Moore's Law

• The Bottom Line: Moore's Law is the observation that computing power roughly doubles every two years for the same cost, a relentless force that both creates immense wealth for innovators and ruthlessly destroys the competitive advantages of laggards.
• Key Takeaways:
• What it is: An observation, not a physical law, that the number of transistors on a microchip doubles approximately every two years, leading to exponential increases in processing speed and decreases in cost.
• Why it matters: It drives technological progress at a blistering pace, which can widen or completely erode a company's economic moat far faster than in other industries.
• How to use it: As a mental model to assess the long-term durability of a tech company's competitive advantage and to avoid value traps disguised as cheap stocks in rapidly changing sectors.

Imagine going to buy a car in 1971. Then you come back two years later, in 1973, and find the new model is twice as fast and twice as fuel-efficient, but sells for the exact same price. Two years after that, the same thing happens again. If this trend continued, by today, your family car would be able to travel at nearly the speed of light and run for a million miles on a single gallon of gas. This sounds absurd, but it's precisely what happened in the world of computing. This incredible, predictable progress is known as Moore's Law. In 1965, Gordon Moore, a chemist and co-founder of Intel, observed a fascinating trend: the number of components (specifically, transistors) that could be squeezed onto an integrated circuit was doubling roughly every year. He later revised this forecast to a doubling every two years. This wasn't a law of physics like gravity; it was an observation of the pace of innovation in the semiconductor industry. Yet, it became a golden rule, a self-fulfilling prophecy that chip manufacturers like Intel, AMD, and TSMC used as a target for their research and development cycles for over 50 years. This simple observation explains why the smartphone in your pocket is millions of times more powerful than the massive NASA computers that sent Apollo 11 to the moon, and why it costs a tiny fraction of the price. It's the engine of the digital revolution.

“The pace of progress in the semiconductor industry has been really stunning. You can see it in your cell phone or your personal computer. What you need to do is to figure out what the investors' expectations are. If the market is expecting that rate of progress to continue, and it doesn't, you're going to have a problem.” - Warren Buffett

For a value investor, who prizes predictability and durability, Moore's Law is a double-edged sword that must be handled with extreme care. It represents both immense opportunity and terrifying risk. 1. The Great Moat-Destroyer: Value investors hunt for businesses with a wide and durable economic moat—a sustainable competitive advantage that protects profits from competitors. In many parts of the tech world, Moore's Law acts like a moat-destroying acid. A company's cutting-edge product today can become a slow, overpriced dinosaur in just 18-24 months. A moat built solely on superior technology is often a moat built on sand. This relentless cycle of “creative destruction” makes it incredibly difficult to confidently predict a company's cash flows 10 or 20 years into the future, a cornerstone of calculating intrinsic_value. 2. The Danger of the “Red Queen's Race”: In Lewis Carroll's Through the Looking-Glass, the Red Queen tells Alice, “here, you see, it takes all the running you can do, to keep in the same place.” This perfectly describes companies on the bleeding edge of Moore's Law. They must pour billions into R&D and capital expenditures not to get ahead, but simply to not fall behind. For a value investor, this can be a red flag. A company that spends all its cash just to survive isn't generating the free cash flow needed to reward shareholders. 3. Separating the Shovels from the Gold Miners: While Moore's Law creates extreme risk for companies in the “gold rush” (e.g., the chip makers themselves), it creates enormous opportunities for the companies that use the ever-cheaper and more powerful chips. Think of software companies, cloud providers (like Amazon Web Services), and data analytics firms. Their business models often become more profitable as the cost of computing power falls. A value investor can use Moore's Law to identify these “pick-and-shovel” beneficiaries who profit from the trend without having to run the Red Queen's Race themselves. 4. Demanding a Greater Margin of Safety: Because of the heightened uncertainty, a value investor must demand a much larger margin_of_safety when considering an investment in a fast-moving tech company. The future is simply less certain than it is for a company that sells soda or chocolate bars. The price you pay must be significantly below your conservative estimate of its intrinsic value to compensate for the risk that the company gets leapfrogged by a competitor.

Moore's Law is not a formula to be plugged into a spreadsheet. It's a mental model to guide your qualitative analysis. When analyzing a company in or around the tech sector, ask yourself the following questions.

1. 1. Where does the company sit on the “Moore's Law Spectrum”?
   • Directly Driven: Is this a semiconductor company (e.g., NVIDIA, Intel, AMD) whose entire existence depends on staying at the forefront of this trend? These are the highest-risk, highest-reward plays.
   • Direct Beneficiary: Is this a company whose product becomes better and cheaper to deliver because of Moore's Law? (e.g., a software-as-a-service company like Salesforce, or a cloud provider like Microsoft Azure). Their costs fall while their capabilities expand.
   • Indirect Beneficiary: Is this a non-tech company (e.g., a modern retailer or a logistics firm) using technology to improve its operations? Cheaper computing makes their own business more efficient.
2. 2. What is the true source of its economic moat?
   • Dig deeper than “they have the best technology.” That can vanish. Look for more durable advantages.
   • Switching Costs: Is it difficult or expensive for customers to leave? (e.g., an entire company trained on Microsoft Office).
   • Network Effects: Does the product become more valuable as more people use it? (e.g., Meta's Facebook or Amazon's marketplace).
   • Brand: Does the company have a powerful brand built on trust and user experience? (e.g., Apple).
   • If the only answer is “our chip is 10% faster,” be very cautious.
3. 3. How does it allocate capital?
   • Look at the company's financial statements. Is R&D spending growing faster than revenue? Is it constantly taking on debt to build new, multi-billion dollar factories? This could be a sign of the Red Queen's Race. A durable business should be generating strong free cash flow after all necessary investments to maintain its position.

Let's compare two hypothetical companies to see this in action.

The value investor isn't trying to guess who will win the GPU race. Instead, they see that ConnectSphere Software has a more durable, understandable business model that profits from the overall trend without taking on the existential risk.

• Forces a Long-Term View: It compels you to think about the forces of disruptive_innovation and how a business might look in 5 or 10 years, not just the next quarter.
• Highlights Key Risks: It is an excellent framework for identifying the specific risk of technological obsolescence, a factor often missed by looking at simple valuation multiples like the P/E ratio.
• Explains Sector Dynamics: It provides a powerful explanation for why the tech industry is characterized by high growth, deflationary pricing, and winner-take-all outcomes.

• Moore's Law is Slowing: The original observation is no longer holding true. It is becoming exponentially more expensive and physically difficult to shrink transistors further. Assuming the historical pace will continue indefinitely is a mistake. This is known as the “end of Moore's Law,” which creates its own set of new risks and opportunities.
• Not All Tech is Equal: Applying the same “fast-obsolescence” lens to a dominant software platform with high switching costs as you would to a hardware manufacturer is a common error. You must identify the type of tech business you're looking at.
• Hardware is Only Half the Story: A company's success is determined by far more than processing power. Software, ecosystem, brand, user interface, and business model are often the most critical components of a durable economic_moat.

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