Oddly enough, I remember the first ever Sesame Street way back in 1969. My kindergarten teacher sent a note with us home telling us about a wonderful new PBS educational TV show specifically for us rug rats. Back in those days Oscar the Grouch was orange and they used to play a game on that show called “One of These Things Is Not Like the Others.”
This taught me a lot about relationships. Some things are indeed like the others, while others are not. Frequently us on Wall Street forget that and classify things where things are surely not where they should be.
One thing that drives me nuts about this industry is the monolithic thinking it often gets itself into. Staples analyst are staples analysts. Health Care analysts would never understand tech and so on. In reality sector boundaries are completely artificial and ignore business realities on how managers run their organizations.
In my opinion analysts don’t follow companies, or even sectors. What we really strive to do as analysts is discern superior business models and business structures (i.e. how are they set up financially to support the business model) and invest in those that offer intrinsic value compared to their current stock price. Sector membership in reality is immaterial to how investors should view a company.
Therefore I find more investment cycle commonality among companies with similar business models than ones that are reside in similar business sectors—much like managers view their own businesses. Certain models are influenced more by consumer sentiment ebbs and flows, others by recurring revenues, and still others by fluctuations in the business investment cycle—things that transcend belonging in a particular sector. Investors can take advantage of those commonalities as each business model has similar investment cycles. There are many more types of models but many companies fall in to one of those three buckets—let’s use the Information Technology sector as one such example.
For instance most semiconductor companies have heavy cyclical components based on a predictable business investment cycle, not unlike most late-stage industrials—the semi cycle is just faster and tougher to time. You usually want to purchase those companies the same way you would with a stock like CAT; when absolutely no one believes anyone will ever buy one of their products for a long time. Software companies are essentially recurring revenue companies and can often be valued on those razor-razor blade revenue streams, e.g. not unlike some medical product companies. However, with the advent of cloud delivery of software, we can see a day when software companies become more cyclically driven like their semi brethren. Finally, some tech companies are primarily driven by consumer sentiment, usually driven by a product introduction cycle, as they are essentially consumer discretionary items—media content delivery and consumption devices. Herein lies Apple.
For example, I sometimes think one of Apple’s best comp companies in terms of the way it is structured, and the mind-set of the company as a whole is Nike. Both are highly innovative companies that have rabid followings in an oligopoly market structure. Distribution channels are crucial for both companies and their products are vitally important for their retailers to carry, but both Nike and Apple also utilize their own storefronts to satisfy the information needs of their “power users” and for promotional purposes. Both offer products that are performance driven, yet can be used as fashion accessories. Both companies have significant opportunities in emerging markets as newly formed middle classes strive for high quality western goods and brands. Finally, this is why new product releases are so crucial to both Nike and Apple—both companies need product refreshes or new product categories to satisfy changing trends with consumers and counter other product releases from competitors.
Would it not make more sense to organize a research division based upon business models? To an outside entrepreneur, I think it would. It certainly would force us to focus on those items that truly drive the business as opposed to simply the S&P sector it resides.
So perhaps one of these things is not like the others, at least the way Wall Street defines it.