Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 230

Investors should avoid extrapolating recent success

When explaining science to my children, I often remind them that everything humanity learns, it builds on previous knowledge.

Except in finance.

The ability to frequently forget that which repeats seems unique to the investor subspecies of the human race.

Forces beyond their control

Businesses and industries don’t operate in vacuums, they are subject to forces beyond their control. Those forces might be social, technological, climatic, competitive, or legislative and those forces all represent changes that can be beyond the ability of company boards to even anticipate, let alone respond.

Companies may be met with different challenges in different jurisdictions, dramatically changing the economics of the enterprise. Change in business appears to follow the expansion and contraction of the bellows of a piano accordion. Expand the accordion: fragmentation. Contract the bellows: consolidation. Fragmentation, consolidation, fragmentation, repeat.

Take, for example, the newspaper business. How different today are our newspapers from only 30 years ago? I can remember delivering the paper, whose weight could be measured in kilograms, on Saturday, to homes that received a morning and afternoon edition.

The classified revenue rivers of gold were not enough to shield publishers from the emergence of more convenient searchable and sortable online versions who would continue to appear and fight until they won. Fragmentation.

Eventually of course, consumers will become impatient with separate apps for real estate, cars, jobs, and the news. Through no fault of their own – perhaps asset prices slump generally, amid a failure of record levels of triple CCC-rated junk bond debt to be refinanced – a new and more exciting offering emerges. Perhaps it’s an integrated newspaper with compelling user-directed news and classifieds with the bonus of fully interactive ads and Amazon Prime delivering anything you touch to your door before you’ve finished reading. Consolidation.

But perhaps we don’t even have to be as far-fetched to see the piano accordion in action.

The here and now: Ubers and taxis

Witness the evolution of the personal transport industry. Through legislation and or acquisitions, a handful of taxi companies became regional monopolies. So dominant and unassailable were their legislated moats that customer service was irrelevant. Heck, in some cities, every single taxi changed shifts at the same time. If you were in a rush to the airport – walk! Consolidation.

Then the gig economy emerged, along with ride sharing and transit lanes. With customer service a priority, social momentum drove Uber’s expansion. So emboldened by its social imprimatur was the company that it expanded in some countries in the face of government opposition. Fragmentation.

But gig economies, and the companies that monetise them, rely on part-time workers willing to operate without employment contracts and their protections. Concurrently, operators are not required to comply with licencing systems and processes such as insurances and regular mechanical checks designed to protect the public.

In Sydney, a taxi operator is required to submit their vehicle to frequent and costly safety checks. In London, a cab driver is required to sit ‘The Knowledge’ test and demonstrate that more than 25,000 streets have been committed to memory. Uber vehicle owners have no such requirements.

In 2018, Europe will decide whether Uber should be regulated as a taxi service, bringing its labour-hire practices under the same terms as any other transport system operator and dramatically changing its economics.

But it’s not a stretch to imagine the deeper-pocketed Uber surviving the change, and the new regulatory costs dissuading new entrants. Consolidation.

Under another scenario, benevolent Uber shareholders could grow impatient with the lack of return on their capital and cease filling the hat with cash every time it is passed around. Fragmentation? Consolidation?

The piano accordion

Tech stocks have commanded the lion’s share of investor attention in the last 12 months and a significant proportion of the market’s return can be attributed to their gains. But investors are mistakenly projecting their growth to continue into the distant future, uninterrupted and unimpeded.

He didn’t have Airbnb, Uber, Google, or Facebook in mind when he gave his famous Farewell Address but perhaps George Washington had a piano accordion in mind when he said,

“It is in the very nature of power that it will expand until it is checked by an opposite power.”

When consolidation of media power, personal data, or plain old return on capital is concentrated among a few, society repels and rejects. And whether through populist governments or by their direct anointing, consumers cause the piano accordion to expand and the industry in question to fragment again.

All the profits of the disruption will not accrue to the disrupter. Throughout history, when new technology emerged to change the world – think cars, air travel, and television – it was neither the innovator nor the industry that earned large profits. In many cases, the consumer benefited the most.

Extrapolating current conditions into the future, and assuming that the rapidly changing forces that birthed the new player will not then challenge it, is a mistake many investors repeat.

Many investors unrealistically assume current circumstances to continue without interruption.  It’s the basis for our divergent expectations framework in our long/short portfolios.

 

Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management. This article is for general information only and does not consider the circumstances of any individual.

1 Comments
Warren Bird
December 12, 2017

This is one of your best pieces, Roger. Good points all, made well.

The disclaimer that fund managers have to use about past performance not guaranteeing future performance applies to all the individual investments in a portfolio too.

The Uber- taxi competition fascinates me. I think the sort of developments you've written about (and which many others have written about) actually started earlier than the on-line phenomenon and apps. It started with mobile phones.

Many years ago I was a regular taxi user. I discovered a driver I liked, who provided great service and he had a mobile phone in his car. I could call him whenever I needed a ride and either he'd come or he'd call one of the others in his group to pick me up. Gradually I got to know the whole group and they knew me.

That was in my home area in Sydney. I also did the same thing in Melbourne where I visited frequently at the time.

When you get service like that, you don't want to ring the Taxis Combined or RSL or whatever number, you just ring your driver. That small group banded together to 'disrupt' their own industry by a new way of dealing with the customer. They got business that other drivers just reliant on ranks and the taxi company were missing out on. A smaller scale than today's technology makes possible, of course, but an early taste of what's since become a phenomenon.

I wonder when the time might come that someone books a ride on Uber and a registered taxi turns up.

 

Leave a Comment:

banner

Most viewed in recent weeks

How much do you need to retire comfortably?

Two commonly asked questions are: 'How much do I need to retire' and 'How much can I afford to spend in retirement'? This is a guide to help you come up with your own numbers to suit your goals and needs.

Meg on SMSFs: Clearing up confusion on the $3 million super tax

There seems to be more confusion than clarity about the mechanics of how the new $3 million super tax is supposed to work. Here is an attempt to answer some of the questions from my previous work on the issue. 

The secrets of Australia’s Berkshire Hathaway

Washington H. Soul Pattinson is an ASX top 50 stock with one of the best investment track records this country has seen. Yet, most Australians haven’t heard of it, and the company seems to prefer it that way.

How long will you live?

We are often quoted life expectancy at birth but what matters most is how long we should live as we grow older. It is surprising how short this can be for people born last century, so make the most of it.

Australian housing is twice as expensive as the US

A new report suggests Australian housing is twice as expensive as that of the US and UK on a price-to-income basis. It also reveals that it’s cheaper to live in New York than most of our capital cities.

Welcome to Firstlinks Edition 566 with weekend update

Here are 10 rules for staying happy and sharp as we age, including socialise a lot, never retire, learn a demanding skill, practice gratitude, play video games (specific ones), and be sure to reminisce.

  • 27 June 2024

Latest Updates

Investment strategies

The iron law of building wealth

The best way to lose money in markets is to chase the latest stock fad. Conversely, the best way to build wealth is by pursuing a timeless investment strategy that won’t be swayed by short-term market gyrations.

Economy

A pullback in Australian consumer spending could last years

Australian consumers have held up remarkably well amid rising interest rates and inflation. Yet, there are increasing signs that this is turning, and the weakness in consumer spending may last years, not months.

Investment strategies

The 9 most important things I've learned about investing over 40 years

The nine lessons include there is always a cycle, the crowd gets it wrong at extremes, what you pay for an investment matters a lot, markets don’t learn, and you need to know yourself to be a good investor.

Shares

Tax-loss selling creates opportunities in these 3 ASX stocks

It's that time of year when investors sell underperforming stocks at a loss to offset capital gains from profitable investments. This tax-loss selling is creating opportunities in three quality ASX stocks.

Economy

The global baby bust

Across the globe, leaders are concerned about the fallout from declining birth rates and shrinking populations. Australia, though attractive to migrants, mirrors global birth rate declines, and faces its own challenges.

Economy

Hidden card fees and why cash should make a comeback

Australians are paying almost two billion dollars in credit and debit card fees each year and the RBA wil now probe the whole payment system. What changes are needed to ensure the system is fair and transparent?

Investment strategies

Investment bonds should be considered for retirement planning

Many Australians neglect key retirement planning tools. Investment bonds are increasingly valuable as they facilitate intergenerational wealth transfer and offer strategic tax advantages, thereby enhancing financial security.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.