Ever since 1990, investors were exposed to the regular occurrence of stock-market roller-coasters this on the back of numerous major game changers (Internet, an excessive housing market, low interest environment, war, as well financial market exuberance, amongst others). Today, investors are exposed to higher average market volatility, bigger stock market swings, and a turmoil occurrence probability which is higher than in the past.
What has changed?
During the last 30 year, major technology developments took place; vast market opportunities have opened up for companies managing well the mix between soft information input, hardware, and manpower. In the period between 1980 and 2010, corporate earnings before interest and taxes, expressed through the key figure EBIT, have tripled. There are various reasons for this positive development but the most remarkable change is probably that more than 1 billion people were lifted out of poverty during this period and that they became valuable consumers.
The world’s biggest firms were up to now mostly based in the western hemisphere. Yet, this is about to change as the most power full consumers will no longer be in the United States of America or in Europe, but most like in Asia. In the past, worldwide consumer markets were dominated by western companies, but tomorrow an enormous wave of new companies based in EMA will compete for their local market share and new industry giants will dominate the business. Labor and capital intensive companies will compete in a much more difficult environment. For instance, raising capital, salary, and social cost will inevitably reduce the earnings power of a company.
Additionally, new technologies and an ever higher interconnection [at job and for day-to-day activities] with information technology, IOT, robotics and automation, will require that companies adapt quickly to new realities to capture emerging opportunities. When this is coupled with new regulations such as higher capital requirements, new emissions and environment standards, or lower prices for commodities traditional business models are not only challenged but highly disrupted. There are a number of recent examples where companies exposed to these threats have taken action. They reshuffled their strategies and business models and laid off employees. This global trend is just about to start and we unable to estimate how far the consequences will go.
We are therefore convinced that the well established measure “Beta” is outdated as from now on and a new paradigm needs used for successful investment decisions. Beta is a look-back function of the equity price development. However, given the far reaching changes which we expect, it would be opportune to consider an element or a combination of elements that gather a forward drift. The key element to consider is no longer how much growth a company can generate by simply conquer [new] markets, but rather how many idea intensive devices is can develop and integrate in its business in order to generate in a more efficient its operations.
We strongly believe that in the future idea intensive goods and services will outperform substantially labor and capital intensive companies. There are plenty of valuable reasons for this: examples that new-entrants having developed technology-enabled solutions exploit an existing infrastructure or ecosystem much more efficient, more user friendly, and highly more cost efficient for end users than the incumbent. There are plenty of examples which could enumerate for each sector, but the most visible are Skype in the telecommunication sector, Uber in the transportation sector, Airbnb for Hospitality offers, Charles Schwab in the asset brokerage business, and Google in advertising.
The analysis below highlights that low Beta and Beta neutral companies do not provide the expected guarantee for a stable portfolio and good long-term performance. In fact, the during the last major stock market corrections, they were hurt in a similar manner than average market while during periods with significant positive market drivers, they tend to underperform the market.
So, is it opportune to give up on the well established Beta measurement and to consider something more sensible changing market conditions? According to the analysis done, idea intensive goods and service generate better long term investment returns than low Beta and Beta neutral stocks.