Disruption is everywhere, from the Internet of Things to robotics, renewables and cloud computing—our world is changing fast. Your investment strategy should keep pace and investing in disruptive technologies is a must for investors seeking out-performance.
Picking winners is key for portfolio performance. Here's our guide to smart investing in disruptive technologies.
1. Identify the themes that are changing the world
In May 2013, the McKinsey Global Institute published an extremely influential and timely report entitled “Disruptive Technologies: Advances that will transform life, business, and the global economy” identifying the 12 most economically disruptive technologies of the next decade. It is essential reading for investors interested in investing in disruptive companies. You can download it from McKinsey’s website.
According to the report, the 12 technologies cited all share four characteristics: High rate of technology change; broad potential scope of impact; large economic value that could be affected; and substantial potential for disruptive economic impact.
Some of the technologies McKinsey believes will be most disruptive include the mobile internet, automation, the Internet of Things, robotics, renewables, autonomous vehicles, advanced genomics and cloud technologies. McKinsey believes the aggregate additional economic value of adoption is between $US14 trillion to $US33 trillion per annum by 2025.
For a potential investor, what is striking about these disruptive technologies is that they are no longer limited to the traditional technology sector. Disruptive technologies now include industries and sub-industries like healthcare, biotechnology, industrials, materials, telecommunications, media, and energy.
This means that an investment portfolio tilted towards a disruptive technologies theme can be intelligently constructed with a view to return and risk, especially since it can now be diversified in terms of industry and market capitalisation. It also means the investable universe is of a reasonable size and contains companies of sufficient liquidity.
Since disruptive technologies and innovation are not driven by macroeconomic variables there is a counter-cyclical bias to many of these companies. While their stock prices will, on a daily basis, be affected by equity market levels, their long-term potential will be determined for the most part by the strength of the innovation itself, not the underlying economy.
2. Focus on three types of companies: Seasoned, Early, Neophyte
Investors keen to participate in the disruptive technologies phenomenon should concentrate on three types of companies:
The Seasoned Disruptors
These are large established companies that excel at innovation; companies that have grown by possessing or using disruptive technologies and continue to innovate. Good examples of seasoned disruptors are:
- Google (NASDAQ:GOOG)
- Amazon (NASDAQ:AMZN)
- Facebook (NASDAQ:FB)
- Tesla (NASDAQ:TSLA)
- eBay (NASDAQ:EBAY)
- Alibaba (NYSE:BABA)
- Gilead Sciences (NADAQ:GILD)
- Illumina (NASDAQ:ILMN)
- PayPal (NYSE: PYPL)
- Tencent (700 HK)
- Fanuc (6954 JT)
This is a partial list. Just as important is the list of the companies being disrupted. (The entire retail industry and the lodging industry to name a few.) You may want to avoid these stocks. Among them:
- IBM (NYSE:IBM)
- Hewlett Packard (NYSE:HPE)
- Eastman Kodak (NYSE:KODK)
- Xerox (NYSE:XRX)
- Barnes and Noble (NYSE:BKS)
- Cisco Systems (NYSE: CSCO)
The Early Disruptors
The second category is the largest and most interesting. These “early disrupters” are companies that are relatively new to the market, having gone public in the last 12-36 months; have a powerful disruptive technology; are growing their top line at a high rate; are beginning to generate cash; and are gaining market share at the expense of larger legacy players and starting to produce earnings. Some are household names while some are not. Examples include:
- Twitter (NYSE:TWTR)
- Netflix (NASDAQ:NFLX)
- Twilio (NASDAQ: TWLO)
- Proofpoint (NASDAQ PFPT)
- FireEye (NASDAQ:FEYE)
- Splunk (NASDAQ:SPLK)
- New Relic (NYSE:NEWR)
- Arista Networks (NYSE:ANET)
- Mobileye (NYSE:MBLY)
- 3D Systems (NYSE:DDD)
- Box (NYSE:BOX)
- Hortonworks (NASDAQ:HDP)
- Square (NYSE:SQ)
- Lending Club (NYSE:LC)
These companies are disrupting big players such as Cisco Systems, Oracle, Time Warner Cable, the banking industry, television networks, and big pharma.
The third category are “neophyte disrupters” – companies that are not yet public but are well funded via venture capital.
They all have seemingly promising technologies and products and may be turning the industries in which they operate on their heads, but as yet are unproven as public companies. Some of them have received so much venture capital funding they are referred to as “Unicorns” – a rare beast in the pre-IPO world with valuations exceeding 1 billion. Many are already high profile and some are likely to go public. Some examples include:
- Didi Chuxing
- Warby Parker
3. Do the research on each of the companies
In investing it always pays to do your homework by carefully researching the companies that you are investing in. A fundamental analysis should look at key critical factors such as the company’s business model, revenue, competitive advantage, debt to equity ratio and price to earnings ratio. Financial statements such as the income statement, balance sheet and cash flow statements are available online via the company’s website.
Besides knowing what’s been in the news about a company, you should pay attention to the company’s quarterly earnings releases- a scorecard, if you will, on how well the company has done relative to expectations. Pay particular attention to the guidance the company offers about the next quarter or fiscal year.
Ideally, rather than investing in just one or two individual companies, you could take a diversified portfolio approach that reduces your risks and exposure while maximising your likelihood of high returns.
4. Avoid IPOs
We do not recommend buying IPOs (Initial Public Offerings), no matter how attractive or interesting the company is. Individual investors, and even most institutions, don’t stand a chance given that the price is not determined by what the company is worth but rather by the perceived demand for the shares.
Many neophyte disrupters will be overhyped by the financial media and the brokers, with the result that the share price will have a huge run on day one. Some will be up 25-50% on the opening bell. That is NOT the time to buy them. Let them become “seasoned”, pick up some analyst coverage, and report a quarter (or two) as a public company first. By waiting there is always the risk that you might forego some upside but, in our experience, many “hot” IPOs revisit the original offering price (or lower) at a future date.
Facebook and Tesla are good examples of over-hyped, overpriced IPOs that declined to attractive levels once public and provided attractive entry points for savvy investors.
5. Take a Portfolio Approach
The McKinsey report identifies the technological disruptions that are going to mean the most for our economy and investors need to pay particular attention to these themes.
It’s important to take a portfolio approach to investing and all the more so when it comes to disruptive technologies. Picking winners is notoriously hard, so investing in a group of companies that you think has a chance at being the next Facebook or Tesla may be a far better approach than putting all of your eggs in one basket.
Macrovue’s experienced investment team has created 22 thematic portfolios for this reason. Many follow the themes that McKinsey have identified like social media, disruptive technologies, autonomous vehicles, clean technology, and the Internet of Things.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.