Lawrence Burns: Manager Review

The Anatomy of an Outlier

Most companies simply do not matter. Research shows that only a small number of companies make investing in the stock market worthwhile. These companies are outliers that exploit the asymmetric pay-off structure of equities: uncapped upside yet mathematically bounded downside.

Whether the world is serene or chaotic, our objective remains the same: to find and invest in extraordinary companies capable of delivering outlier returns.

As with any investment, your capital is at risk.

Asymmetric Returns

The Scope for Uncapped Upside and Bounded Downside

Finding outliers is a challenging endeavour. They are, by definition, very rare, whilst their characteristics are heterogeneous. Define the parameters of your search too narrowly, and you risk missing out on a new generation of outliers that might look very different from those of the past.

It is therefore important for us to be open-minded about the sources of growth, maturity, financial characteristics and nature of operational excellence that lead to outlier outcomes.

Outliers can be young, fast-growing companies, such as Chinese ecommerce giant PDD, which is still less than 10 years old. PDD falls just outside our top ten outliers, but has still delivered a 6x return for shareholders since its IPO in 2018.

This has been achieved through explosive growth, compounding revenues on average over 110 per cent each year while going from heavily loss-making to generating $15bn in profit last year.

Outliers can also be much older businesses with less explosive but steadier, more resilient growth. Ferrari celebrated its 85th birthday last year, but was still able to deliver an 11x return for Scottish Mortgage shareholders over the decade.

Since we invested in 2015, the company has grown the number of cars it sells each year by less than 7 per cent, but with incredible pricing power, rising margins, and the market’s growing appreciation of both the resilience and duration of demand for its products has still delivered outlier returns.

We believe the portfolio today has a diverse range of potential outliers. With companies founded across the globe, from Stockholm to São Paulo to Singapore. The nature of the growth is also diverse, from rockets to digital banking apps to the most coveted handbags in the world.

We would be wary of being too prescriptive as to the characteristics of outliers, but there are several commonalities we have observed over the years:

1. Outliers are Unconventional 

It is not possible to achieve extraordinary outcomes through ordinary methods. Therefore, the strategy, culture and leaders of outliers usually appear as unorthodox.

In the case of SpaceX, to dramatically lower launch costs, it took a radically different approach. It sought to make rockets reusable. To accelerate innovation, it rejected the traditional aerospace approach of extensive planning and validation before building a prototype.

Instead, it adopted an iterative approach of rapidly building prototypes, testing them, analysing the results and implementing improvements in subsequent designs.

In practice, this has meant early test flights, which have often ended in spectacular explosions. Traditional aerospace companies go to great lengths to avoid public failures, whilst SpaceX broadcasts them live to global audiences and frames them as valuable learning opportunities.

This approach to learning has allowed the company to develop rockets in a fraction of the time and at a fraction of the cost of their competitors.

Backing unconventional companies can look prescient when they are successful, but when they fail, you usually end up looking very foolish. However, a willingness to look foolhardy is a necessary requirement for investing in outliers.

2. Outliers are Long-Term Focused

It takes many years, not quarters, to seize large market opportunities and for formidable competitive advantages to form. To succeed, outliers are focused on these long-term outcomes, not maximising value creation over the short or even medium term.

For much of its history, Amazon’s approach to profitability defied stock market conventions. The company chose not to make profits for many years and instead constantly reinvested back into the business.

This long-term approach allowed the company to build out its delivery infrastructure, deepening its competitive moat, seed new business areas such as Amazon Web Services, and deter others who did want to make a profit from competing against them.

Many of the companies we invest in are founder-run because such a leadership structure enables long-term decision making. Others, like Ferrari and Hermès, benefit from multi-generational family ownership to provide a long-term perspective.

The Hermès family owners have even committed not to sell any shares until 2041 at the earliest. We find it pleasing to own companies that can make us appear short-term by comparison.

3. Outliers Address Large Opportunities

Unsurprisingly, outliers need a large market opportunity. This allows a company to grow to multiples of its current size. Wise, the UK-based financial technology company, facilitated £68bn in cross-border transfers in just 6 months last year. However, it still served less than 5 per cent of the consumer cross-border market and less than 1 per cent of the business cross-border market.

The company’s mission is thus to create the financial infrastructure capable of serving not billions but trillions. It has ample space to grow and to continue its outlier journey.

The most rewarding outliers have what we call multiple acts. Having achieved success in one large market, they leverage their advantages to be successful in another. Amazon started as an online book seller but leveraged its ecommerce business to build its cloud services business.

Today, Amazon Web Services contributes 70 per cent of Amazon’s operating profit. NVIDIA started out producing graphics chips for PC gamers before investing heavily and presciently in artificial intelligence.

Mercadolibre started as a Latin American ecommerce platform. However, to reduce the friction of completing transactions when few people had credit or even debit cards, it developed a payment platform and started offering credit.

It leveraged the relationship with its ecommerce customers and its data insights from their purchases to offer a broad range of financial services.

Today, its fintech revenues exceed 40 per cent of the business. It may even have a third act emerging as an advertising platform, leveraging the data its ecommerce and fintech platforms provide to tailor adverts to users.

Spotify is leveraging its leading position in music streaming to offer podcasts, audiobooks and is running a pilot program for education content here in the UK. This pattern of multiple acts is repeated again and again amongst the most rewarding outliers.

As business analysts, it requires us to take an imaginative and creative approach to model the possible (never the certain) value of additional acts at a nascent and uncertain stage. The challenge is often to imagine just how valuable an outlier can become.

4. Outliers are Adaptable 

Outliers are not static but adapt to both opportunities and challenges. Companies must evolve to changing circumstances because to be static is to become obsolete.

The history of outlier companies is one of adaptation. Meituan started 15 years ago as a Groupon clone, fighting with an estimated 5,000 start-ups in China that were also using the group-buying model. It emerged from the so-called 'Clone Wars' victorious, pivoting the business into food delivery, travel and other services before we eventually invested.

Hermès started as a manufacturer of high-quality equestrian gear for the horse-drawn carriages of noblemen and royalty. It took a century before it produced its first luxury handbag.

When I first met the founder of Bytedance (TikTok’s parent company), it was to talk about its flagship product, Toutiao, a personalised news aggregation app. A precursor to Douyin and TikTok.

The end of the pandemic made even clearer the importance of investing in adaptable organisations. The world changed, demand for digital products and services slowed, and the cost of capital rose as interest rates soared.

A number of the leaders in our portfolio recognised this shift in the external environment and pivoted their companies. Mark Zuckerberg of Meta and Daniel Ek of Spotify both sought to right-size their organisations to the new environment early, focusing on efficiency and profitability.

At the same time, both still invested in new growth areas, with Meta spending billions to develop AI tools such as its large-language AI model Llama, whilst Spotify entered into the audiobook market.

I remember visiting Mercadolibre in Uruguay in 2022, where the management team talked with confidence about the size of future growth opportunities, but also the realisation that profitless growth would no longer be rewarded by the stock market. The pivot to balance growth and profitability has rewarded both them and their shareholders handsomely in the years since that visit.

The world is constantly changing. We cannot predict all the ways in which it will change over our five-to ten-year investment horizon. Right now, no one can even predict what global trade will look like 90 days from now.

However, if we are able to invest in companies with adaptive leaders and cultures, we can at least outsource some of this challenge to them. It is for this reason that we endeavour to back great businesses that are run by people far smarter than ourselves.

Risk Factors

Unlisted investments such as private companies, in which the Trust has a significant investment, can increase risk. These assets may be more difficult to sell, so changes in their prices may be greater.

The trust invests in overseas securities. Changes in the rates of exchange may also cause
the value of your investment (and any income it may pay) to go down or up.

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