Optionality: Achieving Asymmetrical Returns

When I look across the top stocks, one thing jumps out to me: multiple revenue streams. Multiple revenue streams evolve from having multiple options in the past. Optionality is the act of having multiple options. The future is unknown. Having multiple paths forward is highly valuable. The more options you have, the better you can react to the unknown. With optionality, you don’t need to always be right. Optionality makes things easy. It makes okay companies great companies, while great companies become trillion dollar companies.

To understand why optionality is so important, take a look at most of the companies with huge market caps. They all have huge optionality and huge userbases that they have continually sold new products. Some have pioneered into new industries. Some have even pioneered new industries! It’s a list of some of the most impressive companies on the planet and when I look at them, what I see is optionality.

The whole point of options is asymmetry. Low fixed costs, high potential upside. Optionality might lead people to think of stock options (puts and calls), but that’s not really what I am after. The problem with stock options is time decay. Stock options aren’t actually a great form of optionality, because you need to know WHEN something is going to happen. The whole point of optionality is that you don’t know the future. Optionality and autocatalysis are highly related, but I’ll save an in depth review of autocatalysis for later.

Having more revenue streams clearly increases revenue. It can also reduce fragility. If you consider Sea Limited as an example, their revenues are driven by gaming and ecommerce. Normally, investors are worried about diversifying their portfolio. Increasing optionality is diversifying for companies! Optionality also helps deal with uncertainty from the unknown.

Optionality makes everything easier. You don’t need to know the future, which is good, because in reality you can’t know the future. The best way to to deal with uncertainty is to have options. Optionality is playing on easy mode. Reacting from the beginning as the world rapidly changes is difficult. Optionality is proactive. Optionality is antifragile. Chaos leads to uncertainty, where having options thrives.

Marketplaces are a favorite topic of mine (FOR GOOD REASON). If given dynamic vendors, a marketplace is loaded with optionality. Etsy is a great example. As a company Etsy did nothing to pursue all the mask sales they had, the vendors did everything. Not only did they do everything, they did it quickly as well.

I trust businesses that have shown past optionality, while also showing the long term focus for future optionality. I believe in having both. A key example of a company only having one is Tesla. Tesla is loaded up on future optionality, but what optionality have they shown in the past? I have heard lots of promises around batteries, robo-taxis and insurance companies, but I’ve yet to see it in the P&L. Potential future optionality isn’t a bad thing, it’s a good thing. However, I’ll believe the past before I ever believe empty promises.

Optionality is low cost experimenting. One successful experiment can provide enough return for all the unsuccessful experiments. For these reasons, every company I review, I check for optionality. I’m willing to pay a significantly higher multiple on companies that have optionality.

Some notes on companies bursting with optionality:

$SQ – First it was credit card readers, then it was other small business services. Now it is cash app. Within cash app, its no longer just money transfers. Now it is buying stocks and bitcoin. Then pay day loans. Banks are on notice. The past optionality is huge and the future optionality is even larger. Long $SQ.

$FB – Facebook is a monster. They were legacy Facebook. Then they bought Instagram. Now they are dominating VR. Layer in WhatsApp, etc… Marketplace is just the first example of leveraging legacy Facebook into something new. Long $FB

$AMZN – Amazon has continually turned weaknesses into revenue streams. AWS was internally developed to keep up with Amazon’s demand. Amazon developed their own supply chain, then leveraged that into Amazon FBA. Alexa is the newest revenue stream, but Amazon is just getting started. Long $AMZN

$GOOGL – Google has too many to list. Very simply, Google was a search engine, but now they are so much more. Android, YouTube, Adsense, Google Music, etc.

$MSFT – Similar to Google. Constantly adapting. Tons of different revenue streams.

$AAPL – A computer company, but then they developed the iPhone and that changed everything. The app store is a monster. Apple has such a natural advantage and so much cash, they can enter any industry they want. The problem is they now lack the creativity. Looking backwards, a business with this much optionality trading for such a low PE was irrational.

$SE – A three headed monster that will only keep growing more heads. The three heads are gaming, ecommerce and payments. Gaming came first and is the cash cow. E-commerce is the big grower. Payments are the wildcard. I’ve heard rumors of branching out into food delivery (odd, but I’m not judging). Very future focused company. What they are now is not what they will be. Long $SE

$MELI – E-commerce, payments and more. Continually growing. The sky is the limit. Long $MELI

As you can see from the list above, I own a lot of businesses that have both future and past optionality. I don’t own $AAPL and $MSFT because I believe those businesses are in the 7th inning.

P.S. here is another good read on optionality.