Being Early is Not as Important as Being Right
– David Wanis, January 2022
As an investor, you are often urged to act quickly on the latest investment opportunity or regret missing out. For those interested in profiting from long term structural change it seems odd that we would need to act so quickly. Surely a profound opportunity that will change the world over many decades allows you time to sort the wheat from the chaff? If the opportunity is so fleeting delaying action misses all gains, then perhaps it wasn’t the structural change it was promoted to be.
At the end of 2021, it is now clear that the last 25 years was one of these generational opportunities to participate in the digitisation of, well pretty much everything. The question we ask: how early did you need to be? Well it turns out that when structural trends run for decades, investors are afforded plenty of opportunity to participate and capture these returns.
The examples we use are flawed by survivor bias, but we think as time went on the likelihood that Apple, Microsoft, Amazon, Google and Facebook were likely to be structural winners became a lower risk assumption. What returns were lost by waiting until these became the more obvious winners?
We start in 1995, when in August Windows95 launched and Netscape IPO’d (Yahoo followed in April 96, Amazon in Jun 97 and eBay in Sep 98). We have marked this as the beginning of the Internet era for public market investors.
Let’s start with Microsoft. Had you purchased Microsoft in August 1995 and held to end Dec 2021 you would have made 19% per annum over 25 years. If you had of waited until the dot com peak (Mar 2000) that would reduce to 11% p.a. Maybe you wanted to wait until the dot com settled. A purchase in Aug 2004 (when Google IPOd) returned 19% p.a. Maybe you had doubts about Steve Balmer and waited until Satya Nadella became CEO (Feb 2014) – you would have made 33% per annum in the almost 8 years since.
In 1995, Apple was still in the wilderness. Steve Jobs had yet to return (1997) and the iPod was still six years away. Holding Apple from 1995 to Dec 2021 has returned 27% per annum (with a near death experience along the way). If you waited until the iPod launched, you got 38% per annum since Oct 2001. Maybe you waited until the iPhone launched (Jun 2007) to achieve 30.5% p.a. Warren Buffett ended up buying AAPL more than nine years after the launch of the iPhone (Nov 2016) yet has still realised a 46% p.a. return over the five years since.
We see a similar pattern with Amazon (37% p.a. from IPO, 20% p.a. from dot com peak, 33% p.a. from when Warren Buffett bought in Dec 2018), Google (26% p.a. from IPO, 28% p.a. from May 2017 when Charlie Munger said “we blew it” for not buying Google) and Facebook.
None of this was obvious or easy at the time. Looking backwards gives a false sense of inevitability to history that is anything but. The future for electric vehicles, artificial intelligence, robotics, blockchain and genomics may contain generational investment opportunities. Unfortunately, there are hundreds if not thousands of companies vying to be the few winners left standing and reward their shareholders as Apple, Microsoft, Amazon, Google and Facebook (and others) over the past 25 years have done. What is hidden from history are all the failures investors have endured along the way – either companies that failed to meet these lofty goals, or investor temperament that failed to hold onto the ultimate winners through an uncertain path.
Flywheels or Waterwheels
As small cap investors, Longwave invest in much younger industries and businesses than is typical of large caps. It is more likely that the industries and companies we invest in are younger than Australia’s banking, mining, insurance, property and supermarket leaders. Just because we are not investing in 100+ year old industries doesn’t however mean we spend our time funding businesses that are 10 months old. There is a lot of industry growth lifecycle between 10 months and 100 years – and the current wave of investment neophiles would have you believe any company more than a decade old is ex-growth.
Our investment approach is to wait until the likelihood of success is more certain. Not guaranteed – because nothing is – just more certain than largely unproven early-stage companies. One measure of more likely success is the demonstration of a genuine and observable growth flywheel. Flywheels are sometimes over-used however we like the metaphor for the image of internally generated and sustained momentum. We seek flywheels that are self-sustaining. A profitable business with high growth opportunities reinvesting positive cash flows internally (capex, R&D, sales and marketing) to drive higher growth and higher cash flows and higher investments and higher growth etc.
Many of the current crop of growth business look more like waterwheels than flywheels. Superficially the effect is similar (more investment -> more growth -> more investment) but the missing part is internal cash generation funding growth investments. Like a waterwheel, these pseudo growth businesses require external liquidity to keep turning. Maybe some of them really are self-sustaining and are using external liquidity to spin faster. Or maybe they are just not going to succeed should this external funding dry up.
Every investor has their own philosophy and process and there are many methods we acknowledge we don’t pursue that may work for those investors. Our process seeks high quality small companies that have been seasoned by the reality of free market competition to emerge as genuine flywheels, not waterwheels in disguise.
This communication is prepared by Longwave Capital Partners (‘Longwave’) (ABN 17 629 034 902), a corporate authorised representative (No. 1269404) of Pinnacle Investment Management Limited (‘Pinnacle’) (ABN 66 109 659 109, AFSL 322140) as the investment manager of Longwave Australian Small Companies Fund (ARSN 630 979 449) (‘the Fund’). Pinnacle Fund Services Limited (‘PFSL’) (ABN 29 082 494 362, AFSL 238371) is the product issuer of the Fund. PFSL is not licensed to provide financial product advice. PFSL is a wholly-owned subsidiary of the Pinnacle Investment Management Group Limited (‘Pinnacle’) (ABN 22 100 325 184). The Product Disclosure Statement (‘PDS’) and Target Market Determination (‘TMD’) of the Fund are available via the links below. Any potential investor should consider the PDS and TMD before deciding whether to acquire, or continue to hold units in, the Fund.
Link to the Product Disclosure Statement: WHT9368AU
Link to the Target Market Determination: WHT9368AU
For historic TMD’s please contact Pinnacle client service Phone 1300 010 311 or Email firstname.lastname@example.org
This communication is for general information only. It is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. It has been prepared without taking account of any person’s objectives, financial situation or needs. Any persons relying on this information should obtain professional advice before doing so. Past performance is for illustrative purposes only and is not indicative of future performance.
Whilst Longwave, PFSL and Pinnacle believe the information contained in this communication is reliable, no warranty is given as to its accuracy, reliability or completeness and persons relying on this information do so at their own risk. Subject to any liability which cannot be excluded under the relevant laws, Longwave, PFSL and Pinnacle disclaim all liability to any person relying on the information contained in this communication in respect of any loss or damage (including consequential loss or damage), however caused, which may be suffered or arise directly or indirectly in respect of such information. This disclaimer extends to any entity that may distribute this communication.
Any opinions and forecasts reflect the judgment and assumptions of Longwave and its representatives on the basis of information available as at the date of publication and may later change without notice. Any projections contained in this presentation are estimates only and may not be realised in the future. Unauthorised use, copying, distribution, replication, posting, transmitting, publication, display, or reproduction in whole or in part of the information contained in this communication is prohibited without obtaining prior written permission from Longwave. Pinnacle and its associates may have interests in financial products and may receive fees from companies referred to during this communication.
This may contain the trade names or trademarks of various third parties, and if so, any such use is solely for illustrative purposes only. All product and company names are trademarks™ or registered® trademarks of their respective holders. Use of them does not imply any affiliation with, endorsement by, or association of any kind between them and Longwave.