Disruptors
Exploring the decision of investing or not investing in world changing companies
In India and in the world there is a lot of disruption going on. Whether it is Artificial intelligence or it is things like renewable energy or electrification of vehicles. In times of disruption we are seeing the traditional companies lagging and new companies rising.
In USA; Tesla has a market cap larger than that of Ford,General Motors, Toyota, Porsche and Ferrari combined now. It is the highest valued auto maker in the world. (Source)
Isn’t that crazy?
So when you have a chance to become a partner with a company like Tesla which is hell bent on coming up with the best electric cars why would you let that opportunity slide.
Something similar could be argued for Ola electric or Ather in India. They are making electric scooters and that is their sole focus. In a country like India where 2 wheelers are much more prominent than 4 wheelers electrification of scooters was going to happen. In fact electric vehicles are the best when they are used for shorter distances and are light. EV Scooters are as good as if not better than traditional scooters already.
An investment in companies which are in these types of industries which are high growth or world changing have high optionality.
Optionality simply means you could have a large potential payoff from a relatively smaller investment.
When you see these businesses list on the public markets they already have reached a certain stage in their business life cycle where you know that something is working. But most of them don’t make money. A lot of them end up failing.
There are a few great investors who think that these type of companies which are changing the world are good for the society but not good for investors;
“I won't dwell on other glamorous businesses that dramatically changed our lives but concurrently failed to deliver rewards to U.S. investors: the manufacture of radios and televisions, for example. But I will draw a lesson from these businesses: The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.” Warren Buffett
"I still believe that the Internet is probably the most important industrial revolution in many decades. But we still have to be very selective because a growing industry is not synonymous with profitability. On the contrary. To have a little perspective on that, here is a passage of a Reader’s Digest article published in October of 1983 entitled “The computer: the servant of the future”: It is believed that annual sales of personal computers will go from $350 million (M) in 1983 to some $2 billion (G) in 1987. In June 1982, Commodore was the market leader with 23,000 units sold for $28M followed by Apple and Tandy with $20M each. But new comers are plenty: Atari, Timex Sinclair and Coleco are now looking for a piece of the action. Also, Osborne is now putting on the market a portable computer that could be stored in an attaché-case." This article – would you believe? - is only 18 years old. Sales growth of PCs turned out to be much higher than anticipated even by the most optimistic forecasters. And what kind of return would an investor had received would he had bought all the companies mentioned? Probably, he would have lost almost all of his investments? The best stock would have been Apple Computer [Q:AAPL], which is today still the same price as it was 15 years ago (and they stopped paying dividends in 1997)." - Francois Rochon 2001
Innovation is often sought by investors but does not always produce lasting value for them. Developments such as canals, railroads, aviation, microchips and the internet have transformed industries and people’s lives. They have created value for some investors, but a lot of capital gets destroyed for others, just as the internet has destroyed the value of many traditional media industries. Big, exciting new developments, even those that change the world, are not necessarily good long-term investments. We do not have the skills or the appetite to spot a new innovation and ride the wave of initial enthusiasm for the short term with the (often unspoken) aim of selling out before the truth about its potential to destroy value is apparent. As investors, we only seek to benefit from product development in long established products and industries.” - Terry Smith
In my opinion this is a very interesting problem to have. I would like to think of these in the errors framework that I discussed in one of my recent posts.
If I don’t invest in a company like Tesla. I will be making the Type 1 error (error of omission). I would have missed out on an alpha company which would have generated a lot of returns for me.(19,725.39% since listing)
If I did invest in companies like Tesla but let’s say I picked wrong and I chose to invest in a company like Fisker. I would be making the Type 2 error (error of commission). In this situation whatever my investment would be I would lose it because the company has gone bankrupt.
The third type of error is critical in this scenario. If you over invest/ under invest in companies like this which generate alpha you might end up overexposing yourself in terms of portfolio management.
NZS capital wrote,
“With the bulk of a portfolio concentrated in companies that express both Resilience and Optionality, we add numerous small positions with pure Optionality, much like a venture capitalist would structure their portfolio. We then attempt to eliminate the unproductive middle – avoid investing in companies that are neither Resilient nor Optional. Resilience buys you budget for Optionality. Having disciplined decision making and paying attention buys you the ability to think creatively and recognize when good portfolio allocation opportunities arise. By optimizing for Resilience and Optionality and eliminating the unproductive middle, you avoid the illusion that you can predict the future.”- Brinton Johns and Brad Slingerlend
I like to think of investments in companies which are part of such industries in a similar way to venture capitalists.
I would invest in them because I don’t want to commit Type 1 error but I would size the bet in a way where even if I do commit the Type 2 error I don’t lose much.
So tails I win a lot, heads I lose but not a lot.
I know there are a lot of investors who like to have concentrated portfolios with companies which have significant moats and good valuations. For an investor like that the error of commission is simply too big to make.
This is my opinion and it is a very personal decision. Especially for people who are looking to grow their capital, I think this makes sense.
Thank you,
Samvit.