Value investing has long been a cornerstone strategy for savvy investors seeking to identify undervalued companies with strong fundamentals. But how does this approach apply to the world of platform businesses - those that create value by facilitating interactions between multiple user groups? As traditional industries are disrupted by digital platforms, value investors must adapt their methods to evaluate these unique business models.

I’ve spent years studying platform economics and how they intersect with value investing principles. What I’ve found is that while the core tenets still apply, we need new frameworks to properly assess platform companies. The network effects that drive their growth and profitability require a different lens than traditional asset-heavy businesses.

Let’s explore four key strategies for applying value investing to platform companies:

1. Look beyond traditional valuation metrics. Price-to-earnings ratios and book value don’t tell the full story for platform businesses. Instead, focus on metrics like gross merchandise value, take rates, and customer lifetime value. These provide better insight into the underlying economics and growth potential.

2. Evaluate network effects and user engagement. The strength of a platform’s network is its key competitive advantage. Analyze user acquisition costs, retention rates, and the virality of user growth. Strong network effects create a virtuous cycle of value creation that compounds over time.

3. Assess platform resilience and competitive moats. How defensible is the platform’s position? Look for high switching costs, data advantages, and economies of scale that make it difficult for competitors to replicate. Regulatory risks should also be carefully considered.

4. Understand unit economics and path to profitability. Many platform companies prioritize growth over profits initially. Dig into the unit economics to determine if there’s a clear path to sustainable profitability as the business scales.

“The stock market is a device for transferring money from the impatient to the patient.” - Warren Buffett

This quote from the Oracle of Omaha reminds us that value investing is a long-term game. With platform companies, we must be even more patient as network effects compound over time. The key is identifying those with strong fundamentals and staying power.

Consider Amazon in its early days. Many value investors dismissed it as an overvalued retailer. But those who understood its platform potential - connecting buyers and sellers at massive scale - saw the true value. Today, Amazon’s market cap exceeds $1.5 trillion.

Of course, not every platform will be the next Amazon. We must be discerning and avoid getting caught up in hype cycles. I always ask myself: Does this platform solve a real problem? Is it creating tangible value for users? Can it defend its position as it scales?

Take Uber, for example. It disrupted the taxi industry by connecting riders and drivers more efficiently. But questions remain about its path to profitability and ability to fend off competitors. A value investor must weigh these factors carefully.

“Price is what you pay. Value is what you get.” - Warren Buffett

This Buffett quote takes on new meaning with platform businesses. The “value” extends far beyond current financials. It’s in the potential of the network being built. But we can’t ignore price entirely. Even great platforms can become overvalued in frothy markets.

So how do we find that balance? I like to start by deeply understanding the problem a platform is solving. Airbnb, for instance, unlocked massive untapped value in unused living spaces. This created a new market that traditional hotels couldn’t easily replicate.

Next, I analyze the platform’s ability to capture that value. What’s the take rate on transactions? How sticky are users? Is there potential for expansion into adjacent markets? Shopify is a great example of a platform that started with e-commerce tools but expanded into payments, shipping, and more.

It’s also crucial to assess the competitive landscape. Network effects can create winner-take-all dynamics in some markets. But in others, multiple platforms can coexist. Understanding these dynamics helps gauge long-term potential.

“Risk comes from not knowing what you’re doing.” - Warren Buffett

This quote highlights the importance of thorough research when investing in platform companies. Their business models can be complex, with many moving parts. Take the time to truly understand how value is created and captured.

One exercise I find helpful is mapping out all the participants in a platform’s ecosystem. For a company like Etsy, this includes buyers, sellers, payment processors, shipping partners, and more. How does Etsy create value for each group? Where are the potential friction points?

It’s also important to stay attuned to emerging trends that could impact platform businesses. The rise of blockchain and decentralized finance, for instance, could disrupt traditional financial platforms. As value investors, we must constantly expand our knowledge to identify both risks and opportunities.

“The most important quality for an investor is temperament, not intellect.” - Warren Buffett

This wisdom applies doubly to investing in platform companies. Their growth trajectories can be volatile, testing our resolve. We must have the temperament to hold steady when others panic, and the discipline to stick to our valuation principles when hype takes over.

I’ve found it helpful to establish clear criteria for platform investments and stick to them rigorously. This might include thresholds for user growth rates, engagement metrics, and unit economics. Having this framework helps me avoid emotional decision-making.

It’s also crucial to maintain a diversified portfolio when investing in platforms. While some may deliver outsized returns, others will inevitably falter. By spreading bets across different sectors and business models, we can mitigate risk while still capturing upside potential.

As we wrap up, I encourage you to think critically about how platform businesses are reshaping industries. Where do you see untapped potential? What platforms do you use in your daily life that seem undervalued by the market?

Remember, value investing in platforms requires patience, deep research, and a willingness to look beyond traditional metrics. But for those who master it, the rewards can be substantial. The next great platform company may be hiding in plain sight, waiting for a savvy value investor to recognize its true potential.

What platform businesses have caught your eye recently? How do you think about assessing their long-term value? I’d love to hear your thoughts and experiences in the comments below.