🧠 The Nuance of Investing

Friends,

Last week, we discussed why gross margin is the most underrated investing metric (and why Warren Buffett loves it).

Today, we will share some additional nuance that investors need to consider when judging it.

Consider Shopify:

Shopify started by selling subscriptions to its platform that help merchants sell products online. Subscription sales have gross margins near 80%.

Then, Shopify started selling additional tools to help make online selling even easier (called Merchant Solutions). For instance, a merchant can use Shopify’s platform to help with payments or fulfillment. Each time they use these services, they pay Shopify an additional fee. Gross margins for Merchant Solutions are closer to 35%.

Offering Merchant Solutions is fantastic for both customers and Shopify. The more merchants sell, the better they do. And the more services Shopify offers, the more money it collects.

What’s even better is that the more Merchant Solutions they use, the harder it is to switch away from Shopify. This widens Shopify’s moat, which is fantastic for investors.

Here’s the rub: the more Merchant Solutions customers buy, the lower Shopify’s gross margin.

Normally, a falling gross margin is a terrible sign. It usually indicates that a company is struggling with sales and has to offer more generous terms to get customers to buy.

In Shopify’s case, it means the moat is getting wider.

Shopify can pull this off because its foray into a lower-margin business checked three vital boxes:

The move was mission-driven (Shopify’s mission: to make commerce better for everyone).
The move was sustainable (Merchant Solutions has positive gross margins).
The move widened the company’s moat (The aforementioned switching costs).

Now, this doesn’t mean that last week’s lesson is moot. In the vast majority of cases, you want the gross margin to rise, not fall.

As Carl Jung said, “only the paradox comes anywhere near comprehending the fullness of life.”

The same is true in investing. The more you learn about investing, the more you realize just how much nuance there is to understanding every investing concept.

Wishing you investing (and life) success,

– Brian Feroldi, Brian Stoffel, & Brian Withers

P.S. – Our next cohort of Valuation Explained Simply starts on August 7th. We holding a drawing to give away three free seats (worth $997). To enter the contest, simply click here. The winners will be announced on July 10th.

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