Book Excerpt: Shareplicity 2, A Guide to Investing in US Stock Markets
Excerpt edited from Shareplicity 2, A Guide to Investing in the US Stock Markets: Secular Growth Megatrends and S-Curve
By Danielle Ecuyer, author
Chapter 5 Secular Growth Megatrends: Part One – An Overview
If you are unfamiliar with the term ‘secular megatrends’ just say secular growth is a fundamental shift in an industry that creates long-term high demand for a new product or service, which far exceeds traditional cyclical recoveries. economic activity; and let Viktor Shvets, global equity strategist and Macquarie Bank thinker, define the megatrends:
“Robotics, cloud computing, AI and 3D printing are revolutionizing energy, manufacturing and consumption. Beyond atoms is singularity (the inability to differentiate between human and non-human contribution). (From his book The big break.)
Viktor Shvets belongs to a group of experts who claim that we are on the cusp of the greatest technological innovation and disruption with the unfolding of the secular megatrends of the 21st century over the next two decades and beyond.
I want you all to consider autonomous robotaxis, smart devices, smart clean energy systems, and digital bitcoin wallets. All these innovations are part of or are part of the acceleration of DANCE, an acronym which designates the business sectors carrying data, algorithms, networks, cloud computing and improved digital equipment. The boundaries between traditional hardware and software companies are becoming increasingly blurred as intelligent hardware embraces software as a service (SaaS) operated in the cloud. As tech analyst Laura Martin said:
“AAPL (Apple) should be appreciated as an ecosystem company because of its seamless integration of hardware, software and content, in our opinion.‘
Yes, I can hear the laughter from skeptics and naysayers, but I bet you’ll make more money by investing in the winning companies – or the “best of breed / sector / class” change makers – at the during the second decade of 21st major trends of the century than buying mature companies in cyclical sectors.
Secular growth trend
E-commerce is a prime example of a secular growth trend. Online retail sales in the United States have grown from about 0.5% of total retail sales in 1999 to about 20% at the end of 2020.
Secular trends may be affected by changes in economic activity of a more cyclical nature, but are generally perceived to be more resilient than traditional business models and cyclical sectors, as demand may be sustained or increase during economic downturns ( this is due to disruptions or changes as consumers move from the old business to the newer). In the case of the pandemic, a mix of forced lockdowns and limits on discretionary spending on travel, tourism, and the like has dramatically increased demand for online goods and services, reducing demand for traditional bricks and mortar ( physical stores).
According to James L. Callinan of Osterweis Capital Management, there are three engines of secular growth:
- Core technology: He is the deepest innovator and the maker of change. There are many examples throughout history, where technology not only enables the evolution of a new market, but also many companies and other technologies can benefit from innovative development. Examples include electricity produced by combustion engines and, more recently, e-commerce from the Internet.
- Replacement product, existing market: This is relatively straightforward: technology allows the development of a replacement product or service that challenges incumbent historical producers. Companies use these products and services to increase sales and market share – and erode the market share of existing players. They do this by offering cheaper, more efficient, or better goods or services; or those that respond to changing market dynamics. I don’t want to sound like a broken record, but the electric vehicle is a current example. It used to be the dishwasher or the washing machine.
- New product, new market: Osterweis cites Google as a prime example of a new service (providing search engines and advertising) that was founded and built on what was a new communications and information transfer network, the Internet. Google’s market share has grown to 92% of all Internet searches, having eliminated competition since the early late 1990s. Arguably, with such market dominance, a business like Google attracts no only a possible regulatory intervention, but also, its growth has shifted from secular to cyclical (as it benefits from a slight increase in advertising spending). When companies dominate the market, the ability to further grow their revenues and profits is more dependent on business cycles and the ability to innovate and adapt.
This leads to what we look for in secular growth companies, the “S” curve.
FIGURE 9 The S-curve
The S-curve shows the turnover of a new business model. Initially, it takes time for the product or service to develop and sales to increase, but once adaptation, demand and popularity increase, sales have the potential to grow very strongly (see middle section of the curve in figure 9). If the company fails to change and adapt by reinvesting, it is likely that the sales of the innovator or change maker will slow down, as shown by the flattening of the curve.
The valuations given to companies on the S curve will also change over the course of the curve. For example, in bull markets such as we saw in 2020, there was a lot of liquidity generated by the Fed and most secular stocks rose, and often sharply, even though the company was at the point of Entrance. This meant that investors were giving the company the benefit of the doubt in terms of future growth potential, known as the “long earnings trail” when earnings look good going forward. If the market believes that a stock will grow its revenue and profit at a high Compound Average Growth Rate (CAGR), the Total Addressable Market (TAM) is huge. In bull markets, with low interest rates, these stocks will be given insane valuations, equal to and above 50 times the price / sell ratio. Investors may well view these valuations as excessive “bubble” -type multiples in a world of low interest rates.
Many S-curve growth start-ups have no reported profits and their valuations are derived from the price-to-sell (revenue) multiple. (Valuation measures will be explained in more detail later in this chapter and in Chapters 6, 8 and 9.)
However, if there are any indications of slowing revenue growth (whether reported or indicated via the company’s outlook), the share price is normally sold heavily. This means that a stock’s valuation will contract or rise depending on whether the company can successfully execute the next phase of high revenue growth to penetrate the big TAM.
Danielle Ecuyer has been involved in equity investing in Australia and internationally for over three decades. Due to the success of his first book Shareplicity: A Simple Approach to Equity Investing (Major Street Publishing $ 29.95) his second book Shareplicity 2 A Guide to Investing in U.S. Stock Markets (Major Street Publishing $ 34.95) was released in July 2021. Learn more about www.shareplicity.com.au
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