This week we were delighted to connect with Simon Erickson, founder and CEO of 7investing, to chat about a topic that underpins both the 7investing and Telescope Investing strategies – investing in disruptive innovation.
Simon shares his thoughts on finding and evaluating disruptive companies, why larger companies find disruptive innovation difficult, playing offence and defence in your portfolio, plus we chat about hype vs fundamentals, craft beer, and being neighbours with Morgan Housel!
If you’re a growth investor, this episode is pure gold – highly recommended listening for all Telescope subscribers.
If you enjoyed this episode, please subscribe to the Telescope Investing podcast at Spotify, or on your podcast platform of choice
Transcript
Albert: Hi, this is Albert.
Luke: And this is Luke.
Albert: Today is Thursday, the 14th of October.
Luke: Welcome to the Telescope Investing podcast.
Intro
Albert: Listeners, we’ve really got something special for you today.
Luke: Albert and I are delighted that we’re being joined on today’s show by Simon Erickson, founder and CEO of 7Investing. If you haven’t heard of Simon, he’s one of the stock market’s most forward-looking investors focused on identifying disruptive innovation and finding developing trends before others may even be aware of them. And he certainly brought some interesting ideas to Albert myself over the years, through his various services. Hi Simon.
Simon: Hey Luke, thanks very much for having me. Thanks, Albert. I’m really impressed with a methodical approach that both of you take to investing. It’s a real pleasure to be chatting with you on your show here today.
Albert: Thanks Simon. Actually, Simon, Luke and I are both 7Investing subscribers and have been for the last year or so. And we consider it to be one of our key sources for investment ideas, research, and also market commentary. I really love your podcasts and we’re really honoured to have you join us on the Telescope Investing podcast today to talk about disruptive innovation.
About Simon
Luke: But before we get into that headline topic, Simon, you are one of the best-known names in FinTwit, and I’m sure many of our listeners already know who you are, but why don’t you kick us off and just tell us a little bit about yourself?
Simon: Hey Luke, I’m flattered. Thank you for the kind words. And my background is I’m a Texas engineer, grew up as a chemical engineer and spent some time in chemical plants. Before I went on to become a technical sales rep, so I was the guy that was racking up the frequent flyer miles, you know, travelling all over the country. And I felt for a while like that courtyard Marriott room was my room for the majority of the week. But the thing that was the eye-opener from that is it’s kind of a combination of engineering and chemistry working with product development. They all wanted to create innovative new products. They always wanted to have something that was new to get a step up on their competitors. And so whether that was organic farming, whether that was deep-water drilling and demulsifiers and a variety of other things, you kind of saw where a bunch of industries were going.
Transitioned after that to working for a large oil company that was trying to figure out renewable energy. We were going out and developing a lot of solar projects, enhanced oil recovery as an alternative to natural gas. And putting the business plan, projections and the financial expectations for those projects together and then pushing it up to corporate. And then after that, I went out and I worked for the Motley Fool for seven years. I ran a couple of services for them. Really was kind of taking the opposite approach, rather than building things internally from companies looking at them externally and seeing what was going on in the markets and what companies were well poised to take advantage of those changes. And as you mentioned, in March of 2020, pulled together a fantastic team of fellow lead advisors for 7Investing. We try to look at all sectors of the market. So it’s not just growth-style investing, that’s just in AI or just in biotechnology or just in financial services. Try to have this full buffet for everyone to pick from and figure out what is the right investment for them and their portfolio every month. And we let people run with it from there.
Albert: No doubt you’ve been extremely busy, Simon running 7Investing since you launched the service early last year, but what do you do in your spare time? If you have any.
Simon: Darn, I don’t sleep, that’s not an option. I caffeinate most of the time. I have a young daughter, I have a son that’s due in November here, so that’s definitely keeping me busy. Big music fan, I’ve been a musician since I was very young. NFL football fan here in the United States. And I really like craft beer. I always like to try a new brew with some of my friends. A kind of a combination of all of that, I guess, keeps me busy when I’m not working on 7Investing.
Luke: We don’t have the NFL over here, but I’m definitely a craft beer and a music fan, and those two things go together really well.
Simon: Absolutely.
Starting 7Investing
Luke: And as you were saying, 7Investing, it covers all sectors and I think that’s a real advantage for an investor. Albert and I lean on the advice of some of the other big FinTwit names, guys like Muji at Hhhypergrowth and Software Stack Investing. They’ve got really great insight into particular sectors, but I think actually being a bit of a jack of all trades, master of none can be quite an advantage and you don’t get locked into a silo, perhaps driven by your domain knowledge.
Simon: Yeah, I think so. I mean, really the market is as a whole meant to be structured for individual investors. There are kind of limitations that funds have. Especially when they have to have a certain size market cap, they have to only look at a certain sector. I mean, that’s just a limitation that they impose upon themselves. It’s great to have a depth of knowledge, but I do think that when you look at the market as a whole, the best opportunities aren’t necessarily in one sector or one specific size of company, that’s at least how we approach it.
Luke: I guess, you launched 7Investing back in March 2020, and it was just as the pandemic was taking hold and there was a bit of a rapid stock market correction around that time. Well, the market’s come back strongly since then. I guess, it must’ve felt like the worst time to launch a stock recommendation service. In hindsight, it was a gift for investors with a long-term mindset. If you can take us back, what were your thoughts at the time the market corrected around then?
Simon: Oh my god, Luke, it was so intense, right. Okay, so we launched on March 1st, 2020, right. On the very, very first day we launched, we actually crashed our servers because… it was a good problem to have, right. It thankful that we had so much traffic that we totally underinvested in capacity to serve all of that. And servers go down the very first day, you know, here’s our big launch. We can’t take orders from people. Thankfully, people stuck with us on that, but then a couple of weeks later we had kind of a different issue, which is that COVID breaks out in the United States and there’s of course, a lot of uncertainty and panic from that.
My goodness, it was intense. That’s the right word to describe it, but it was also team building in a way. We would be up at two or three in the morning, answering questions from people right on Twitter. And several of the advisors on our team were working full-time jobs and they actually took vacation days, so they could focus on this and get everything right. I think in a way we built a lot of trust with a lot of our customers just because they saw, hey, we were all in on this. It was going through a tough time right there in the first couple of weeks. But to your point, my goodness, there’s certainly a silver lining to this that when COVID hit in the United States, a lot of the best companies in the stock market were incredible bargains. And so right out of the gate, we got the pick of the litter of a whole bunch of different companies. Man, what better gift for a long-term investor than to buy into those right in the first month that you launched. So yeah, definitely a double-edged sword, very intense in many ways, but really good for our team and really good for our investment returns.
Albert: Yeah, we’d been through a couple of crushes ourselves and it wasn’t fun at the time, I remember. And I think one of the things that we realized, that one of the worst things you can do at that time is to sell out of panic, but it’s very tempting to actually press that sell button when everybody else is doing that. And one thing that we did to keep ourselves busy was to start an investing journal, to write down our thoughts at the time and just to keep us from hitting that sell button. I think that journal led to us doing this podcast, so you can say the pandemic almost led us to do this Telescope Investing podcast.
Simon: Absolutely. It’s very interesting. I mean, selling is probably one of the most difficult parts of investing. It’s personal, everybody has a different goal that they’re trying to achieve in a different risk tolerance of things. I tend to agree with you that the best time to sell is when the market is giving you either an egregious valuation on the companies you’re invested in, or you’ve reached the goal that you’re saving money in the first place for. The most challenging is when, of course, everything is crashing and you hit the panic button, or you pull the ripcord, right at, perhaps the worst time to sell and the best time to buy. As long-term investors, I typically always think of anything I entered into personally have at least a five-year time horizon, if not 10.
Luke: Yeah, we totally support that. And having nearly 20 years under the belt now, the market goes up, the market goes down, you really see a thesis play out over the long-term. So as Albert said, we found the discipline of keeping a journal and writing down your thoughts, maybe doubling down on your due diligence, much more valuable in controlling that emotion in that panic that can take hold.
Disruptive innovation
Albert: And Simon, we really liked your session at the FinTwit Summit earlier this year, where you talked about investing in disruptive innovation, but just to kick us off, what is meant by disruptive innovation and how do you spot it?
Simon: It’s one of my favourite topics in all of investing. It’s something I’ve been a student of is learning about disruptive innovation. To start with some terminology, innovation kind of refers to a change in technology, but not all innovations are disruptive in nature. In fact, most of them are what we would call a sustaining innovation, which is an improvement to something that’s already existing out there, right. So every time there’s a new iPhone, Apple makes it a little bit better, but still built upon the previous version, right. Every time that Intel releases a new processor, it’s kind of built off of a similar architecture. Disruptive innovation is completely different, completely different technology, a completely different business model.
Kind of flipping the script on what we’ve known and the reason that’s so interesting is because the larger firms, the competitors to these smaller companies are already so established in the way that they’re doing things. They’re working out all the overhead expenses. They’re becoming more and more efficient in the way that they do things. It’s very, very difficult for a newcomer to compete against that, right. How am I going to go start an Intel microprocessor production fab and my garage? I’m not, there’s no way, it’s going to cost hundreds of billions of dollars and decades of experience. But if you can create something completely new that is interesting, that is disruptive to the incumbents. That is where there’s a lot of opportunity. And as an investor, I think it is really advantageous to us too, because they’re not really well understood. There’s an aversion to change. Institutional investors are typically risk-averse. They don’t want to take big bets in new technologies and disruptive new companies that are not understood. And so a lot of times, these companies are mispriced. Their stock prices are mispriced compared to the opportunities that they pose. If we can find those right opportunities and get in early, that’s a huge advantage for us as individual investors.
Luke: And you make the distinction there between a disruptive innovation and a sustaining innovation, and I know that comes from some definitions shared by one of your favourite authors, Clay Christensen. Do you think that’s a useful distinction? Ah, I see Simon’s reaching for the book right now.
Simon: Had that on the bookshelf, ready for you, Luke.
Luke: Very good. I’ve just started reading it myself. Do you think that distinction between sustaining and disruptive innovation is a useful one as an investor? When you’re looking for, perhaps that next breakaway company that could be a 10-bagger or 100-bagger of the future.
Simon: Yes. Because a lot of attention to innovation, as it should be, focuses on the market, but it’s not enough to just say, oh, the market size is this large, right. Like I know that you guys both come from the banking industry, banks have huge switching costs. They want to hold onto their customers. It’s not so easy to just go say, oh, well, we’re going to go and get all the existing customers from all the banks and just switch them over to digital apps that we have. Things like that are hard to do. It’s more than just an addressable market. There should be some reason why the existing customer base will change even if our large market opportunity exists. And I think that probably the best disruptor that we have in our era right now is Elon Musk, who not only realizes the really, really large market opportunities, but he just is so passionate about fine-tuning, every aspect of the process, in a way that is really hard to compete against him for a lot of good reasons. You really have to be at the top of your game and think about things completely outside of the box, which is exactly what Elon does.
Albert: Yeah, I’m a happy Tesla shareholder and in recent years, another Tesla shareholder, ARK Invest has popularized investing in disruption and they build their portfolios around five foundational technologies, and I believe they are DNA sequencing, energy storage, robotics, AI, and the blockchain. And here at Telescope Investing, we follow about 12 megatrends that we think are happening in the world right now. Well, I guess disruption can happen in any industry. Where are you seeing the most disruption happening now?
Simon: I’m so glad you brought up ARK Invest. Not a well-known story is that years, years ago, I actually interviewed with them when they had $8 million of assets under management if you can believe that, and looking at the size of some of those now. Great amount of respect for them, they’re really sharp analysts and a really good leadership team there too.
Some of the popular areas of disruption today, that we always hear about are electric vehicles and autonomous vehicles. This is very different from internal combustion engines and us personally, putting our foot on the accelerator. Blockchains, as you mentioned, is certainly a disruptive opportunity right now, Albert. Not only just the fundamental technology of blockchains but also the functionality that’s built upon that. The smart contracts that of course can cut out a lot of middlemen. NFTs, non-fungible tokens, kind of having identifiers for the metadata, so you can track and digitally guarantee the authenticity of certain things and then get higher prices from those. I think that a few less familiar, disruptive trends that are taking place out there right now is more proactive screening for oncology. We have gotten used to having symptoms appear in stage three or stage four cancers, and then you go to the doctor and they say, yes, you’ve got a tumour, we need to do what we can to try to make you as healthy as possible. If you can detect those through liquid biopsies or more preventative ways, that’s certainly is great for life expectancy of patients
Luke: I’ve been an investor in Guardant Health for quite a few years and I know that’s a company you used to cover yourself.
Simon: Absolutely, absolutely. And so they’re looking for fragments of DNA that are floating around in the bloodstream, as opposed to actually doing a tissue biopsy of an existing cancerous tumour. You catch it super early if you do that.
Luke: And how amazing to be able to take that technology and if you can get the cost model right, be able to roll it out at scale. Becomes part of your regular kind of annual MOT. That could be transcendent in terms of getting ahead of cancer.
Simon: Absolutely. And it kind of the foundational technology from that is genetic sequencing, right. You’ve got to be able to actually detect those small fragments of cells of DNA that are floating around. It’s very difficult to do, but my goodness, the progress is incredible so far. Several other disruptive trends. I could talk about this for the next two hours! I won’t with you, but this is a topic I’m very passionate about.
Valuing disruptive innovation
Luke: Simon, once you do find a disruptive investment opportunity, how do you go about valuing the company? Are things like traditional financial metrics still helpful, or is a lot of the value intangible when the companies perhaps such early stage?
Simon: It is intangible, but there are kind of clues you can tell what’s working versus what’s just hype. I’m not sure how many of your audience are familiar with the hype cycle, but it’s kind of predictive that as there’s more headlines and more Google searches for exciting things out there, the valuations of the companies, whether they’re private or public are going to go along with the hype. And you guys are certain as investors for the last 20 years are very familiar with this. So there is part of that, but there are also clues you can say, okay, well, how do we separate the wheat from the chaff on this? I tend to look for first of all, what is the market? How large is the market opportunity? But then what are the sustainable growth rates of this country? Have they been at this and shown a track record of 50% revenue growth for the last five years? Do we think that that will continue for the next three to five years as well? And if they’re scaling their business as they should, what do we think that this business looks like maybe five years out from now considering the growth rates, considering the size of the operation, considering the vision and the strategic roadmap that the company lays out there?
And then from that, what is a realistic multiple that the market would assign? The market likes growth companies. They like seeing that there’s plenty of opportunity in the future that is not already part of the financials. That’s a huge benefit for a founder to have that kind of story, as opposed to saying, hey, we’re just in a stagnant or a dying industry and here’s our numbers, and then you’ve got some value investors that want to capitalize on them. So in growth-style investing, there’s a lot more qualitative than strictly quantitative, but I think that the numbers-crunching part is more at the market level and the growth potential, rather than just, what are the cashflow margins of the business profile today?
Albert: Would you say that soon valuations have become, let’s say, stretched? For example, I believe Snowflake has a price to sales ratio of over a hundred. That to me sounds a bit unsustainable, regardless of what their growth rate is. Unless they’re growing up 10 times per year, that seems quite ridiculous.
Simon: Albert, it all depends on the business model to me. I think that Snowflake is one that’s worth paying up for, because it’s entirely usage-based. Almost all of revenue is based upon the computing that’s being done, the storage is being used in the applications that are built upon that. So it’s a very transparent look into the engagement that they have with their customers. That’s very different than a per seat licence model, like a Zoom. I could be using it one minute a month or 100 hours a month and I pay them the same amount for the licence. And then of course, just for a lot of the traditional software. CD-ROM that you install and then you just get one sale versus continual.
And I think that we’re kind of learning a lot, and software as a service has enabled this, of what is valuable out there. How do you capture that value and how can you build a sustainable business on top of that? I think Snowflake has done actually a very good job with that. I think that one of the counterpoints to that if we look at the other side, the bearish side of this coin, is I think that there is a lot of hype right now in electric vehicles and batteries. I think that a lot of that is in SPACs too, special purpose acquisition companies. To a lot of those kinds of companies, especially in that industry, are capturing huge valuations right now. I don’t think they’re going to be able to grow into that anytime soon.
Luke: I think, did Musk recently quote of Rivian, that he raises eyebrows at any company that has more than a billion dollars in market cap per vehicle or created?
Simon: It’s almost insane, right. When you see that they’re going after the very high end of the market, going to compete against one of the greatest innovators of all times, and the market has given them that. Good for them, let’s go get it, let’s go show that you’re worth that much. But man, I’m hesitant about one.
Adoption curves
Albert: Well, you might find a potential disruptor, but it might be too early to invest. I definitely feel we’ve done that a few times in our own investing careers, but how do you know it’s the right time to invest, Simon? What are the signs that you look for that tell you that an innovation is investible?
Simon: Disruption tends to follow an adoption curve where you’ve got the early adopters first, who are the techies that are playing around with Bitcoin and buying and selling it in their basement before anyone else even knows what it is. These are the people if you’ve ever talk to anybody that’s bought Bitcoin for 10 cents or, you know, delivered pizza for Bitcoin and found a way to put it in their wallet. I mean, there’s all sorts of fantastic stories about that. There’s a very, very early adopters’ phase where no one even knows about this. That is obviously the best time to get into something, but it’s also the riskiest because no one knows what the market’s gonna look like.
There’s a next step where there’s kind of the early adopters transition to what I would refer to as the early majority, where you start seeing people understanding what these do and why they’re interesting. It’s not just tinkering. There’s now specifications that might go into business projects, or you might have a personal reason to adopt something like this. And then of course, the crossing the chasm moment, right, of when it actually hits the mass market is you’ve actually got to have efficiencies. You’ve got to build teams around this. It’s got to be understood by larger organizations and enterprises.
And so the question of is it too early to invest in a disruptor is a curious one because it’s almost never too early. It’s just a question of how much risk are you comfortable with taking. Knowing that if you’re going to invest super early, if you’re going to be the person in the basement, investing in Bitcoin and you put your life savings into it, maybe you become a billionaire off of that. But it’s probably much more likely that unless you’re a genius that just can predict what exactly what’s going to happen five years out, it’s more likely that you’re going to have to place a lot of bets and then add to them over time.
So disruptive innovation is the same way. There was a really interesting quote. I heard, I forget the gentleman’s name, but a Korean inventor who worked for Samsung had something like 300 patents to his name. Fascinating. And people were asking him about public perception, about what, you know, what about public perception? I don’t think the public understands a lot of the innovations that you’re doing. Don’t you think that that’s a problem of just trying to educate them and make them understand what you’re doing? He says, no, no, no, no, no, no. This is the person that has 300 patents to his name. He says the public is never wrong. Public perception is never wrong. It is always right. It is our job to adapt and create things that are useful and valuable to them.
And this is the same thing with any innovation that’s going on out there. If you’re trying to create the world’s greatest thing and you’re slamming your fist down on the table saying, no, why can’t you guys understand what I’m trying to do here? You’re dead in the water. You’ve got to build something that’s fitting in the market that you serve. And so that’s kind of how I think that you can think about a lot of these. Whether it’s too early or not, it has to be the right fit, and a lot of times it takes time and patience for markets to understand those things.
Albert: As an example of investing early, when I look back, I was an early believer in electric cars and I first invested in a company called BYD around 2010, I believe. And the investment’s done well, but most of the gains has happened in the last two years or so, and I would have got the same returns, whether I invested in 2010 or 2019. So I definitely feel I was early on that investment.
Simon: Yeah, it’s interesting, right. You know, it’s a timeframe kind of thing. If you see a hockey stick. Okay, so two examples, say that you invest 10 years ago and it has a straight line that goes from $100 to $200 linearly over 10 years, versus if you started at $100 that goes nowhere for nine years and then pops up to $200 in one year. Your returns if you’re a long-term investor are exactly the same, just a matter of when did it catch on and how patient can you be. That’s kind of why we always say long-term investing works. You don’t have those psychological biases of getting out or I’ve got better money and my money is better spent elsewhere. Again, it’s all personal. It’s a different decision for everyone. But if you’re a long-term investor, it doesn’t matter if it goes to let her know you’re up and down.
Albert: Well, it sounds like you’re saying don’t try to time the market.
Simon: And have conviction too, right. Like you said, you were saying you don’t have a thesis. Luke, you’re talking about it earlier, write it down, why are you investing in this? Stick with your conviction. If you’re in this and you’re in this for the long-term, don’t worry about things taking time and not going anywhere for a while.
Luke: Yeah, exactly. A strong thesis could take best part of a decade to play out, and you can’t panic about the short-term market reactions. And I think as you say very wisely, place a lot of bets. If you find an industry that you think is going to be really interesting and you can find a couple of companies that are perhaps quite early stage, ideally with slightly different strategies, have a bet on everybody and just kind of see how the sector plays out as the technologies mature.
Simon: Yeah, absolutely. I don’t forget, Elon Musk, he get assigned a less than 10% probability of success for Tesla. Almost went bankrupt personally because of the business. And he would go to auto shows and nobody would even listen to him. He’d be speaking to a group of five people where all the other ones were getting all the attention. I mean, and look at Tesla today, amazing story.
Albert: But didn’t he invest 100% of his money into Tesla?
Simon: Yeah, all in. And that was not an insignificant amount of money either, right. I mean, you know, from the stuff that he had been doing with PayPal and previously.
Early-stage disruptors
Luke: I guess there’s an example of an enormous company that’s done fantastically and has still maintained their innovation and disruptive culture, even as they’ve grown into an enormous market cap. But I guess when you think of disruptors, you’re normally thinking about smaller companies and startups, who are perhaps coming up with a new idea and challenging the larger incumbents. So although some large companies have innovated and grown, what do you think stops larger companies generally from maintaining that culture of innovation and becoming disruptors?
Simon: Yeah, it goes back to the comment we made just a moment ago about sustaining innovations, right. That companies want to protect their margins and their cash flows because you want to do what your customers are telling you that they want you to do. That’s your business. That’s what’s paying the salaries of your sales folk and your R&D folk. You hear it all the time, right. We want to take care of our customers. We’re customer-focused. That’s what most companies are and should be, to be honest about it. The problem with that is you’re kind of locking in all of your resources and your time and attention into what your customers, your largest, most profitable customers are telling you to do.
And because there’s limited resources and a scarcity at all times for businesses, you almost by definition have to ignore or pay less attention to the underserved minority, who were saying, oh, we can’t afford these expensive products you have. Can’t you design something completely different and disruptive for us? And it’s challenging. It’s challenging to wear both hats as an organization that wants to be profitable and is being pushed by your customers and public investors and street expectations and earnings per share estimates and all these things to just say, okay, we’re going to completely flip the script and do something completely disruptive.
I think the most successful companies have an autonomous organization who is allowed to work independently from the cash cow. Alphabet does it really well. Other bets, you know, the XLabs that Google has. I mean, they’ve kind of got science projects, so they can go out and do whatever they want to and they’re funded to do what they want to. And that they can go out and work in life sciences, contact lenses for diabetics things like this. Internet that is broadcast from balloons in the remote places of the world. I mean, stuff like that or science projects that aren’t going to move the needle right now, but could they 10 years from now? Yeah, they certainly could. Netflix did a fantastic job of disrupting itself when it said, hey, we had a cash cow business delivering DVDs by mail to everybody. We’re going to invest heavily in digital streaming because we see this as being in the future. People thought that they were crazy and that this was just a complete waste of money. It was not where the margins were. Reed Hastings laughs last in the decisions that he made for Netflix.
Luke: I remember a really interesting decision he made, kind of on a dime, way back then. I think Albert and I were investors in Netflix when they were DVD by mail business, and I think when he was just about to launch the streaming service, actually right up until a month before they announced they actually had a hardware product. I remember reading an anecdote about a board meeting where Reed spoke to the put up managers, realized very quickly with his insight of his customers that hardware wasn’t the right way to solve this problem. And they sidelined in that project and doubled down on software and trying to build a platform that they could embed into everybody else’s device. I think that’s been really key in the rapid growth that they’ve enjoyed.
Simon: Large companies had the advantage that they have the resources too, right. So Luke, if you have a leader that is willing to take those bets and be wrong, it’s much easier for a large company to be wrong than it is for a small company. Remember the Qwikster thing with Netflix, that was a mistake and Reed came back and said, hey, sorry, you’re kind of laughs about it. I shot myself in the foot, let’s get back on course here. Jeff Bezos has had plenty of mistakes. Remember the phone that, you know, the Fire phone that Amazon had was certainly a failure. Elon Musk kind of laughs every time he makes a mistake. He makes a publicity event out of it where he’s shooting ball-bearings through the windows of the truck and things like that. It’s an advantage to have a disruptive visionary leader who’s willing to take risks and be wrong, and it’s not going to sink the company. Large organizations have that advantage.
Albert: Well, that is a key point, Simon. It’s the leadership of the company that often drive the innovation within that company. And I guess we remember the classic story about Kodak, where they had created one to first digital cameras, but they held back because they didn’t want to disrupt the existing business of selling rolls of film and look at them now, they nowhere now.
Transition to sustainers
Luke: So, I guess if we think about that company life cycle, do you think there is a point where a company perhaps goes from being a disruptor to a sustainer or, you know, they become just much more mature and now they’re focused on that huge mass market. They’ve kind of lost sight of the early opportunities. Is that a time if you’re invested to perhaps reconsider your investment thesis? Has it played out at that point?
Simon: I actually think the opposite, Luke. I think it’s actually a real advantage for companies to transition as they kind of get past that initial opportunity, right. Like that’s a sign of success. If you actually get to the point where you don’t have to read the disruptor anymore, you actually be the sustainer, you’ve made it then, right. And even myself, I have the public persona of being just an all-in growth investor. You know, go put all my money into disruptive innovation. I would say it’s about half. Half of my money is in disruptive kind of growth-style investing. The other half is more retirement accounts where I’m looking for the sustainers.
It’s a completely different type of investing. I think about it as playing offence on one side and then playing defence on the other. When you’re playing defence, you want to find those strong, competitive advantages. Capital allocation is a term that is very important for those types of companies, which is once you actually have cash flow, congratulations, you’re making money now. How are you using that in the way that’s best for investors? Apple has done this very, very well. If you remember several years ago, there was kind of this stigma or paranoia of what was going to happen when Apple couldn’t be a growth company anymore. They hesitated for years to even pay a dividend because they thought the market was just going to crush the multiple that they got. Oh, Apple, you know, is yesterday’s news. Now it’s a value company. That’s just paying out dividends. Show Apple’s stock chart to anybody who’s a naysayer when they did that of the past decade or so. Apple has done fantastically well, just because they’ve said, okay, we need this much money to grow the business, but we’re not just going to light money on fire or chase growth for any cost. We’re going to be disciplined about this. And we think it’s better to pay out a dividend and buy back shares with this amount of our cash flow that we’re receiving, rather than just go out and go growth for all costs. So I think, things like that, to your point about sustaining innovations. Yes, growth is still important for any company out there. Look internationally, look at how your market’s changing, but be smart about how you’re spending your money. And there’s nothing wrong with being defensive. You don’t have to go all in growth all the time. There’s nothing wrong with finding a company that pays a steady dividend and that lets you sleep at night.
Albert: Did you hear that Luke? Dividends!
Luke: I think Simon has given me a slap on the wrist. I’m an all in growth guy. Albert’s got a much more balanced portfolio.
Simon: I feel like there’s a story behind that, behind that comment.
Albert: We had an episode called the dividend debate, where Luke tried to convince me that dividends aren’t worth it, and I said, they are worth it. Actually, Apple is one of my biggest missed opportunities. I had the opportunity to buy this back in 2010, but because of my company’s compliance department, I was not allowed to buy it. I never bought it and the stock is 10X since then, or even more.
Luke: You’ve even on this podcast said, oh, I know this is my price fixation, I should buy in now, and then months later you didn’t and you’re still regretting it. Just jump on board, Albert.
Albert: But they’re almost $3 trillion. How big can they get?
Simon: Yeah, it is amazing. I mean, especially when you look at the largest companies in the S&P 500 here in America, right. The largest companies by market cap, you’ve got the Apples, they’ve got Microsoft, Amazon, Facebook. These are huge companies that are still over the past five years, five or six baggers, they’re up five or 600%. And these are the largest companies in America. So when you say, Hey, I want to go for. A lot of the times, those kind of get excluded from the conversations, but they get stronger. They’re investing in themselves. They are a better fit to serve a lot of those opportunities out there, and they pay dividends!
Disruptor red flags
Albert: Obviously being a disruptor doesn’t automatically mean a company will be successful, but apart from being just a bad idea in the first place, what are the main ways that disruptive innovation can fail after what seems like a promising start? Things an investor should look out for when evaluating a company?
Simon: Yeah. I mean, maybe drawing the connection back to the hype cycle again, there’s almost like this push to be like, can’t you just embrace our disruptive idea that isn’t catching on. The 3D printing I would argue is one of those, that everybody thought everyone was going to 3D print every Christmas gift for the rest of eternity in their own homes, you know, from this 3D printer that really, you had to buy these expensive materials and then you had to figure out how to get the designs. And all the software was very confusing for most people that were just saying, well, why can’t I just go buy this from Walmart or something like that? It didn’t catch on. Certainly had a niche for it, for prototyping, for automakers, but I think that that just got way too far ahead of itself. 3D printing was disruptive, but it was not ever going to make it into the mass market like many thought.
Virtual reality. I kind of have an issue with virtual reality. I think that people are pushing virtual reality too hard right now. It seems like we’ve been right around the corner of VR catching on for like the last 10 years. And even though we’ve fixed a lot of the technical issues with latency and the headsets being lighter and people not getting headaches from wearing them, I just don’t think that that is really consumer-ready now. I don’t think it’s going to be there even a year or two from now. We see Facebook has got a very active community and a lot of developers that are kind of building VR on its platform. But I still think that for most people, even a couple of hundred dollars for the headset is still several years out.
Luke: If I could just jump in on those two. In one hand, I’ve got a 3D printed coaster and the other one I’ve got my Oculus Rift.
Simon: Luke, you’re an early adopter! You’re the early adopter I was talking about.
Luke: But I think it’s a really interesting alignment between both of those companies or both of those sectors perhaps, because maybe the initial thought was these are consumer products and 3D printing certainly failed, you know, companies like 3D Systems and Stratasys, you know, initially they were going after the wrong part of the market. And I think, as we now see these sectors maturing and maybe VR, perhaps more AR and XR, I think we’re going to see real success in includes in a commercial environment.
Simon: Yeah, it’s really neat. I mean, some of the stuff that you’re doing with augmented reality. They’ve also got diminished reality now, too. We can block things out that you don’t want to see. I mean, there’s some kind of neat stuff going on that either augmenting or inhibiting our five senses, sixth sense when you really think about the digital things you’re trying to keep up. Yeah, I don’t know. I think that a lot of it is really interesting. I mean, we talked a lot about AI. I think one thing that’s kind of underappreciated is the use of AI coupled with natural language processing, right? So like, what is Alexa doing? How is it understanding the intent of what you’re asking? The progress that is being made for Alexa, which is one application for Amazon, can certainly be applied for customer service, call centres, you know, anything troubleshooting, which has been a really challenging for a lot of enterprises. If you can get that to get into the majority of the largest companies out there, I think that there’s a huge opportunity for something like that.
Luke: Really interesting innovation from Google actually, sort of voice assistant led conversations, where now you try and make a restaurant booking and Google Maps, the assistants phoning the restaurant for you to make the booking on your behalf and leading that conversation. Really fascinating.
Simon: It sounds lifelike too, doesn’t it? It sounds like a real person. You can’t even discern if you’re talking to a robot or a human.
Albert: Simon, I was really dismayed to hear that you have concerns about VR because one of my highest conviction bets is Unity, the platform for creating VR and AR applications.
Simon: It could still be fantastic, Albert. You know, I’ve got a good friend that started a VR company here in Houston and he’s gone big time with it, but even he has had to pivot. He wanted to put a VR headset and actually an omnidirectional treadmill, so you guys should play video games on zero friction, move around within the game with the VR headset on. It’s fantastic. Even something like that is still catching on within the home. He has pivoted to focusing more on gaming centres, you know, arcades. China’s really big on a lot of things like this, which by the way, that’s a rabbit hole we can talk about in the next conversation of China limiting the amount of gaming time for its youth to three hours a week right now.
But I mean like stuff like that, it could still be potential. It could just still not be the right time. I wouldn’t want to discourage VR. Like we said, we’re long-term investors. I think within 10 years, we’re there. I just don’t want anybody to get too excited and think that within 12 or 18 months, this is going to redefine the world. Personal opinion, feel free to disagree. Your mileage may vary, yeah.
Investing influences
Luke: I think that’s been a really fascinating overview of the topic of disruptive innovation. And a lot of the thinking in the industry has come out of quite a famous book, The Innovator’s Dilemma by Clayton Christensen. And I know that’s influenced your own thinking over the last few years. Are there other finance writers or other resources that have really kind of led you to the place you are today?
Simon: Yeah. I mean, Pat Dorsey kind of did some fantastic work. He was the Director of Research at Morningstar. The Little Book That Builds Wealth, as I remind myself of the exact name of the title, kind of looking at competitive advantages. Those are the things that companies are trying to build and disruptors are trying to break. And so, you think of things of switching costs. Why do customers stick with you? Network effects? We talk about all of these things quite a bit as investing. Warren Buffet, of course, is a huge fan of moats and thinks about this all the time from Berkshire.
That’s kind of the defence side of the portfolio is how is it hard to break an existing company that needs to capture a lot of cash flows and hire tens of thousands of people across the world. And so that’s kind of the Pat Dorsey side. The Clayton Christensen side is more of, well, what is not a super strong moat, is a huge company that I can break? And so that’s more of The Innovator’s Dilemma disruptive approach. And those are kind of somewhere in between the two of those right. There’s opportunities that can be innovative, that aren’t necessarily disruptive, they’re just underserved. And so there’s a lot going on in the investing world. I tend to think that the academics and the principles that they come up with are kind of lesser followed. Clayton Christensen was a Harvard professor, right. He was an academic. He was dismissed by a lot of institutional investors that just want to look at quarterly earnings per share and, you know, no, you aren’t hard and fast enough, and looking at the terms of the numbers. He actually had his own portfolio. He only had it for private investors. And it had a 30% internal rate of return, which was smoking a lot of those institutional funds that dismissed it. A lot of it’s more qualitative, a lot of it’s more principles-based, but that’s a very different way of thinking it than the entire financial system of institutional investors we have, at least here in the United States.
Albert: Yeah, I agree, SImon. I think one of the things that investors can do to improve as an investor is to just read more, read more books, read more articles. And one of my favourite authors is Morgan Housel. I read his blog at the Collaborative Fund and I’ve had read all his books several times actually and I think his latest book, the Psychology of Money is required reading for all investors.
Simon: Absolutely. Albert, Morgan was my neighbour in Alexandria, Virginia, when I lived there. I would always go out and he would walk his kid at the same time I’d be walking my dogs. So a fantastic author, a really great investor, great person too.
Advice for new investors
Luke: Very good. I’m sure Morgan and yourself exchanged some great advice back in the days. What advice would you give to anyone starting out on their investing journey today though?
Simon: Yeah, I mean, Albert kind of nailed it, right. Always be learning, always be reading. Find things you are interested in. I liked the investing thesis. I’m sure you’ve had other guests that have said the same thing but write it down. And why are you investing? What is your conviction? What are you watching specifically? Not just earnings, not just revenue, but like, what are the metrics? At the end of every one of our 7Investing reports, I challenge my advisors to come up with three metrics that are not just top-line revenue that we should be watching and know if things are going well, or if they’re going bad.
Don’t just believe the headlines. Don’t just be steered by, oh, that Wall Street hated the results so the stock sells off and you think you should jump ship. A lot of times that’s wrong or at least if you’re a long-term investor, that’s too short-sighted. Think about what the market is. Think about what the company’s doing and how they’re making their money. Follow metrics that are more closely aligned to that rather than just kind of the exhaust that comes downstream, right. So you’ve got the way that the car is being driven and you’ve got the exhaust that comes out that’s a reflection of how the car is being driven. If you’re always stepping on the gas, you’ve all had this giant plume of smoke coming out of the car. And of course, that’s costing a lot of money but is it worth it to get ahead in the passing lane? Maybe it is. Elon Musk showed us that it was a lot of the times and Bezos has too. But again, and you can’t just flush money down the toilet. You’ve got to make sure that you’ve got the right plan and the right team to do things like that.
Albert: Yeah. Investing, it’s quite strange in that, the more you trade, probably the worse you do, and your time is probably best spent just doing nothing. Inaction is underrated in investing.
Simon: I completely agree.
Luke: And perhaps follow your own passions, your own interests. If there’s a sector that actually, as a hobby, you’re tinkering with the gadgets there or you’re reading about or you’re researching. You probably know a lot more than many professional investors investing in that sector. You know, why not leverage that knowledge and experience for your own portfolio?
Simon: Yeah, and there’s also kind of a lot. Staying humble is a huge advantage as an investor. Not being too locked into thinking that we know more than we do. We can convince ourselves that we’re right and we’re smart and that we’re always going to be right with our stock picks. The reality is if you’re right 60% of the time, you’re doing very, very good out there. I think that it goes the same thing goes with good businesses, right. As the two of you gentlemen have seen in computer science, coding language has changed over time. If you were the world’s best Fortran coder, that might not be as applicable today.
Doctors, if you are locked into a certain way of doing procedures, those change over time. We need to be adaptive. We need to be flexible. We need to be open-minded, especially as investors because we see that the world is changing. Don’t get too locked into one style of investing, knowing that the world is going to change, and admit to yourself when you’re wrong and have a team that looks at alternative things that you are not looking at. Otherwise you kind of have this risk of having blinders on. I don’t know, a better way to say that, but kind of looking too narrowly at things. And in reality, technology changes very quickly, especially today in the digital world that we live in
Luke: It’s definitely helpful to have, you know, if you don’t have a team around you, having friends that share an interest in investing, and try and challenge each other, maybe try and shoot down each other’s investment ideas. That can be hugely valuable to try and have that objective debate.
Simon: It’s one of the things I think I’ve learned the most from 7Investing is more of the leadership side of things. It’s been incredible to work with seven advisors, not just a handful, but seven that look at things very differently than I do. Everyone on this team looks at different sectors. We also think about the business itself in different ways. And so there’s an investing side of it. It’s like, okay, yes, this is great. We have a diverse buffet of options every month, but it’s also like, how are we running 7Investing? What are the decisions we’re making to grow this company too?
There’s kind of a balance between, you know, you want to build a culture that embraces new ideas and the ability for people to speak up when they don’t agree with things and also making decisions. It’s like, hey, we need to be a fine-tuned machine and we have to make decisions. We can’t always be all over the place with every idea.
It’s fascinating. It’s the same opportunity that business leaders at the largest organizations in the world face, of how should we spend our money? What’s the team and the culture that we want to create? And what’s the ultimate strategy of what we want to be? It’s a little more touchy-feely when you look at a business’s mission statement, but it’s very important. It defines what they’re going to do and what’s worth the time to pursue, and what’s kind of out of bounds and off-limits. I think a lot of America’s largest tech companies are trying to define that, right now.
Albert: And I think one of the things that we look at when we evaluate a company is the leadership. One of the first things we look at is how are they running the company? And what is their stake in the company? Do they own significant portions of the company? Are their incentives aligned with their shareholders?
Simon: And the board of directors too. And then also how leadership is compensated and what are the metrics that they’re trying to knock out of the park because incentives will be a big factor and what the leadership team is telling everyone who works for them to accomplish. So keep an eye on the proxy statements.
Luke: And you know something that’s quite powerful you said that hadn’t really occurred to me. When Albert and I examine a stock, we produce a kind of one-page overview and we try and look at different aspects of the company, and we call out the key green and red flags. But often we don’t look for quantitative metrics that we can point at that are perhaps quite unique to that organization. And that’s a much more objective way of assessing whether you were right or wrong, rather than just kind of pinning yourself on a bit of a story. I really like that.
Programmatic advertising
Simon: If you wouldn’t mind, I’d love to give an example of this, kind of that might tie together several of the things we’ve been talking about. Maybe something that’s disruptive right now, this is kind of off the cuff so bear with me. It’s not perfectly well thought out. But we hear a lot about programmatic advertising. This is an industry that is kind of transitioning from direct placements, right. So if you had a website, the old way that used to be was you’d have handshake agreements with somebody that wanted to place their ad on your site. Banner ad, it’s there for X number of weeks, you pay this much money. There’s now auctions that are doing that programmatically, algorithms that are placing all of those. And one segment of this that is incredibly lucrative is connected television advertising. We know that this is some of the highest rates that advertisers will pay because you have people’s attention. When they’re sitting on their couch, watching the football and soccer game, they’re not getting up and clicking on other things off the internet. It’s got their full attention. You’re willing to watch those. And so they have really, really attractive rates, but this is still mostly regional programming, right.
Linear cable TV, which is based on the part of the country, at least in the United States here, where I live, that you live in. That is changing and it is being disrupted. And so anyone who’s wanting to run the algorithms that would appeal for programmatic advertising for connected televisions needs to think this through and needs to capture that market that is growing.
And so as I look at the ad tech space today, I’m laser-focused on what are your growth rates in connected TV and what are the deals that you’re signing with publishers out there? Because to me, this is an untapped market that is still vast majority served by direct ad placements, but it’s going to be multiple billions of dollars, and there’s going to be some consolidation behind the winners in this space.
So one example again, as I kind of go off a tangent on this, but kind of when you think about disruptive opportunities, you look at the market opportunity out there. You look at the actual metrics you want to look at for an investor. How can that define the winners from the losers?
Albert: Yeah. I’m glad you mentioned programmatic advertising. As a shareholder of Magnite and The Trade Desk, we’re quite bullish on that sector as well.
Simon: Yes, absolutely. And different plays. You know, those are what you just mentioned. The Trade Desk is more on the demand side, which represents the ROI of advertisers. Magnite of course, operating on the supply side, which represents the publishers. They integrate as partners with one another. There’s multiple winners from that space for sure.
Luke: Exactly, a really exciting sector. And as you say, the huge majority of advertising dollars are currently spent on linear TV. When you can hyper-target a specific advert at a specific pair of eyeballs based on a lot of information you know about that individual, that is so valuable for advertisers. I think there’s some catching on to be done, and we’ll see a real movement in where the ad dollars are spent in the future.
Simon: Yeah. And it’s so early, Luke, I mean, just look at what the transition that even Google went through. Google used to be a cost per impression auction, right. You just saw the ad and then all of a sudden you get 10 times the ad rates when it’s cost per click. There’s an interaction now. We’re still talking in CPMs when we’re talking about connected TV. We don’t even have a way to interact with those ads yet. Imagine when you can suddenly buy something for what you see on TV with the remote or through your Alexa app. And then all of a sudden the ad rates are going to shoot through the roof. I almost guarantee it.
Luke: That’s a really interesting vision of where the industry goes. I totally agree.
Where to find Simon
Simon: This is a fascinating discussion. Once again, I thank you for all of these questions. UK and Hong Kong, right? Next time I’m in the area, I think we need to go out and get a couple of beers together and chat about this even more.
Luke: That would be fantastic. We’re definitely buying. Well, maybe as we bring our interview to a close though, perhaps you could tell us a little bit more about 7Investing and perhaps where our listeners might come and enjoy some of your own research.
Simon: Sure. So, we are 7investing.com. Our mission at the higher level is to empower people to invest in their future. That phrase we developed because we think that investing is personal. We think that everybody has their own goals and their own risk tolerance. It’s your future. We want to empower you to get there by giving you options. We spend a lot of time on finding the best opportunities. There’s seven advisors on our team. We go out and individually find our best idea in the stock market. Independently, we bring them together into a subscription product we sell for $49 a month or $400 a year unless you’re a student in which case it’s only $84 a year. But we basically, it’s a collection of our team, which includes PhDs and computer science and biotechnology and masters in science and materials. We’ve got a bunch of people that follow AI and financial services. Kind of this diverse group that is looking at all corners of the market and pulling together our best ideas. And we write reports on them. We follow those companies over time and we present them to our subscribers. Tomorrow, we’re actually gonna be hosting our October subscriber call, where we chat about our previous picks and our current picks. I’m having a lot of fun with this, Luke. I really have enjoyed the 7Investing experience. So we’re about a year and a half in now.
Luke: I always keep the subscriber call marked out in my diary every third Friday of the month.
Simon: It’s a lot of fun and it’s really rewarding too. It’s something that we are very inspired by what we do because how fun is it to hear from people that are buying the dream home or they’re retiring early or they’re going on a vacation saying, yeah, you know, I bought this pick of yours and this enabled it. And stuff like that is very rewarding. That’s what gets me up in the morning to do this.
Luke: That’s fantastic. Well, you’re making a huge contribution to what we turned the FinTwit body of knowledge. I don’t think we could dream of aspiring to the scale of 7Investing, but we do try and put out articles and episodes every week ourselves that help advance understanding in some of these niche areas.
Simon: I would love to collaborate with you all. This has been very enjoyable. You’re both very methodical and great backgrounds and really understand the importance of thorough research in investing. This isn’t something that you can just shoot from the hip and guess, or throw something into the wind and see which way it goes. Good thorough research is rewarded.
Albert: We always say the old do your own due diligence, your own research and build your own conviction.
Simon: Absolutely.
Investing quote
Luke: That was a really great discussion, Simon. Should we round out today’s episode with an investing quote though, Albert?
Albert: Yeah, I believe you found this one from Clayton Christensen himself. And he said, “Research suggests that in over 90% of all successful new businesses historically, the strategy that the founders had deliberately decided to pursue was not the strategy that ultimately led to their businesses’ success.”
Simon: Wise man Clayton Christensen was. He was brilliant. I chatted with him after Competing Against Luck was published. He’s unfortunately passed away now, which is very unfortunate, but his mind was a Rolodex. You know, he would think of things, seven layers deep and have immediately examples to connect all the dots. It was fascinating to hear him do what he did so well. What a great mentor.
Wrap
Luke: That was a really great chat. And it’s been a delight to have you on the podcast this week, Simon. Really appreciate you taking the time to share some of your knowledge and wisdom with our listeners
Simon: Hey, Luke and Albert, thanks very much for having me. I had a great time.
Albert: Yeah, thanks, Simon. Well, that’s all for this week. Thanks for listening.
Luke: If there’s a future topic you’d like us to cover, you can message us on Twitter. I’m @LukeTelescope.
Albert: And I’m @AlbertTelescope, or you can email us at feedback@telescopeinvesting.com.
Luke: One of the best ways you can show support for our podcast is to leave us a review on Apple Podcasts.
Albert: And if you have a friend who you think would also get value from Telescope Investing, we’d love it if you could take a quick moment now to spread the word and send them a link.
Luke: Thanks. Albert.
Albert: Thanks, Luke and thank you, Simon.
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