Throughout the history of Wall Street, an original and thoughtful concept often generates exceptional results, at which point it attracts competition and capital to the point where the excess returns are eliminated… [T]hese once-sound theories frequently reach levels where it is more profitable to bet against them than on them.
This quote comes from Steamboat Capital Partners 2016 investor letter and is used to frame a discussion of the recent selloff in growth stocks. In this article, the original and thoughtful concept was the search for ‘compounders’ which became incredibly popular in the mid-2010’s. These were the high quality, capital light businesses with recurring revenue and dominant, durable intangible assets. Think the software giants Microsoft, Adobe, Facebook and Google.
So investors piled in to the next generation of compounders. Those with promise to follow in FAANG and friend’s footsteps. Armed with analytical frameworks like Hamilton Helmer’s 7 Powers, investors searched for businesses with strong network effects, high switching costs, a strong counter position, a cornered resource or any of Helmer’s other 7 powers. And as more and more investors piled into the space they moved from businesses with strong unit economics and competitive advantages to those that could have profitable unit economics and with uncertain competitive positioning. And from more liquid, publicly listed investments to less liquid, late stage venture capital investments. Or even from capital-light software businesses to capital-intensive hardware businesses (Peloton anyone?). Fuelling it all, we saw the emergence of ‘crossover hedge funds’ – made famous by Tiger Global – who deployed billions into funding the next generation of potential compounders.
Now the compounder trade is unravelling. Many of these publicly traded growth stocks are down between 50 and 90%. And many of these companies are having their core business models questioned. This article takes a look at the evolution of the food delivery space to ask this very question. Uber, Delivery Hero, Doordash, Deliveroo, Just Eat – they’re all down more than 60% from their all time highs. But has the market overreacted on the downside? Are there real profitable businesses underneath the hype or are these businesses where the unit economics just don’t work? This article goes deep on one of the hottest industries of the 2010’s to answer these questions.
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