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Today, I want to show you two popular growth stocks that could have evaporated your investment.
Zillow Z -2.88%↓ which plunged 84% since its highs. And Groupon GRPN 3.58%↑ which crashed 98%.
I’ll show you what went wrong in both cases. And the warning sign investors should have spotted before the damage was done.
Then I’ll show you one popular growth stock I’d avoid today because it’s falling into the same trap.
Zillow’s business was booming.
It was fast becoming the place to look for real estate online. In 2019 alone, revenue surged 159%.
Then Zillow made a strategic blunder that would cost it dearly.
Millions of Americans were already using Zillow to browse homes. The company had one of the best-known brands in real estate, mountains of housing data, and an algorithm estimating the value of homes across the country.
So Zillow decided to start buying homes itself.
Zillow Offers would make homeowners an instant offer, buy the property, spruce it up if needed, and sell it again. Zillow was already sitting in the middle of the housing market. Why not take a bigger bite of it?
The answer became painfully clear.
Buying and selling thousands of houses required Zillow to predict what individual homes would be worth months into the future. It had to coordinate renovations, contractors and local operations across dozens of markets. It was a completely different business from Zillow’s core operation. And every pricing mistake left Zillow holding an expensive asset on its own balance sheet.
In the end, Zillow’s home-flipping operation raked up around $810 million in losses. CEO Rich Barton pulled the plug and admitted they had underestimated just how unpredictable home prices could be.
Unfortunately for investors, the damage was done, and the stock never recovered.
One of the fastest-growing companies America had ever seen...
Was Groupon.
Its original business was beautifully simple. Groupon connected local businesses with customers looking for a deal, then took a cut of every voucher sold.
Restaurants cooked the food. Salons cut hair. Hotels provided the rooms. Groupon just brought them customers.
Revenue exploded more than 100X from just $14.5 million in 2009 to $1.6 billion in 2011.
Then, in September 2011, Groupon entered a completely different business: retail.
It launched Groupon Goods, selling everything from electronics and toys to jewelry and household products.
At first glance, the move made sense. Groupon already had millions of customers opening its emails and visiting its website every day. Why not sell them physical products too?
But while Groupon’s audience was transferable, its competitive advantage wasn’t.
Selling physical products meant competing on sourcing, inventory, shipping, fulfillment, returns, and price. Groupon had no special advantage in any of them.
It had gone from connecting merchants with customers to competing with Amazon.
By 2015, the business accounted for nearly 60% of Groupon’s revenue. The problem was it barely made any money on those sales. For every $100 worth of products Groupon sold directly, only about $11 was left after paying for the products themselves.
Still, Groupon kept pushing Goods to its customers. By 2019, it took up roughly 40% of the website but generated only about 20% of Groupon’s gross profit.
Management finally called it a “significant drag” on the company in 2020, pulled the plug and refocused on its original local marketplace.
By then, the stock had plunged 98%.
Now look at Amazon’s AWS pivot.
AWS may seem like a strange side business to launch. Amazon went from shipping books and household goods to renting computing power to corporations.
But the move was less of a leap than it first appeared.
As Amazon.com grew, the company had to build enormous amounts of computing infrastructure simply to keep its own website running. Its engineers spent years figuring out how to provision servers, store data and build systems that could handle huge swings in traffic.
Those were hard problems that Amazon spent years mastering.
Eventually, the company realized thousands of other businesses were wrestling with the same issues. Amazon could package what it had learned internally and sell it to everyone else.
AWS launched in 2006, eventually becoming Amazon’s biggest profit engine. It also helped propel $AMZN stock up 13,800%.
Unlike Zillow and Groupon, Amazon entered a new market by reusing technology and infrastructure it had already built for its core business.
Apple has been playing the same game for decades.
When it launched its first smartphone in 2007, Apple was stepping into a market dominated by experienced phone manufacturers. Nokia, BlackBerry and Motorola had been making mobile phones for years.
Apple still had plenty of cards up its sleeve.
The company had decades of experience combining hardware and software through the Mac. The iPod had taught it how to build small consumer electronics at enormous scale. iTunes had given Apple experience distributing digital content. Its retail stores gave it direct access to customers.
Apple wasn’t starting from zero. It was reusing capabilities it had already built elsewhere in the business.
The iPhone simply pulled those pieces together.
And every successful product since gave Apple more advantages it could reuse in the next market.
The iPhone brought hundreds of millions of customers and a massive developer community. The App Store gave Apple a built-in distribution network. Its custom chips and supply chain made it easier to launch new hardware at scale. And its growing ecosystem made each new device or service more valuable because it worked with everything customers already owned.
And Apple now appears ready to play the same hand again with the iPhone Fold.
It’s entering a category where Samsung, Huawei and others already have years of experience. Apple, however, can bring almost everything it has built around the iPhone along for the ride: iOS, the App Store, custom chips, developers, retail stores, supply-chain relationships and an enormous installed base of customers.
(If you missed Chris Wood’s excellent two part essay on Apple, catch up here and here.)
Avoid this stock.
When a company in your portfolio, or one you mean to invest in, enters a new market, don’t assume it will succeed.
Ask what does it already have that will help it win there?
Sometimes the answer is obvious. Maybe it owns technology that can be put to a new use, has millions of customers ready to buy another product, or possesses distribution that would take a newcomer years to build.
Other times, the connection looks good from 30,000 feet but falls apart once you get closer. A big customer base or famous brand can open doors, but it doesn’t magically supply every skill needed on the other side.
That’s why, after talking with Chris Wood, I’d be cautious about Hims & Hers Health $HIMS.
Hims built its business around a powerful consumer brand, digital distribution and marketing. But it’s increasingly moving deeper into healthcare infrastructure.
Over the past couple of years, Hims has acquired a compounding facility, a peptide manufacturing facility and a diagnostics business.
Those businesses reward a different set of skills: manufacturing scale, regulatory expertise, supply-chain management and operational efficiency.
Maybe Hims can build those capabilities. But unlike Amazon with AWS or Apple with the iPhone, it isn’t simply reusing advantages it has already spent years mastering.
There are already signs the economics are changing. Hims’ gross margin fell from 76% to 64% over the last year, with the company pointing partly to new offerings and recent acquisitions.