Disruption & Equity Investing

Disruption & Equity Investing - Devang Mahendra Mehta, Mumbai (Mandvi)

I’m not stereo-typically a subscriber to “this time it’s different”, but when it comes to the emerging disruption in so many businesses, I have a feeling it really may be different, because today’s disruptions are everywhere, and that means that there are investment prospects right across the spectrum, from the disrupters to those “incumbents” enthusiastic to invest in the future.

We have become used to new entrants toppling a wide range of markets and industries. For example, Amazon, which now accounts for a bulk of US retail spending or Netflix and YouTube, which are escalating ruthless competition to US cable and satellite television companies. Artificial intelligence and Cloud will disrupt traditional consumer and technology businesses, while driver-less cars will threaten longstanding automotive manufacturers. Even services are not exempt from the revolution, with everything from banking to dry cleaning moving online.

Much rarer, and in many ways more interesting for investors, are the incumbents that are successfully adapting to change. Equity investors know they must incorporate the risk of ground-breaking disruption into everything from individual stock valuations to the allure of initial public offerings. Historic growth in revenue and earnings with a rosy near-term outlook isn't enough anymore. Companies must exhibit their capability to weather competition from disruptive new entrants, even when they presently own clear advantages of scale and scope.

In modern India, investors have to accept that disruption and opportunity go hand in hand. The challenge is to figure out who is adapting most intelligently. India’s economic progress, too, is a driver of product or service demand and innovation. A burgeoning middle class is seeking to better their lives with state of the art systems that provide them luxury & enhanced standard of life. For that companies need adoption of technology that can speed data capture and analysis and ultimately digitalization of systems, processes, services and client interface.

Firms that capture these opportunities for growth and competitiveness will be the ones that create the best potential to thrive as they invest in robust, scalable technology systems that can support long-term business growth, reduce costs, centralize compliance and oversight, and bolster operational efficiency.

Disruption is messy, erratic, volatile, impulsive and unpredictable. That is not the formula for structurally predictable corporate earnings. At the same time, societal change rarely happens at the pace the experts predict. Equity valuations are always and everywhere a function of future cash flows and interest rates.

It is imperative in today’s environment to understand the sectors which are going through disruptive trends. Media as a sector, be it print, digital, electronic, has been in the limelight. Smaller companies are unable to sustain on their own as it requires loads of investments in up-gradation of technology & competing with foreign counterparts. We are seeing a lot more mergers, acquisitions, strategic stake sales happening in these areas of business.

Similar examples are visible across Indian telecom & retail, which are exposed to the changing dynamics and disruptive movements. Market share gains or at least preservation here is of utmost importance to survive & grow in the longer term. You have to be mindful of the competitive intensity in such sectors. However, market leaders & disruptors here can be good choices for tactical investments, if you can understand the evolving trends by being proactive and ahead of the curve.

In a consumption oriented nation like India there is an aspirational mass wanting to come up the curve. Hence, consumption related stocks have always been investors delight and a space where wealth has been created & multiplied.

By having a well-known brand name, pricing power and a large portion of market demand, a company with a wide moat possesses characteristics that act as barriers against other companies. Economic moat describes a company's competitive advantage derived as a result of various business tactics that allow it to earn above-average profits for a sustainable period of time. Firms that enjoy strong economic moat tend to demonstrate solid financial performance and rising returns on capital over time.

While it is very important to be a long term investor, it is also essential that you focus on closely following the impact of disruption on your portfolio constituents. Great businesses with durable or sustainable competitive advantage will have the wherewithal to survive, thrive & grow in difficult cycles & disruptive environments. Major part of one’s portfolio has to be in so called non-disruptive types of businesses. Monopolistic or oligopolistic businesses command that pricing power & hence survive most economic cycles.

To select businesses less prone to disruption, stick to basics. Market leaders and high market share companies in the consumption basket are less likely to get impacted. The demographics of our country will continually support strong market leaders in discretionary & non-discretionary consumption universe, where demand for basic products & premium products will rise along with income levels & hence aspiration levels. Typically, all these companies carry premium valuations, deservedly so. The willingness and capability of the promoter/management in these companies to upgrade, innovate and increase market share plays a key role in stakeholder wealth creation.

The market pays a premium for simple stories. Stay away from the onions where you have to peel back multiple layers to understand them....



The author is Head – Equity Advisory at Centrum Wealth Management.



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