by James T. Tierney, Jr. – Chief Investment Officer of Concentrated US Growth
In fast-changing industries, it’s not always easy to know which companies offer the most promising investment opportunities. Hot products grab attention, but identifying enablers of change is often a better way to find companies poised to benefit disproportionately from transformational trends.
From cars to computers, technological change is sweeping through every industry. Yet many companies expediting the digital revolution aren’t household names. They manufacture the essential components found beneath the hood of popular products. Enablers of change are like “pick-and-shovel” providers—a concept that goes back to the gold-rush days of the mid-19th century. While many miners experienced disappointment in their search for gold, people selling equipment were far more prosperous as they sold more picks and shovels to each new wave of prospectors.
Different Perspectives: Investors vs. Consumers
Consider a recent groundbreaking product in the auto industry. In late May, Ford announced that it would launch an electric pickup truck in 2022, the F-150 Lightning. Its features are eye-catching: zero to 60 miles per hour in 4.4 seconds, 300 miles per charge and the ability to power your home during a power outage.
Equity investors might react differently to the product than a consumer will. Looking at the automotive industry, we believe the peak annual global auto production rate of 90+ million vehicles in 2018 is not going to change meaningfully over time. And the autonomous driving revolution—if it happens—might even reduce the number of cars sold each year.
So investment questions revolve around whether Ford will ultimately sell more electric vehicles (EVs) than internal–combustion engine vehicles, based on market-share gains or higher profit per electric car. Additional challenges include a hypercompetitive automotive industry with mounting competition from new entrants. What’s more, the share-price performance of traditional automakers—many trading at levels seen decades ago—suggests new technology has become commoditized at the manufacturer level. Companies with exciting new products ultimately need to be evaluated on their ability to overcome hurdles to growth.
Is the market wrong to get excited about new innovations? This is a critical question for investors—are you adequately rewarded for picking winners in various industries? We believe that in many cases, the reward potential doesn’t justify the risk taken. Of course, some industry leaders have strongly performing stock prices and attractive fundamentals. However, when industries change with an elevated level of uncertainty, it can be hard to identify the winners.
The electrification of the automotive industry is a megatrend that many investors want to capture, given its expected industry growth. But what’s the best way to do that?
Pick-and-Shovel Providers for Cars
Looking for the enablers is a good strategy, in our view. Pick-and-shovel providers in the auto industry are companies that are creating critical new technologies for global automakers. With the transition to EVs, auto manufacturers are replacing legacy wiring harnesses with more capable and scalable “smart architectures.”
Car manufacturers are also introducing diverse products for 21st century vehicles, from automatic emergency braking to blind-spot detection to surround view. Customers are willing to pay for these features and, after using them, few will be willing to go without on their next vehicle.
Companies such as Aptiv, a supplier of technology components for vehicles, offer diverse products that automakers will be increasingly compelled to add to their cars and trucks. Even if some of these products are installed in relatively few vehicles globally today, we believe they will roll out in waves over the next decade. And with an increase in EVs—which require even more sophisticated components—content per vehicle is set to rapidly expand, driving growth well above any change in the number of cars produced each year.
Beyond autos, digital technology is transforming many products, from computers to trains to spacecraft. These products rely on connectors and sensors, low-priced but highly valuable electronic components that connect a product’s core microprocessor to the outside world. Amphenol is an example of a company that plays a vital enabling role by virtue of its engineering prowess for digital applications. Amphenol sells sophisticated connectors for a range of products across diverse industries and regions, so its growth potential isn’t defined by the success or failure of a single hot product.
Healthcare Enablers: Vaccine Testing
In healthcare, the development of COVID-19 vaccines provides another pick-and-shovel case study. Dozens of companies seeking to develop vaccines needed support from contract research organizations (CROs) that help design and conduct clinical trials needed for new drug approvals.
Investors in vaccine developers faced big challenges. Which company would figure out the science? Which product would the market prefer? Then, the investor needed to be right on timing and materiality of impact. But CROs generate revenue from the process of developing a drug, not from its success (or failure). One example is IQVIA, the world’s leading provider of clinical-research services to the biopharma industry, which helps speed the time to market for new treatments and reduce the overall cost of drug development. The company’s global reach and data-analytic assets made IQVIA a preferred CRO for pharmaceutical companies looking to develop COVID-19 vaccines.
Pick-and-shovel providers might not always look like the sexiest investments. But often, enablers offer more attractive growth prospects at lower risk than better-known brands. For investors, we believe it can be easier to forecast the growth path of technology enablers than the demand potential for blockbuster products making headline news.
