Buy Right Sit Tight - 2018

Is Your Equities Portfolio Susceptible to Disruptive Attacks? Part 1

By Amit Rupani

In this fast-moving world, change seems to come at the speed of light, may be even faster thanks to technology driven disruptions. Blackberry, Nokia, Kodak, Polaroid, Blockbuster, Borders, Toys “R" Us were all market leaders that fell prey to disruptive technology. Blackberry had such dominance during its peak that no one imagined that in few years it would go bankrupt and be replaced by Apple and Samsung. Many famous companies failed to innovate or didn't adapt to new consumer preferences, resulting in their business failure. Companies like Apple, Amazon, Google, Netflix, Tesla, Uber, and Airbnb continue to innovate and create many new disruptions. If they don't innovate or adapt to newer market demands, they know that their best days will be behind them. “Innovate or Die" is the hot mantra of today's many businesses.

The average lifetime of companies is shrinking. In 1935 the life span of a company was 90 years and today it is 18 years. Nearly 90 percent of the Fortune 500 firms that existed in 1955 are gone or have fallen from the top Fortune 500 list. There are good odds that such fast-paced changes will continue and today's giants like Apple and Google will be challenged by newer companies which shall become future industry leaders. No one can confidently say which phones, cars, tablets, e-commerce sites, or streaming services people will be using 10 years from today or if they will be replaced by new inventions.

Many investment and market experts prescribe to buy stocks with long-term investment horizon. They say that wealth is generated in equities over decades of holding period when you literally “Buy & Forget." But today, where lifetime of companies is shrinking, how can one invest in businesses and sit tight on them for decades? How can one Buy and Forget? While the future is largely unpredictable, following are some predictable mundane industries with slower changes meeting basic human needs and wants which are likely to exist for many more decades.

Tires: More than 100 years ago, the Ford Motor Company made the automobile available to many, which revolutionized transportation and disrupted a number of industries including wagon and carriage business, and the makers of buggy whips. Transportation has been a basic human need for centuries. Globally, average miles driven per person are increasing every year. People should continue to use cars for transportation, at least in the near future. While Elon Musks' Tesla is giving other car companies a run for their money with its new innovations, it shouldn't take long for other big car manufacturers to catch-up and offer Tesla's similar features at a competitive price. Today, it's very difficult to take a long-term call on which car company will lead the industry in future and have a sustainable competitive advantage. But I can say with reasonable confidence that all the car manufacturing companies will always need tire for their new cars. And consumers will have to replace worn out tires keeping replacement tire demand intact. So, the wise bet would be a long-term investment in “high quality" tire manufacturing companies instead of direct investment in car manufacturing companies. In my opinion, future earnings visibility is more clear and predictable for tire companies than auto companies. A possible threat to tire industry is humans moving to drones for transportation needs, but that seems unlikely in the immediate future.

Food: Today, the majority of the food energy required by the ever-increasing population of the world is supplied by the food industry. Food is usually of plant or animal origin and contains essential nutrients to ensure that human body gets required energy to perform day-to-day activities. But most food has its origin from plants as even animals that are used as food sources are raised with food derived from plants. Corn, wheat, and rice account for 87 percent of all grain production worldwide. Due to increased awareness of healthy eating, there are good odds that in future more people will prefer for healthy and organic food options. I am not surprised that Subway became the world's largest fast food restaurant chain providing healthy food at affordable price. In developed parts of the world, more and more health-conscious people are cutting down on red meat and moving to healthy food options – “skate where puck is going to be, not where it has been," to use a hockey adage. An intelligent bet would be an investment in businesses that are focused towards farming, cultivating, processing, and distribution of essential food items that are healthy and economical in serving mass populations.

Not all businesses in these predictable industries are worth investing. One still has to do the hard work of understanding the business and industry dynamics. You need to ensure that business is run by smart and ethical management which is generating good return on equity and is available at reasonable valuation (you don't want to buy a Corolla at Ferrari's price). In short – you need to “Buy Right."

Warren Buffett has been asked several times for his reason on not investing in Amazon. He mentioned that he was watching Amazon right from the start and what Jeff Bezos has done is something close to a miracle. And if the odds are stacked for a miracle, he tends not to bet on it. Warren puts a “heavy weight on certainty" on the existence of the business and its future earnings potential. By limiting himself to investing in businesses that will meet basic human needs and wants, he limits the risk of permanent loss of capital.

My take on more predictable mundane industries will continue in Saathee's August edition. Happy investing!