Metaverse

The metaverse is a visionary concept for the next evolution of the internet: a persistent, shared, 3D virtual space where users, represented by avatars, can interact with each other and with digital objects. Think of it less as a single game or app and more as an interconnected network of immersive worlds, much like the current internet is a network of websites. Instead of browsing flat pages, you would “step into” a digital environment to socialize, work, shop, and be entertained. The idea, popularized by science fiction, was thrust into the investment spotlight when Facebook rebranded to Meta Platforms, signaling a massive corporate push to build this digital frontier. For investors, the metaverse represents a potential paradigm shift, but one that is currently clouded by immense hype and uncertainty, requiring a sober, long-term perspective.

For a value investor, the word “metaverse” should trigger a healthy dose of skepticism. The narrative is exciting, but investing is about separating compelling stories from profitable businesses. The key is not to get swept up in the vision but to analyze the tangible opportunities and risks it presents today.

The metaverse is a textbook example of the Gartner Hype Cycle. We have passed the “Peak of Inflated Expectations,” fueled by massive marketing and media attention, and are now navigating the “Trough of Disillusionment.” The grand vision of a seamless, interoperable digital world is likely decades away. What currently exists is a fragmented collection of siloed virtual worlds and gaming platforms, many with limited user bases and clunky experiences. A prudent investor understands this gap. The multi-trillion-dollar market forecasts are based on a future state that is far from guaranteed. The real opportunity, at this early stage, may not lie in the metaverse platforms themselves, but in the technology that enables them.

Rather than gambling on which specific virtual world will eventually dominate, a value-oriented approach focuses on the “picks and shovels” of this digital gold rush. During the 19th-century gold rushes, the most consistent fortunes were made not by the prospectors, but by the merchants who sold them tools, clothing, and transportation.

This strategy involves investing in the established, profitable companies that provide the essential infrastructure and tools required to build and power the metaverse, regardless of which consumer-facing platform ultimately wins. These are the companies with existing economic moats, strong balance sheets, and real-world earnings that stand to benefit from the long-term growth in digital interaction and computing power.

An investor can look for market leaders in several key areas that form the foundation of the metaverse:

• Processing Power (The Brains): High-end computer graphics are the lifeblood of any immersive experience. This puts companies that design graphics processing units (GPUs) and other advanced semiconductors in a prime position.

1. Key Players: NVIDIA, AMD

• Creation Engines (The Construction Kits): 3D content needs to be built, and sophisticated game engines are the primary tools for developers. These software platforms are essential for creating realistic and interactive virtual worlds.

1. Key Players: Unity Software, Epic Games (private company)

• Cloud Computing & Data Centers (The Digital Land): These persistent virtual worlds require enormous amounts of computing power, storage, and low-latency connectivity, all of which are provided by cloud infrastructure giants.

1. Key Players: Amazon Web Services (Amazon), Microsoft Azure (Microsoft), Google Cloud (Alphabet)

While the “picks and shovels” approach is more conservative, investing in anything related to the metaverse is not without significant risk. A value investor must be hyper-aware of the red flags.

Many pure-play “metaverse” companies are currently burning through billions of dollars in capital expenditures with no clear or immediate path to generating a sustainable return on investment. Their valuations are often based on hope and future projections rather than current earnings or a proven business model. Following the wisdom of Benjamin Graham, investors should be wary of companies that lack a history of profitability.

The metaverse concept has spawned a wave of highly speculative activities, particularly around virtual “real estate” and NFTs. The prices of these digital items are often driven by momentum and the hope of selling to a “greater fool” for a higher price, not by any discernible intrinsic value or cash-flow-generating capability. This is the hallmark of a speculative bubble. A value investor steers clear of such gambles, focusing instead on productive assets that generate predictable income.

The metaverse is a compelling technological trend that may reshape our digital lives over the next few decades. However, for the disciplined investor, it is a marathon, not a sprint. The most reliable way to participate in its potential growth is not by speculating on unproven virtual worlds or digital collectibles, but by investing in the high-quality, profitable companies that are building the foundational tools and infrastructure. By focusing on the “picks and shovels,” an investor can gain exposure to the theme while maintaining a crucial margin of safety.