Most important game in town is disruption
Inspect how company adjusts to pressures
As a portfolio manager, I’m often asked what’s the most important thing I look for in a company when it comes to making a decision whether to invest. In my old days as a sell- side equity analyst, I would have said either the management team or the underlying assets of the company. Today my answer is a bit more specific.
Instead, I begin by trying to determine if the industry in which a company operates is being disrupted or about to face disruption, whether management has experience in dealing with such situations, and how the company’s assets are positioned or are being transitioned to the new reality.
Disruption is becoming quite the buzzword these days as it is used rather too often and intermingled with innovation.
To clarify, innovation is the creation of a new product or service that is a desirable alternative to an existing product or service. While there are those willing to pay a premium for the privilege of being first it usually takes the price of that new product or service to fall to a comparable level, despite its superior attributes, before it becomes a truly disruptive force.
An interesting observation is that the pace of disruption is accelerating and companies have to react that much quicker or risk losing market share or worse, go out of business.
A great example of this is the slow pace of transition from record players to cassettes then to CDs. Since this transition happened over years, record stores had plenty of time and could adjust by changing their inventory accordingly.
Then smartphones arrived making it easy and inexpensive to download individual songs, a model that was soon replaced by streaming music services. Almost overnight consumers could listen to their favourite music without having to buy an entire CD and all for a small monthly subscription fee. This left zero options for companies like HMV.
The same slow transition also took place from smaller stores such as Radio Shack into big box stores such as Best Buy, which are in turn being disrupted by online retailers like Amazon in a fraction of the time. One can also apply this to the current transition from traditional cable TV into streaming services such as Netflix, Amazon Prime, Hulu or even YouTube with the software already built into most TVs.
The one area that is of particular interest is the electric car market, which currently represents only 0.2 per cent of total lightduty vehicles on the road in 2016, according to the International Energy Agency.
Electric cars are still at the innovation stage and, despite all of the media attention, should not be a disruptive force for some time yet. This is because it is estimated to take about eight to ten years until their price falls to a comparable level to the traditional gasoline vehicle. It could happen sooner should there be a development in battery technology which currently represents a significant part of the cost of an electric vehicle.
That s aid, l arge auto manufacturers aren’t sitting idle and are gearing up well ahead of time knowing that the pace of transition could turn on a dime once that price point falls.
The only industries that can stop or slow the pace of disruption are those oligopolies protected by a government regulated market such as our telecommunications and banking sectors. This allows them to continue to charge excessive prices for services that not only cost significantly less elsewhere but are often inferior. But this also means high margins and profitability and a sector that is a safer one to invest in — for now.
At the end of the day, the world is becoming a much more dynamic place. Capital is global, meaning innovation and disruption can enter a market or industry that much faster and therefore having a management team that is in tune with this phenomenon is paramount not only for the success of the company but also their investors.