Investing in the Age of Disruption

 We’re hearing the word “disruption” a lot these days as it relates to business. Traditional industries that were once seen as invincible and immune from advances by smaller competitive forces are tangibly under threat. Many industries appear to be at a crossroads. One can only open up the daily newspaper (speaking of disruption) these days to see these competitive threats being played out:

Potash: A once stable cartel that controlled prices and supply has been thrown into upheaval as a result of the breakdown of the Russian potash cartel. Companies like Potash Corporation and Mosaic are under threat of falling prices. Their respective stocks have been discounted to reflect this new reality. (Disclosure: I owned Potash)

Cable and Satellite: Entertainment content was distributed either through a copper wire or through satellite radio waves like DirectTV (Disclosure: We own). The internet has changed all that as upstarts such as Netflix, Amazon, as well as Google have introduced competitive models that allow for more customization of content at a much lower price point. These new distributors are even developing their own original programming that can give them much more control.

Retail: Brick and mortars were once the leaders of retail but over the past several years they have served as an effective foil via show rooming for online retailers like Amazon, and EBay that carry much lower overheads and in some cases charge no tax.

Restaurants: The emergence of the gourmet food truck with low overhead and flash following is challenging the premise of the traditional in-dining and takeout food experience.

Personal Computing Technology has been driven in the 20th and 21st century by the Windows PC and the processing of information through Intel chips. The past five years has seen the emergence of newer technologies like smartphones and tablets that are smaller and yet have just as much or even more processing power that the PC.

The genesis of this new era of disruption can be traced to a combination of technology levelling the information playing field, to younger generations who want to develop products and services that will make the world a better place (and make a few bucks at the same time) as well as disdain mistrust in the larger monolith corporate entity. As a result, we are seeing a lot of well-run, well-managed companies that are literally overnight becoming questionable investment plays and the stock market has discounted them accordingly. Potash Corporation has a very competent management team that has demonstrated an ability to generate solid, consistent Economic Profit. Granted it operated in a cartel so there was some cooperation. Now however, the business dynamic has changed overnight. They could now be forced to compete in a global, market-driven market. In the long-term this is not a bad thing, but in the short to medium term there will be significant upheaval. The share price already priced them accordingly.

From a capitalist perspective, disruption is healthy because it forces businesses to be constantly searching and exploring new ideas to create products and services that society truly needs. It forces businesses to make better use of investing their scarce capital in areas that tangibly benefits society. It keeps companies from sliding into mediocrity and complacency.

The problem with disruption is for investors, it can make it awfully difficult to determine a company’s future capability to create tangible, consistent, and durable wealth in the long term. Going back to the case of DirectTV, the company is a cash-cow with a captive client base, but with the NFL Ticket and the risk of losing it to Google out there, combined with a possible game-changer moment where consumers can access premium content without accessing traditional distribution channels, do those numbers become relevant in the decision making? We are witnessing a lot of well run, well managed companies literally overnight become questionable investment plays.

Investing In The Age of Disruption

Disruption has and will force companies to take a hit on their share price. We can see stocks falling which could make them enticing from a value perspective, but if the industry has undergone the negative game changer moment, it makes them essentially value traps.

Under these circumstances, we cannot just rely on and analyze financial statements. The numbers may not tell us the whole story. We will need to consider other qualitative factors which could include:

  • We need to better understand the strategy and make a rational assessment of whether it will be successful. To achieve this, we will need to seek out and listen to hear viewpoints from people working in the sector and have different and independent perspectives that are free of conflicts.
  • We to understand management competencies. Does the leadership have the skillset to transition to the future? The management at Potash is indeed competent, but their skillset has been nurtured in a price-controlled world. Now that the future might be more market driven, do they possess those types of competencies to operate the business in a more competitive environment?

Investing in a disruptive world is not intuitively hard. It just requires more work beyond crunching numbers to better understand the strengths, weaknesses and threats an organization is facing. It truly reinforces the notion that investing is indeed more art and science. The best and most successful investors have built this discipline into their decision-making workflow to the point where becomes second nature.