Investors must learn to ride the wave of disruption and innovation
JORGE Paul Lemann, the billionaire co-founder of 3G Capital, told a conference last April that he was “a terrified dinosaur”.
Lemann, pictured, who has invested in a range of global consumer brands including Burger King, Heinz and Kraft Foods, told the audience that he has ‘’been living in this cosy world’’ where management simply had to focus on driving efficiencies with brands which they believed ‘’could last forever’’. Lemann then described how all of a sudden, this cosy world was being disrupted. Disruption is not a new phenomenon. What investors are grappling with now, however, is the pace of current disruption and how it is revolutionising industries and changing our lives. In Lemann’s case, the transformative impact of social media and ecommerce, through advertising and distribution, are clearly impacting traditional consumer brands, many of which are exhibiting declining margins and slower growth.
However, it is not just in consumer brands where we see disruption. Disruption and potential disruption is evident across multiple industries today, including transportation, energy and healthcare. So what are investors to do? Should they invest in leading bio-technology companies? Should they invest in the pioneers of artificial intelligence and deep learning? Should they invest in Bitcoin? To our minds, the first step is to understand which industries and businesses are vulnerable to disruption. Over the past few years, many investors have argued that the outperformance of technological leaders can’t be sustained and that investors should focus on ‘unloved’ value stocks. (Value stocks are typically defined as shares which trade at a significant discount to their true or intrinsic value).
Whilst everyone loves a bit of value, we believe this is a gross simplification of the market today.
Equities should be valued on future cash flows and investors today need to carefully consider whether the stocks which appear cheap today will appear expensive tomorrow. Avoiding the losers and value traps is a key step.
The apparent value in a number of traditional healthcare stocks today, for example, strikes us as one potential pitfall. We are also sceptical about the future for ‘cheap’ oil stocks.
The next step is to recognise which businesses have truly defendable business models. We must then also ask whether the market is valuing these businesses correctly. Over the past few years, we have argued that the market was undervaluing the cash-flow power of the leading internet platform businesses and we continue to believe these businesses represent reasonable value.
The third step, in our minds, is to identify investment managers who have a track record of investing successfully in pioneering, disruptive businesses. It is often the case that these look very expensive through traditional valuation lenses and the volatility of their stocks can be agonising.
Amazon looks obvious now, but it has not been an ‘easy’ stock to hold. The stock has looked ‘expensive’ for the past two decades and experienced incredible draw-downs, losing 6pc in a single day no fewer than 199 times and falling 95pc from December 1999 to October 2001. Most investors would find this difficult to stomach. Investing in such businesses requires genuine insight, skill and resolve. Over the past year, investor focus has very understandably been on geopolitical events and near-term economic growth.
This is, of course, valid. But over the longer term, we believe it is incumbent on asset managers to place a greater emphasis on the innovation we see all around us today.