Friday, June 24, 2011

The Perils of Technology Investing: RIM & Cisco

I'm always surprised when media pundits and analysts are surprised that one-time dominant technology firms exhibit flagging total returns. Consider two recent examples, RIM, the maker of the Blackberry, and Cisco.

The nearby price chart for the two firms and the S&P500 Index for the past twelve years demonstrates several points.

The first is that buy-and-hold for technology stocks is very risky, even coming in different varieties of risk. For example, RIM rose, then fell precipitously in the early 2000s, only to rise stupendously by 2008, then stall and falter. Such volatility would have tried any shareholder's patience.

Meanwhile, Cisco entered its lost decade after the late-1990s technology stock bubble collapse. Both would have been good bets, in 2000, to hold, if you believed in long-cycle holding for technology issues.

However, of all the companies to experience Schumpeterian dynamics, I suspect technology firms are the most vulnerable.


Because, being at the cutting edge of technology probably attracts more smart, well-funded and motivated competition than being in, say, laundry detergent. The intricacies and dynamics of early-users and trend followers, plus the nature of technologically-based competition can cause market shares to plummet almost overnight.

Prior to the iPhone, who would have foreseen RIM's demise? But what was an interesting sideways expansion by Apple of its iPod vehicle into personal communications has essentially wrecked RIM, probably for good.

Technology companies seem to be especially vulnerable to what my old Chase Manhattan boss and mentor, Gerry Weiss, and his former GE colleagues Don Heaney and Jack Grossman, identified in the 1970s as competition from different arenas.

What they meant by the term and characterization is exemplified by Apple's iPhone. A company from one sector finds that its strengths and capabilities would completely undermine the business models of existing firms in another sector, creating a new competitive arena. The new entrant, Apple, rewrites the rules and redefines the nature of competitive offerings in the existing sector.

In contrast, Cisco seems to have succumbed to conventional competitive forces in its traditional product/markets while squandering resources on new products which didn't develop profitably. This is a more classic example of how technology firms age and die. Their original business segments become saturated or attract competition, while their new initiatives prove to be less successful than their original ones. Growth slows, spending on new products fails to ignite new profit streams, and the company's total returns stagnate as investors become disenchanted.

I read with some humor this morning's Wall Street Journal piece involving Ralph Nader. According to the article, Nader first bought Cisco shares in 1995, and, by 2000, his $1MM position constituted a third of his portfolio.

"At Thursday's closing price, his stake is valued at $278,460....."Just think of what people who have been loyal to them have endured (Nader) said. It's absurd." He said he didnt' sell his Cisco stake because he thought the shares would rebound."

I actually laughed when I read that quote of Nader's. Loyalty? To a technology company? What does Nader think equity invesetment is, a close friendship? Nader's experience demonstrates how not to approach investing in technology firms.

The only thing that's absurd is Nader's blind faith that a firm leading one of the hottest technology areas of the 1990s- network routers' would retain its dominance and relevance in the same manner for another decade.

Technology issues offer prospects of rapid gains, but rarely have successful second acts. My equity portfolio strategy profited nicely from owning Cisco at one time, but it never re-entered the portfolio after 2000.

Buy-and-hold investment styles in specific technology companies is risky and typically unsuccessful due to the dynamic and hyper-competitive nature of the segment.

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