Recurring Revenues and New Products

A saturated market, increased competition, or longer replacement cycles (due to a "good enough" product) eventually cause product sales and profits to flatten or decline. 

To compensate for flat sales and profits a company may be able to create other successful products. Unfortunately it's impossible to determine: (1) whether and what future products will be created; and (2) whether any future products will generate meaningful sales and profits. Some things are too difficult to predict.

Because the success of hypothetical future products is too difficult to predict, an investor should believe a company is undervalued -- or at least fairly valued -- based on recurring sales of existing products, factoring in flattening sales and profits. An investor should be confident these recurring sales/profits will occur, hopefully because the company's offering is produced through a defensible, unique, trade-off based set of activities that's difficult for competitors to match. Recurring, defensible sales and profits provide the investor with a "floor" of downside protection.

In choosing between two companies that appear undervalued based on defensible recurring revenues, it makes sense to invest in the company with the best track record of creating successful new products. While it may be too speculative to determine whether a company is undervalued based on unknown future products, it makes sense to prefer companies that: (1) are undervalued based on defensible recurring revenues from existing products; and (2) have the demonstrated ability to create profitable new products. Some companies are better at creating and marketing new products than others, often due to internal capabilities -- what Christensen calls resources, processes, and values -- acquired over time.