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One of the most common mistakes investors make is to underestimate the paradigm shifts brought about by the power of new technology and connectivity.
This is important in today’s environment where products and services offered by old world companies have suddenly been disrupted as barriers are broken down and bridges over once impenetrable moats are being built. It’s amazing what consumers will do when suddenly being given choice and at a dramatically lower price thanks the democratization and commoditization of those products and services.
I am of course referring to the loss-lead model where products are essentially given away at or below cost in order to build a network organically or by stealing someone else’s. Once these networks are established, premium products that have been customized to fit the consumer’s needs can be launched.
This process has all kinds of implications and is creating a world where low-cost manufacturing will win the day, meaning size is paramount. So is having access to large pools of capital especially at the front-end when one’s ecosystem is being established.
The problem, especially in corporate Canada, is that even those with capital and an ability to adapt are instead relying on government regulation as a means to protect the status quo. As I have written in the past, our banking industry is a great example as it is still not only the most expensive but also among the least technologically advanced in the world. Meanwhile, south of the border, trading and custody costs have gone to zero, ETF fees have gone to zero, mutual fund fees are quickly following suit and investors have access to a very competitive wealth management market offering an impressive array of high-end financial services.
Many investors, however, fail to grasp the disconnect in valuations between the innovators and the moat builders until it’s too late. Interestingly enough, the past decade has shown that those who have been able to deliver on this new model haven’t been so expensive after all.
Charlie Bilello, Director of Research at Pension Partners, provides an excellent example.
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“In 2007, Apple had $25 billion in revenue and $3.5 billion in net income. This year, Apple is expected to do $259 billion in revenue and $53 billion in net income. In 2007, Goldman Sachs had $45 billion in revenue and $12 billion in net income. This year, Goldman is expected to do $35 billion in revenue and $8 billion in net income.”
And consider this, over this entire period, Goldman Sachs’ share price has tread water with a four per cent loss compared to Apple, which is up nearly 1,250 per cent.
It is worth noting that these companies are not without risk: Even those high growth disruptors can rapidly lose market share if they become complacent or do not adapt their models for competitive threats. Take Yahoo, IAC, Netscape, Excite, and eBay, which all once dominated the dot-com landscape.
As an investor, it is important to look for those companies that are always trying to find new ways to leverage their network. Take a look at Amazon’s latest quarter for example. While it disappointed by missing expectations, one very interesting bright spot was its advertising revenue hit $3.59 billion and is up 45 per cent from last year. Here you have a behemoth company creating a new revenue channel and growing that division’s annual recurring revenue at a high double-digit pace.
Those who win the day are those who view competition as a means of improving their product or service offering and enhancing their client experience. This old world thought has been amplified by new world technology and like in the past, those who build bridges instead of filling moats will succeed — just at a much faster pace.
Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.