Turn fantasy into profit.
Technology. The corona crisis is a huge challenge for economy and society. And a disruption of historic proportions. For equity investors, it will be even more important now than before to invest in companies with disruptive business models.
When investors are asked where they would most like to invest, they often get a simple answer: "To the nearest Amazon, alphabet, Facebook. Because the Corona crisis will further accelerate disruptive processes in the economy."
The idea is, of course, correct. The only difficult thing is to identify companies that can benefit from disruptive processes. Nobel Prize winner Friedrich A. von Hayek even said in similar cases that it would be tantamount to an overkill of knowledge if individuals were to try to anticipate such complex developments.
This is also the reason why we are critical of small expert panels. They may be able to recognize the disruptive potential of business models. But when it comes to estimating when this potential will become relevant for the price of a share, experience shows that these people are often wrong.
At Warburg we take a different approach. We have put forward two working hypotheses. Firstly, in this particular case it makes more sense to rely on the intelligence and intuition of a large number of people than on individual recommendations. Secondly: it is not very helpful to want to anticipate disruptions before they actually become relevant and visible in business terms.
From both premises we developed a special selection method. Thousands of analysts around the world maintain databases with estimates for a large number of key corporate figures. We use this data set in the sense of Big Data to search for patterns in the course of these estimates using statistical methods, as was typical for successful companies in the early stages of disruptive processes in the past. Among the many key figures we investigate are estimates of cash flow, sales, profits, but also, for example, book value.
The focus is not on the level of the key figures as in classic selection processes. It is always only about the dynamics. Companies with visible disruption processes are characterized by the fact that estimates of their balance sheet ratios break out of a development path typical for the company and thus make a structural break visible.
The trick is to be able to make a distinction with sufficient certainty between "statistical noise" and an economically relevant development with relatively few data points and thus little time delay. In doing so, however, the algorithm may encounter patterns suspected of corruption, which turn out to be special effects such as changes in commodity prices or regulatory interventions. Therefore, a final check by an experienced portfolio manager is essential. The human factor is therefore not excluded from the process - it is only applied where it can add the greatest value.
Sometimes investors ask themselves how they can invest in companies that are still working on the next big innovation in their "garage". The honest answer is that this is not possible. But it is also not necessary. For example, the digital camera was developed by Kodak - and Kodak went under anyway. Often it is precisely the pioneers of disruptive business models and ideas that fail before the ideas are successfully developed in a second or third attempt. That's when our selection approach has to show its capabilities. ®
Dr. Christian Jasperneite
CIO, M.M.Warburg & CO