The following reflects the core tenets of our investment philosophy. Our strategies operate according to the these beliefs.
Disruption: the key to opportunity
Disruptive forces marked by new and innovative ideas, technologies, and processes are fabulously healthy for the economy and create tremendous opportunities for wealth creation and re-distribution. However, with tremendous opportunity comes upheaval, chaos, and unforeseen risks.
In contrast to the many investment managers who shy away from potential uncertainty and risk, we focus our efforts on, and fully embrace, industries with large addressable markets being reshaped by disruptive forces. This is where we have found the greatest potential for asset mispricing, outsized winners and losers, and opportunities both long and short.
With entire industry groups up-for-grabs in a fast-changing, rapidly evolving business landscape, the opportunities are easy to see. Given that disruption can enter any industry, we do not limit our universe to certain industries or market caps.
The Value proposition: crucial for stock selection
In a rapidly evolving, “up for grabs” business environment, how do you pick stocks and identify winning business models within an industry? Contrary to the backward-looking, historical emphasis that predominates much of our industry, we’ve developed a forward-looking playbook, with our own set of valuation tools, theory, and process. We do not discount traditional models, however, simply see them as helpful in certain environments only. As a “shortcut to value,” the PE ratio and other standards can work well – when verticals are stable and largely industrialized, in our view.
Enter disruption, and suddenly upstarts and businesses with new, yet to be understood technologies become harder to value. Using traditional valuation models and screens predicated on shortcuts, past data, and outdated assumptions can quickly become a disadvantage. Incorrectly accounting for an uncertain, dynamic future landscape may lead to a gross overvaluation (or undervaluation) of a potential investment. In our view, this is likely without an updated research and valuation method.
Industry disruption has the potential to create a “land-grab” environment, leading to a higher probability of domination by a business or businesses with the best products and services. This environment is where younger upstarts, innovative thinkers, and an “anything goes” mentality often have a better chance to succeed. Businesses with models acclimated to stable environments and optimized around quarterly earnings can easily become disadvantaged.
In any given industry, the business with the best product or service is typically the one who provides its clients a superior value proposition. With a focus on relentless innovation and a forward-looking attitude, a value proposition can be protected and often strengthened. This generally improves a product’s quality and extends its life cycle, increasing the probability of not only substantial, but also enduring future earnings growth.
If identified early in the growth phase, these companies have the potential to substantially outperform expectations, ultimately providing superior long-term returns. We look to invest in opportunities like these and hold for the long term. We avoid, or even short businesses we believe lack innovation, adaptability, and have a high probability of becoming a shell of their former selves or even totally obsolete.
In short, we believe products beat PE ratios, or, put another way, the ability to satisfy the customer’s value proposition often represents more long-term value than last year’s operating metrics.
think like an engineer: Creating a sound process
Rather than seek out wide industry and security diversification, we strive to become experts in the verticals we identify as the most opportunistic, and know each company within better than anyone else. To help us focus on what is important, we have our own classification system and original theory on business model design and industry selection.
We view each industry as a thousand-piece puzzle. Our research motto reflects what is a common problem in our industry: “We don’t take shortcuts.” Before deploying any capital, we typically spend months, if not years, monitoring and researching a given industry to gain an expertise. We seek a thorough understanding of the past, current, and potential future landscape to identify attractive opportunities – or challenges - we believe may exist.
From an engineering perspective, we ask foundational questions: How much opportunity is there in each vertical being disrupted; what is it's addressable market? How does each business model within work; what are the inputs and outputs? Is it poised for long-term success or is it as risk; how does it fit the vertical in which is competes? Most importantly, how well does it meet the customer’s value proposition?
To answer these questions, we commit ourselves to original research, starting from the ground up with source documents. We make no assumptions and qualify our approach and conclusions with facts, data, and grounded intellectual theory.
Ultimately, our goal is to examine, research, and dial-in to those measures we believe could play a role in predicting a business’s longevity, some of which may be subtle and contradictory to traditional Wall Street views.
Management: critical to Long-Term Success
For businesses in which we choose to invest, we always seek management that is forward-looking and competing for the long run.
Often, what is best in the long-term is not what is best for the short-term. This is where we see poor management come into play, and why we are publicly vocal about these issues. Many CEOs are overly focused on short term metrics to please Wall Street analysts and hitting misguided incentive targets. They actively make decisions to improve short term results to the detriment of long term value. This is problematic for long-term investors like ourselves, and requires careful decision-making when analyzing the future potential of a given business.
All too often it seems many executives ignore change and would rather boost short term EPS in lieu of investing in research, technology, and innovation—ultimately harming the businesses value proposition and long-term prospects. While a short-term boost may be nice, we always look towards the future and have no problem going against conventional Wall Street views. We want management to be the same way. As a rule, we avoid investing in businesses we feel sacrifice long-term innovation for short-term boosts in stock price.