Technology is powering new industries, economic growth and growth investing. Portfolio manager John Ettinger explains.
Q: Is innovation creating entirely new markets? Yes, absolutely. We are in an exciting time when the old economy is being disrupted by the new. One key example is the rise of the virtual marketplace. We’re seeing an entirely new freelance economy made possible by the internet. Artisans and small businesses across disciplines now have platforms to sell at a global level from their homes and workshops. Through sophisticated music platforms, musicians can reach listeners like never before—likewise listeners can discover artists they would otherwise never know about. Algorithms make it possible for artists to pinpoint geographical locations where they are most popular and what songs most resonate with their audiences so they can more effectively target where and what to perform.
Thomas Sowell, an economist out of the Hoover Institute, noted that progress, innovation and wealth creation have historically happened where trade occurs—at seaports, in the public square. Today’s virtual marketplace is bringing the old economy into the new, supported by everything from the cloud and big data to web hosting services and online review sites. As a result, individuals and businesses now have the ability to set up shop and compete in vastly expanded markets. It’s a major new source of economic growth.
Q: Given the inherent volatility in innovative companies and their technologies, how do you determine likely winners? We have a term that describes our approach and that is being “citizens of the industry.” That requires full immersion: meeting with managements, competitors, going to user conferences, trade shows and participating in industry conferences. We also talk to clients of companies to determine what they like, what improvements they’d like to see, whether they are considering alternate providers. If you don’t stay ahead of the change, it’s very easy to fall behind.
From our perspective, it’s important to perform that deep analysis and buy leaders in the industry and ideally hold those positions longer term. I recall one company that went public 20 years ago with a market value of $200 million that now is worth $14 billion. That may be an exception, but there are many companies we’ve first purchased at the initial public offering stage that have grown into large-cap stocks. From our perspective, as long as a company continues to execute and its fundamentals are sound, market sell-offs are buying opportunities.
Q: What about distinguishing sustainable ideas from fads? It’s all part of the research process: understanding companies, their financials, their industries and their customers. For example, among many factors that we look for in the very competitive software-as-a service (SaaS) and information services industries is customer switching costs or “friction to switch.” In other words, how embedded is that software into their clients’ workflows? How difficult is it for those clients to switch to a competitor? For these companies, we want to see customer revenue retention not just at 100% but at 110% or greater. That growth tells us that the company isn’t just holding onto customers but is also expanding customer usage—and continuing to generate more revenue.
Q: How do you avoid overpaying for quality? Our objective always is to buy stocks of excellent companies that are succeeding and are able to consistently beat their estimates. We concur with Warren Buffett’s view about buying great companies at a fair price versus fair companies at a great price. Except for mispriced small companies that have stayed under the radar—an opportunity we actively pursue—there’s a reason why companies with strong business models, recurring revenue streams, superb management and wide competitive moats often trade at a premium. So while we’re not price insensitive, we won’t turn down an exceptional company on price alone.
Q: Is there a game-changing technology on the horizon? A strong possibility is 5G wireless technology, which will enable super-fast mobile internet access. Beyond making it possible to stream more music, shop more conveniently and watch more content, 5G will open up a huge number of applications due to its ability to process enormous amounts of data at high speed in real time. Autonomous driving will be reliant on 5G because it is capable of delivering on-the-spot information about the car’s speed and its surroundings, enabling it to react to situations.
5G technology will transform the delivery of health care. Instead of always coming to the doctor’s office, patients will be able to connect with doctors from around the world right from their homes. Overall, 5G will lead to significant growth among many Internet of Things applications—across manufacturing, health care, governments and commerce—as more devices become connected to the technology. There are challenges ahead, not least of which are the large investments required to build the necessary infrastructure as well the need to tackle privacy concerns. But ultimately, 5G will dramatically advance the economy and yet-to-be discovered opportunities.