Disruptive technologies may be shaking up many of today’s industries but applying proven investment principles still makes sense
In previous articles in this series, we have introduced the concept of disruption and profiled companies which exhibit the characteristics of this now commonly-used term. In this third and final article we discuss the investment implications of this trend and provide a framework for evaluating opportunities and risks.
While there has always been technology-induced disruption, it is arguably accelerating in pace and impact. This is due to a confluence of new technologies occurring at once.
Internet platforms, cloud computing, the Internet of Things, the gig and sharing economy, artificial intelligence and automation are just some of the emerging developments in technology. Yet they are not unique to any one sector or geography. Instead they are inter-sector enablers driving structural changes in the way we live and work. They are also causing significant shifts in the profit pools across the corporate landscape. And given these developments are relatively new and embryonic, there are still ample opportunities for investors to gain from the value they are driving.
Applying proven investment principles ensures investors can benefit from the seemingly constant change in the corporate landscape, whilst helping them drown out the short-term noise and stay focussed on their objectives.
Here, we explore the three pillars that help investors identify sound opportunities even when never-seen-before forces are re-shaping the global economy.
Taking the long view
Competitive advantage, capital allocation and runways for growth are the three pillars that support a stable, solid wealth-creation philosophy, and a sustainable investment case requires all three components to be present.
- Competitive advantage is the ability for a company to generate persistent, protected and superior cash flows over and above the cost of capital, both in good times and in bad.
- Capital allocation requires wide reinvestment of cash flows to provide a financial buffer for a business and increase shareholder returns. The most important thing CEOs have at their disposal is a cheque book: what they buy or build can either set the company up for success or destroy value. So, capital discipline and good governance is essential to wealth creation.
- Runways for growth must support sustainable income and profits, which increase the rate at which excess returns can be reinvested and accelerate the process of compounding.
The competitive foundations of companies have changed over time away from physical assets such as plant and machinery towards intangible assets such as innovation, patents, research and development, process know-how, brand and intellectual property. These intangibles account for the vast majority (over 80%) of company asset value compared to less than 15% in 1975 (1).
Understanding these intangible drivers is a highly nuanced process. As such, we see longer-term investing as one area of active investment management where a fundamental investment philosophy still has a sustainable edge against the rise of the machines and the quants.
As an investment philosophy, fundamental investing is connected with the real world, not the world on our screens, and is rooted within longer-term trends as opposed to shorter-term speculation. The ability to create a healthy and sustainable economic profit over and above all costs, including the cost of capital, and to continually reinvest and grow those economic profits over time, is what unlocks the potential for long-term, enduring wealth creation.
This is relevant to today’s investing environment where the rapid pace of transformative change has upturned many industries. These shifts are largely driven by individual companies with highly disruptive and resilient business models and bottom-up research is well placed to forecast and exploit these important shifts.
AMP Capital is committed to building market-leading, bottom-up, fundamental insights about individual companies and investment opportunities and harnessing the full breadth of our active investment capabilities to successfully invest in the digital age.
(1) Source: UBS and Bloomberg, Annual Study of Intangible Asset Market Value from Ocean Tomo, LLC, 2015
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.