Anyone buying shares of start-up firms during the recession is likely to see the investment multiply several times. To make a killing, however, it is as crucial to take a long-term view as it is to identify star performers.
Cash in on the crisis by taking a chance on newcomers
Despite the billions of dollars wiped off share portfolios across the world in the financial downturn, there has never been a better time to make a long-term killing in the investment market.
Many of the companies that have become household names, such as Google, Microsoft, Apple and FedEx, were launched during previous recessions.
Google was founded in September 1998, on the eve of the dotcom crash, which wiped out a large proportion of the internet start-ups of that era. At its launch, Google was merely a minnow swimming against the economic tide together with thousands of other start-ups. But, since the internet search engine's initial public offering (IPO) at US$85 (Dh312) a share in August 2004, the stock price has risen to its current level of more than $600.
When the Harvard dropout Bill Gates founded Microsoft in 1975, the start-up specialised in developing rudimentary computer languages in the wake of the western oil crisis and the mid-1970s downturn. Today, the computer software giant generates annual revenues of roughly $60 billion.
Nor is the trend of companies spawned in a recession becoming long-term winners confined to technology companies. In 1973, two years before Mr Gates founded Microsoft, the US packages delivery company Federal Express (FedEx) began operations. The start-up delivered only 186 packages on its first night of operations, but today, FedEx manages more than 7.5 million shipments worldwide each day.
The trick, of course, is in spotting winners such as FedEx, Microsoft and Google at the starting gate. But the rewards for acquiring this difficult skill are potentially limitless in practical terms. Any investor buying at the IPO stage could see his or her initial investment multiplying several times over. Someone lucky enough to get in on the ground floor by being an angel investor in the early days of a successful start-up stands to make a real killing.
But the science of spotting rising stars in the start-up firmament is not a simple one. Companies that are genuinely ahead of the curve are difficult to identify. Investors are also likely to be confused about the business plan of a start-up, which often bears little relation to the roller coaster ride that becomes the company's commercial future, at least in the early years.
That does not, however, mean that investors should disregard the business plan or pay no attention whatsoever to fundamentals. By ignoring the simple rules of investing, many people, particularly inexperienced investors day trading online, lost money. Many start-ups have very little possibility of commercial success. At the end of the dotcom boom, naïve investors were putting their cash into any company with a website and over-optimistic financial projections.
One San Francisco-based internet company selling white goods online was astonished when the corridor to their tiny office and half the street outside filled with returned cookers and fridges. They had forgotten to factor a returns policy into their business plan and customers had simply sent unwanted goods to their business address. The omission had, of course, also gone unnoticed by the start-up's backers.
There are a few simple rules that investors should follow when trying to invest during a downturn. The first is to keep a level head when markets dip. According to a study of more than 11 million participants conducted by Fidelity.com, the US-based online brokerage, investors who did not exit from the market did far better than those who cashed in during the financial crisis.
According to another Fidelity study of more than 11 million participants in the 401(k) US retirement plan, investors who stuck to their guns and kept making regular contributions to stock investments fared significantly better two years later, in 2010, than those who bailed out of stocks or stopped making contributions when the financial crisis hit.
"The investors who reduced their stock allocations to zero per cent during the fourth quarter of 2008 or the first quarter of 2009 saw their average account balance decline nearly 7 per cent during the 18 months through [to] March 2010," says Fidelity.com. "By contrast, the investors who maintained an exposure to stocks saw their account balances jump an average of nearly 22 per cent over that same time period."
The stock market's powerful rally on March 10, 2009, was a determining factor. Investors who hung on to their shares benefited from the market rebound. But investors who thought they could time the market took a hit when they sold their shares and therefore failed to see the value of their portfolios rise.
"One of the fundamental principles of investing is not to try to time the market. The good news is that only a very small percentage of people actually reduced their equity exposure to zero per cent," says Beth McHugh, the vice president of market insights at Fidelity.com. "Most people stayed the course and saw their account balances grow."
Inexperienced investors tend to sell when the market hits bottom, precisely the time when more experienced investors consider increasing the scale of their portfolios. This can be particularly true of start-ups whose business cycle is affected by the downturn.
But shrewd investors should try to identify those areas most likely to not only weather the downturn, but to be in a strong position for growth when markets recover.
To do this, it is necessary to be able to identify prime market growth areas. In a time of recession, it is necessary to take the mid- to long-term view of any particular investment sector.
Gold prices, for instance, have risen dramatically. Almost as soon as the equities market began a slide after the financial downturn, investors fled to the one commodity that has survived all previous recessions throughout history. The process was accelerated by the dramatic drop in real-estate prices that accompanied the financial crisis.
Analysts believe that 2010 saw gold mature from a commodity to a currency. With global currencies weakened, gold prices consolidated previous rises and finished the year with a 30 per cent gain. Gold prices rose $325.72, making 2010 the best year for a gold rally since 2001. Analysts believe the rally will continue this year.
Investors looking for a safe haven are increasingly interested in the rare metal. Gold-vending machines have been selling well in Abu Dhabi and in Germany. But for investors who wish to make a killing, gold is seen as a safe hedge but not the main challenge. In retrospect, it will appear obvious that companies shrewdly occupying a sweet spot in the next big technological change were bargains waiting to be snapped up.
Google and Microsoft are both classic examples of companies founded during a downturn that were perfectly placed to take full advantage when markets recovered. Mr Gates managed to sign a deal with IBM, the global computing giant of that era, to licence Microsoft software rather than buying it outright. Mr Gates's brilliant deal meant that almost every IBM-compatible personal computer in the world was powered by Microsoft. This commercial strategy was the key to the company's success.
There are two lessons to be learnt from Microsoft's early history. One is that the quality of the underlying software was in this case less relevant than Mr Gates's business strategy. Many information technology (IT) experts have been highly critical of the software on Microsoft's Windows operating systems. They say that it is unwieldy and has too large a digital "footprint" and that it was not designed for computers that are linked via the internet.
But technical criticism had little effect on Microsoft's stellar growth from start-up to the world's biggest IT giant. And, despite recent competition from rivals such as Apple, few IT analysts would care to underestimate Microsoft's skill for survival.
However, Apple is also another company founded during the mid-1970s downturn. It was co-founded by its current head, Steve Jobs, in 1976. Since then, investors have had many opportunities to take advantage of movements in Apple's share price. At the start of last year, for example, Apple shares were worth about $214. At the start of this year, they were selling for about $322, a gain of 50 per cent. In retrospect, it is easy to see that with its highly successful entry into the mobile phone market and its new product rollout last year, Apple stock was destined for growth.
But before trying to identify potential rising technology stars, analysts believe it is vital to locate key growth sectors within the IT and communications industry. Last year saw massive growth in fields such as social networking, a trend that is now spreading rapidly into the business arena. Other rapid growth areas include mobile entertainment, with books, newspapers, television, movies and games now all available anytime anywhere on devices such as smartphones and tablet computers.
However, while spotting new start-ups is the cherry on an investment cake, it is important to balance an investment portfolio with more mature stocks and surer long-term bets. The history of investment shows that each downturn offers shrewd investors ample opportunity to grow the value of their portfolios.