The great acceleration

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03/09/2020
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Creative destruction is accelerating. A recent study by Innosight suggests that nearly 50% of the current S&P 500 will be replaced over the next ten years, whether that be through acquisition, merger or dropping out of the index due to a decrease in market cap or rivals with larger market caps emerging. Many will argue that this ruthlessness in the life expectancy of companies is exactly what the market system is designed to do, but it undoubtedly raises questions for investors.

Figure 1 shows how the average tenure of an S&P 500 company has been reduced from a 33-year average in 1964 to a projected 12-year average by 2027.

Figure 1:

average tenure of an S&P 500 company over time

 

Much of this decrease in the average lifespan of a S&P 500 company is being driven by technological change which is happening at unprecedented speed. Figure 2 shows ecommerce sales as a percentage of total retail sales in the United States. It demonstrates the rapidly increasing demand from shoppers to make purchasers online which has seen a significant spike during the COVID-19 pandemic.

Figure 2:

ecommerce sales as a percentage of total retail sales in the United States

Figure 3 represents the current top five businesses by market cap in the S&P 500 and the amount of years since they were founded. Three of these businesses have all been created in the space of the last 26 years, this is quite incredible for a company to go from conception to one of the biggest companies on the planet in such a short period of time. In all but the case of Apple, the original founders are still alive, and many are still running or actively involved with the businesses they founded. Facebook CEO Mark Zuckerberg is only 36 years old. These businesses have been built at a record speed, a trend that only looks set to accelerate with time as technological advancement grows exponentially.

But what does this acceleration in change mean for investors? The trend presents itself as two-fold, both in opportunities but also great dangers.

Figure 3:

current top five businesses by market cap in the S&P 500 and the amount of years since they were founded.

Opportunities

The pace of this change means there could be opportunities for investors to make large capital gains in an incredibly short period of time in a historical context, if they are able to determine and target particular themes and trends. The speed at which companies can amass a global customer base has never been faster due to the ability to gather customers online, with huge companies being created in years not decades. Many will argue that a great deal of this wealth was created before these businesses became publicly listed on stock exchanges, meaning ordinary investors have missed out. This is partly true, many companies are now finding it easier to raise money privately and are waiting longer to go to public markets, but there have been some great success stories such as Facebook, the company is now in the top five of the S&P 500 has seen a meteoric share price increase since its IPO back in 2012.

Dangers

This pace of change also presents dangers. Investors may hold businesses within their portfolios that are vulnerable to technological innovation - perhaps they find themselves on the wrong side of the trend to more digitalisation. Many traditional retailers have found it hard to transition as new online businesses have sprung up quickly taking market share.

Take GymShark for example, a company with a one billion plus private valuation built solely through social media and a Shopify website. The business has grown without the need for huge amounts of capital. The days when established retailers could monopolise the best high street locations, thus picking up the prime footfall through financial muscle are over, while barriers to entry have crumbled.

The same can be said of a whole range of different industries. Take television networks, a regulated industry that has been ripped apart by online streaming services running subscription models with no need for cyclical advertising revenue. Innovation and technology are changing industries faster than ever before, and companies need to be on constant alert as new threats emerge.

Threat or opportunity

Many will have heard of the term ‘unicorn’ being used to describe a privately held company with a valuation of a billion dollars or more. Now, due to the amount of privately owned businesses with even larger valuations, the term ‘decacorn’ had been used to describe businesses that have been valued privately at over ten billion dollars. Epic Games ($15bn), Space X ($33.3bn), Stripe ($36bn) and Airbnb ($18bn) (Source: CB Insight, 2020) are all current well known decacorns, many of which have openly discussed plans for an IPO in the near future. These businesses have the ability to disrupt some of the current established S&P 500 cohort and could be the S&P giants of the future, again presenting opportunities to gain from them when they list publicly but also presenting threats to the established companies in sectors which they would seek to disrupt.

To conclude, it is important that investors examine their portfolio and what the longevity of the businesses they hold may be. Do they hold companies positioned well to take advantage of this acceleration in technology to grow revenues and profits? Or does their portfolio consist of a holding that could struggle in the decades ahead. This is where active investment managers can add real value doing the detailed company and fund analysis on client’s behalf, seeking to spot the trends of the future for capital again and also analysing emerging threats to current holdings.

 

 

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