Albert Wenger has been one of the VC’s I most admire for a long time. He was very present in the early days at Etsy, and sat in giving counsel on some, uh, significantly astray engineering team meetings. Albert is a smart, data-driven guy whose values roughly align with my own.
That said, I have an axe to grind with his latest post, Don’t Mind the Share Price. In it, Albert deploys the story of Amazon as a warning against focusing too much on how the market values a company. This is the story of Amazon:
Amazon was riding high in the late 90s, then felt the DotCom burst roughly along with the rest of the tech sector. Albert points out that history has shamed anyone that might’ve judged Amazon on its share price fifteen years ago, since it’s returned north of 2000% in the years since.
So whether you are running a tech company, working for one, or investing in one I highly recommend not reading too much into changes in share price. Focus instead on whether your company is making real progress.
Albert is careful to stress that you should focus on fundamentals over fluctuations in the price, which is generally good advice. But I think the subtext is clear: don’t be discouraged by even large declines in price, because you might be working at the next Amazon.
This is a premise that we can investigate quantitatively.
The Odds of Being an Amazon
Suppose that we’re working at a public company that’s experienced a decline in its share price of at least 50%, relative to a recent high price. We’d like to approximate the odds that this company is going to recover [1].
It turns out that since 2002, there have been 2,132 companies traded on the NASDAQ that fit this description. One of these is indeed Amazon. But how many others are like it?
We can take this set of companies and categorize them. Let’s identify companies that wound up being completely wiped out—losing 90% of their remaining value or more—and then all other companies that declined in value. For companies that increased in value, we’ll differentiate those that beat the market (defined as the S&P 500 Index) from those that didn’t. The idea being that you would have been better off just buying an index fund with your cash surplus from working for Google in a parallel universe. And finally, we’ll identify the miraculous: those companies that return 1000% or more, of which Amazon is one example.
If we do that, it looks like this:
| Category | Count | Percent | Cumulative Percent |
|---|---|---|---|
| Wiped Out | 239 | 11.21% | 11.21% |
| Declined | 794 | 37.24% | 48.45% |
| Beaten by Market | 344 | 16.14% | 64.59% |
| Beat Market | 661 | 31.00% | 95.59% |
| Miracle | 94 | 4.41% | 100.00% |
Here we can see that about 65% percent of public companies that find themselves in this situation don’t recover. But 35% of companies do. These are tough odds, but definitely not impossible odds, right?
Recovery is not Good Enough
Albert asks us to consider investors, officers, and employees of the company as having roughly identical situations. This is a mistake. Things are significantly worse in the case of employees [2] at a public company that have been issued options. In these cases, the company may very well recover, but we have to contemplate several other horrifying possibilities.
- Employees may have already exercised options at a strike price higher than the current market price. If so, they’re screwed if the company never recovers above that price. Even if the company beats the market from here out.
- The strike price may be below the current market price, meaning that the options are worth something. But employees may owe taxes (or AMT), forcing them to sell before the recovery.
- Options may be underwater and worthless. At least in this scenario, there is clarity.
From these situations we can see that as an employee [3], it makes sense to consider the odds that the company will not just recover, but will ultimately get back to where it was. That looks like this:
| Category | Count | Percent | Cumulative Percent |
|---|---|---|---|
| Wiped Out | 239 | 11.21% | 11.21% |
| Declined | 794 | 37.24% | 48.45% |
| Beaten by Market | 344 | 16.14% | 64.59% |
| Recovered Below High Price | 210 | 9.84% | 75.04% |
| Beat Market | 441 | 20.66% | 95.69% |
| Miracle | 92 | 4.31% | 100.00% |
This makes it worse: 75% of companies won’t recover using this definition. And only about 4% will make miraculous comebacks of Amazon’s order of magnitude.
Are You Making Progress?
Remember that Albert provides us with an important caveat: we should “[f]ocus … on whether the company is making real progress.” But this can be tricky to surmise as an employee, for several reasons:
- You are in unavoidably close proximity to a coordinated propaganda campaign. It’s called the company’s internal communications and morale efforts. You may find yourself thinking unreasonably positively about these things.
- You are putting in hours at this company, and human nature compels us to confuse effort with progress.
- Remember that we’re talking about a public company. So unless you’re an officer, you’ll have a difficult time of getting detailed information about how much progress the company is really making. And of course timing trades on such information would be illegal.
We should agree that the outlook here is going to be hazy at best, and self-deception is a hazard.
The Base Rate Fallacy’s Perverse Tyranny Over the American [4] Mind
If there is any line of reasoning that really drives me crazy, it’s the following:
- A series of cosmically unlikely events has unfolded.
- This is submitted as evidence that it can happen to anyone.
Examples of this are everywhere. Someone is going to win powerball, therefore it makes sense to buy tickets. Barack Obama was elected president, therefore systematic racism is toothless. Mark Zuckerberg struck it rich, so you’ve just gotta have faith.
In looking to Amazon (or Google, Facebook, Netflix, or dear god Apple) as consolation in the event that a company has experienced a decline in share price, we make the following mistake. The probability that successful companies have stumbled in their past is not the probability that a company will succeed, having stumbled.
This isn’t a call for nihilism if you find yourself in such a situation. Far from it—it’s a call to realize that the odds are now against you, and to behave proactively.
The code and data for this article is available here, on Github. It’s a bit sloppy and hastily written, sorry. We started from a dataset of companies traded on the NASDAQ that experienced a decline of 50% or more off of a previous high. our dataset started around the year 2000.
- You may notice that I've switched questions, from "are you working at Amazon" to "is the company Amazon." Calculating the odds that you are working at Amazon would of course require a richer dataset that includes company headcounts, and I am a lazy man.
- Investors can more easily scale their commitment to the company by having a diverse portfolio. Employees and officers, however, give 100% of their labor to the company. And in the event that things go well, a large percentage of their net worth derives from the value of the company. Officers have a high floor on their returns, via guaranteed bonuses, parachute provisions, accelerated vesting schedules in the event of termination, and so on. Employees on the other hand are screwed.
- This refinement doesn't apply to all employees. Early employees probably have strike prices that are very low, and can make money despite a large drop in the share price. But at a newly-minted public company, most employees are probably new, and most employees are therefore affected.
- I know that Albert Wenger is German.