Your opportunity

The market as an extrapolation engine is selectively irrational around changes in the operating environment – the type of change helps define the investment opportunity:

 

  • Business cycle opportunity
  • Structural change opportunity
  • Socio/Macroeconomic opportunity

A business cycle opportunity relates to mean reversion in profitability and valuations and relies upon the identification of a catalyst or turning point.  Whilst “mean reversion” may occur in many turnaround situations, the risk of substitution and obsolescence can also lead to “mean reallocation” (e.g. mainframe computing redistributed by the PC revolution, newspaper classifieds by internet verticals and paid search,  broadcast and cable television by on-demand streaming, etc.).

For business cycle opportunities we apply the following investment framework:

  • Determine whether the downturn is cyclical or structural – avoid value traps
  • Analyse historical patterns, identify catalyst and timing of expected upturn
  • Protect downside by maintaining preference for industry leaders (scale/cost position, balance sheet, management)
  • Buy stocks in area A and avoid those in B

For an example of a business cycle opportunity see our investment case summary for Nippon Electric Glass.

A structural change opportunity relates to non-linear (disruptive) or compounding change in situations where most investors expect incremental or cyclical change. Dominant companies or “incumbents” can unwittingly open the door to “disruptive innovations” by over investing in sustaining innovation and creating price umbrellas.  The value opportunity occurs in symmetrical form: 1) Early identification of a real disruptor; 2) Identification of an incumbent incorrectly assessed as a victim of disruption.

For structural change opportunities we apply the following investment framework:

  • Apply sustaining versus disruptive innovation principles
  • Consider power laws, non-linear change and fat-tails
  • For a disruptor, establish inflexion point for mainstream adoption ahead of the consensus
  • For an incumbent, look beyond the time horizon of the average investor
  • Buy stocks in area A and avoid those in B

For an example of a disruptor opportunity see our investment case summary for Jiangsu Yanghe Brewery.  For an example of an incumbent opportunity see our investment case summary for Amerco.

Consider the following:

  • Globalisation and ubiquitous access to information as a potential leveller of returns and a force of empowerment for the other 6 billion
  • Debt and wealth imbalances are extreme, Central Banks’ politicised and large corporations have never been more powerful
  • The attitudes, institutions and structures that lead to a more resilient society, e.g. rule of law, social cohesion, specific biases, etc.

For socio/macroeconomic opportunities we apply the following investment framework:

  • Consider socio/macroeconomic factors when evaluating an individual company’s prospects, e.g. relative attractiveness of exporters versus domestic exposures, health of the institutional environment, etc.
  • Manage the currency risk that arises from stock selection
    – Identify significant valuation anomalies
    – Sovereign risk assessment and real world reality check
  • Identify tail risks and opportunities

For an example of an opportunity with a macroeconomic component see our investment case summary for KB Financial.