Lucky Breaks

In a previous article, I wrote about the importance of discovery. You either buy before discovery or after the discovery bubble bursts. The first discovery move in a small stock is normally the result of a breakout quarter or event. Often, it’s a lucky break which creates short-term excitement (days to quarters) but longer-term questions.

• A large new contract catalyzes growth for the next 12-months, but can management get another big contract?  
• An FDA ruling goes in a company’s favor, but how will they fund the next trial or commercial launch?
• The 80^th drill hole hits 30 meters of 45 g/ton gold but can this management team turn a drill hole into a mine? 
• The loosening or tightening of a law provides a tailwind, but can management capitalize before new competition follows? 

One of the hardest parts of microcap investing is figuring out if management is skilled enough to take advantage of a lucky break. 

I often think about this story in the Bible. 

The Parable of the Talents (Matthew 25:14–30) is a story Jesus tells to illustrate the importance of faithful stewardship and using what God gives us wisely. In the story, a master goes on a journey and entrusts his property to three servants. He gives five talents (a large sum of money) to the first servant. He gives two talents to the second servant, and one talent to the third – each according to their ability. 

While the master is away the servant with five talents trades and earns five more. The servant with two talents earns two more. The servant with one talent hides it in the ground and earns nothing. 

When the master returns, he praises the first two servants for being faithful and trustworthy rewarding them with greater responsibility and inviting them to “share in your master’s happiness.” But he rebukes the third servant for being lazy and fearful.

There are many lessons in this short story but one of them is God expects us to grow what he entrusts to us - our gifts, abilities, and even luck.

In 1980, Microsoft (MSFT) was an $8 million revenue company with 40 employees. IBM was largest public company in the world and controlled 70% of the global computer market which was primarily mainframe computers. 

At the time, IBM was developing its first personal computer, the IBM PC, and needed an operating system. IBM initially approached Digital Research, creators of the CP/M operating system, but negotiations fell through. IBM then turned to a relatively small software company—Microsoft—primarily known for its programming languages.

Microsoft didn’t have an operating system ready, but it seized the opportunity. Bill Gates and his team quickly acquired an existing OS called QDOS (Quick and Dirty Operating System) from Seattle Computer Products for a modest fee—reportedly around $50,000. Microsoft then modified it and rebranded it as MS-DOS (Microsoft Disk Operating System). Crucially, in the deal with IBM, Microsoft negotiated to retain the licensing rights to MS-DOS, allowing it to license the software to other hardware manufacturers.

By retaining the rights to license MS-DOS to other manufacturers, Microsoft not only supplied the software for the IBM PC but also positioned itself as the operating system provider for the entire PC industry. MSFT didn’t coerce or manipulate IBM into the deal. IBM wanted this deal, and that was the lucky part. 

In 1986, five years later, Microsoft had its IPO. Goldman Sachs took them public and raised $61 million at a $777 million valuation. The company was extremely profitable even in these early years.  

In 1986, Microsoft produced $197 million in revenues (40% growth YoY) and $32 million in net income (60% growth YoY). They had 1,100 employees. 

The agreement with IBM enabled Microsoft to establish dominance in the software market and laid the groundwork for decades of growth that was pivotal in creating modern Microsoft and a $3 trillion company. 

In a recent interview, former Microsoft CEO Steve Balmer, said, “Luck is important in the creation of all great companies.” 

In 2024, Ryan Pape, CEO of XPEL spoke at our annual Summit. You can watch the interview here. He stepped into the CEO seat when the stock was less than $0.10 per share. Today it’s $35.00 per share. In the interview, Ryan Pape was asked how much luck played a role in XPEL’s success. 

“I think luck is a huge part of all success. It’s at least half of the reason we are here today. You have the decisions you make which are both good and bad and then those are compounded by what happens to you. Part of our success was we were the right company with the right brand with the right product at the right time. It’s at least 50% luck.”

Luck plays a role in every great business and every great stock. Luck initially gives a company an early advantage - a head start (time) and/or windfall (resources) they weren’t expecting. 

Skilled management can take the limited resources and luck they’ve been given and multiply it. Mediocre management can’t.

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