All new technology companies, however great their success over many years (or even decades), eventually become out of date and are superseded by rivals with new and better technologies. Those that have become losers rarely come back from the dead. One of the few exceptions to prove the rule was General Electric, which has successfully reinvented itself several times over the course of more than 100 years in business. Unfortunately one of its later reincarnations was to take on the characteristics of a bank – which did not serve it particularly well during the global financial crisis.
11. Investing in new technologies is a high-risk business
What all these factors underline is that there is – and should be – a substantial risk premium attached to long-term equity investments in most new technology companies. The irony, of course, is that these risk premiums tend to fall, and are frequently eliminated completely, at times of fervent market speculation. In such cases, many companies reach the stock market that would not normally be able to do so.
There are many groups and individuals who make money out of technology booms both before and after companies reach the stock market. Those on the supply side, including the issuers and traders of shares, generally generate the more immediate and more certain returns. There is nothing wrong with seeking speculative gains, provided investors are comfortable with the real risks they are taking. The mistake is to believe that such gains can be anything but transitory for most participants.
Those without specialist knowledge of what they are buying need to display particular caution at such times. Investing in new technology demands a thorough understanding of the impact it will have, and also the patience to watch events unfold and pick the correct time to invest. This will be when the risk/reward profile is at its most attractive, not when everyone else is clamouring to buy the same things.
In aggregate, the evidence clearly shows that it is the application of technology – what you do with it, not how wonderful it may or may not be – that is vital. This typically takes time to emerge. History suggests that leadership rarely remains with so-called ‘first movers’, and even where it does, the investor who ignores reasonable valuation parameters does so at his peril. The typical result of ignoring the price of what you are buying is that even if you pick a subsequent technology winner, it may be at the cost of never actually making any money.
12. Spotting the losers is easier than spotting the winners
In reality the losers from technological change are much easier to spot than the winners. Losing technologies often face insurmountable obstacles in reacting to their new competitors. Canals, for example, simply could not achieve the speed of throughput that railways could. The telephone allowed voice transmission, whereas the telegraph did not. Cars made horses redundant as a means of transport. The digital computer provided greater accuracy and speed than any analogue equivalent could achieve. Online retailing of branded products and the advent of price-comparison sites redefined the ability of retailers and service providers to segment their markets and benefit from differential pricing. As a consequence customers both flocked to online provision and offline suppliers saw dramatic price deflation. This left a trail of devastation through traditional retailers, from books to consumer electronics to travel and insurance agents. Accompanying this, the exponential growth in Internet usage that followed search and online sales created a data treasure chest for advertisers. The ability to more accurately target potential customers left the advertising revenues of offline media such as newsprint and magazine advertising on the wrong side of history as a secular shift to online gathered pace.
Once persuaded of the losers, investors should typically disinvest. This is because losers from new technology are usually consigned to a period of persistent share price underperformance, in relative if not absolute terms. Incumbents rarely find a way to adapt their businesses to the new technology that threatens their existence. The classic example is Western Union’s failure to buy Alexander Graham Bell’s patents on the telephone when they were offered. In the public markets merely avoiding the shares of long-term losers from new technology is a more reliable way of achieving excess returns from an investment portfolio than trying to spot the winners, which is a high-reward but low-probability exercise. Even if the ‘losers’ manage to adapt and survive, they typically have shed a large part of their value through the struggle.
It is hard to overstate the importance of this aspect of investing. Knowing that a technology or method of doing business is in the process of being replaced should be sufficient incentive for professional investors to focus on those companies most likely to be adversely affected. While trying to pick the winners from a new technology is something of a lottery, figuring out the probable losers is a more straightforward business, and every bit as important. It may not be as glamorous but it potentially has a more profound effect on the ability to preserve and grow wealth. It does, however, require imagination as well as hard-nosed analysis. Even now it seems extraordinary that a company such as Eastman Kodak, so prominent for so long, should have effectively gone out of business as quickly as it did once digital photography became a commercial possibility.
For the Internet, the pot of gold is the financial sector. Banks, whose position was underpinned by the need for a branch network to collect deposits, now find that in the digital world this asset which acted as a barrier to entry is effectively a liability. We are still at the very early stages but one should expect the next ten years to bring signifcant disruption to existing business models throughout the financial sector, not least because the other barrier to entry – trust – was severely undermined by the global financial sector. Other than to set up the bank account itself, how many millenials ever have reason to visit a bank branch? Different elements of the financial sector are at different stages of disruption but from insurance to banks to asset management, all will face threats that have hitherto not existed.
The failure of Thomas Edison to create a battery which had enough life to sustain a motor vehicle resulted in over 100 years of domination for the internal combustion engine. The electrical vehicle might have been more efficient but it lacked range. The evidence is pretty clear that science has now grasped this nettle and the market share of 30% which electric vehicles achieved in the early 1900s will again be reached – and then surpassed. The impact of this is profound, not just for automobile manufacturers but for the entire industrial supply chain. The development of batteries also carries implications for the set-up and operation of the electrical-supply grid system and the economics of alternative energy sources. The cycle of technological change continues to roll on, challenging investors to understand and adapt to the new disruptive forces at work.
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First published in Great Britain in 2001.
This updated and revised second edition first published in 2018.
Copyright © Alasdair Nairn
The right of Alasdair Nairn to be identified as the Author has been asserted in accordance with the Copyright, Design and Patents Act 1988.
Hardcover ISBN: 978–0–85719–599–9
eBook ISBN: 978–0–85719–600–2
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Engines That Move Markets (2nd Ed) Page 65