s most customer-centric company.” It wasn’t about selling more books than Barnes and Noble or being the leader in e-commerce, which it achieved. The company had bigger goals than that.
Another indication is failure, oddly enough. High-option companies will inevitably launch products that fail. While Wall Street typically punishes companies for this, smart investors know it’s the price of ambition. As seen with Amazon, it only takes a few successful launches to moonshot a business.
A current example
A small-cap company that is showing signs of optionality today is the language learning platform Duolingo (DOUOL 3.58%).
While the company is best known for its fun language learning app, the mission statement is: “To develop the world’s best education and make it universally available.”
In its most recent investor presentation, the company expressed this mission as extending beyond language learning to offer a plethora of educational products, from reading and writing to math.
CEO Luis von Ahn provided an update on the recent Q2 earnings call: “We’ve already launched Duolingo ABC, which is aimed at literacy. We’re going to have a public beta of our Math app later this year. , and it will happen.”
While this doesn’t necessarily scream Amazon-level optionality, it does show that the company has an ambitious vision for its future and is investing in new products.
Investing in optionality requires a long-term view
A successful long-term investment requires patience, it is undeniable. But it also requires an ability to see where a company is heading even if the market has written it off in the short term.
The current market environment is eerily similar to the dotcom bubble when Amazon’s stock lost 95% of its value. But investors who were able to separate the company from the stock and see where the company was heading – not where it was – have seen their lives changed by the resulting wealth creation.
There will be battered companies today that will do the same for patient investors. This is the value that optionality brings to the investment.