Actual investors look to the future. Not the past:
Assuming that companies’ past performance will continue takes no account of how the world is changing.
As ‘the future’ will be unrecognisably different from the present, it’s better to invest in a business because of what it can become, not because of how profitable it is now. Many investors avoid yet-to-be profitable companies for fear of looking stupid if they never generate free cash. We care more about how a company might make money in the future.
According to this mindset, share prices are determined by extrapolating past operational performance into the future. It’s an easy mental shortcut, but a spurious basis on which to calculate a company’s worth. Such projections often ignore the potential impact of changes in the market, or of technology shifts in the wider world. From healthcare to energy, we’ve seen how the game can change completely.
We call ourselves Actual – not just active – investors, because the companies we seek are those investing to secure their place in the world of the future. The best companies adapt, evolve and innovate, and we encourage them to do that, not just to aim for quarterly earnings targets. For Actual investors, extrapolation is unimaginative and usually misleading. It can also be destructive of value for index investors as swathes of once-reliable stocks are displaced by businesses exploiting newer technologies.
Take energy for example. Solar and wind is becoming cheaper than fossil-fuelled energy, even without subsidies. Solar panels and wind turbines are cheaper than ever to make and more efficient to operate. They make sense economically regardless of carbon pricing policy, which is likely to toughen as greenhouse gas emissions attract political attention. Renewable energy is where future growth will come from. But despite the end probably now being in sight for the legacy technologies of ‘big oil’, investors remain rooted in the past, leaving the major producers still enormously valuable in stock market terms.
For Actual investors to ‘look to the future’ should be more than: ‘This oil company looks cheap this week, but the oil price will go back up and it still has billions of barrels under the Gulf of Mexico’. Valuing on the basis of reserves makes no sense. Oil likely to stay underground has no value.
As ‘the future’ will be unrecognisably different from the present, it’s better to invest in a business because of what it can become not because of how profitable it is now.
Many investors avoid yet-to-be profitable companies for fear of looking stupid if they never generate free cash. Actual investors don’t care so much. Or rather, we care more about how a company might make money in the future. If we can envisage that, we ask how much capital it needs to be able to sustain itself through its own cashflow.
Healthcare offers a good example of how our lives will be transformed. From trial and error methods of drug discovery, we’re getting better at understanding the genetic causes of disease and at tailoring therapies to the patient. The cost of the gene sequencing that enables this has collapsed thanks to firms such as Illumina. Along with telemedicine – turbocharged by the coronavirus pandemic – it points to a massive disruption of healthcare, so assuming the continued dominance of today’s ‘big pharma’ makes little sense.
Imagining the new healthcare world means backing the companies likely to thrive there, such as vaccine maker Moderna or cancer drug developer Genmab. Some companies we own are not yet profitable, nor would we expect them to be at this stage. Working at the frontiers of medical science, some will bear fruit and others proved wrong. But waiting until a company is profitable before anticipating further growth is not what Actual investment is about.
Future-mindedness doesn’t just mean prospecting for exciting new companies. Familiar and unloved businesses that have shown minimal growth and whose stocks are undervalued can sometimes reinvent themselves. They sort out internal problems, outfox competitors caught on the wrong side of the capital investment cycle, or successfully move into an adjacent business.
Netflix offers an extreme example of the last of these, a DVD rental business that disrupted its own model to become the world’s largest content streaming service. CEO Reed Hastings sidestepped future failure and imagined a new kind of entertainment service.
None of this is to argue that the past never matters. Baillie Gifford was founded in 1908, when we invested in Malayan rubber to supply tyres for the Ford Model T. The automobile age, and many subsequent waves of innovation, taught us how new technologies attract capital, and how the cycle of investment and return plays out. We learned to imagine how future industries and companies could emerge.
Looking to the future will always be an imprecise art, but it’s important to practice it. We should assume that almost anything in any industry can be done better. Actual investors support those companies looking for a better way, in the hope that the value of that discovery will be recognised.
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