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Single Rule to Find the Next TCS or Tata Elxsi podcast

Apr 18, 2022

Do not let high growth opportunities slip away for want of historical evidence or low PE multiples.

Rather stress test the companies to see if they can handle rapid technology catalysts.

The easier it is for the businesses to overcome challenges... the better they are to follow the hockey stick rule.

In 1994, a 30-year-old Jeff Bezos was a vice president at a prestigious hedge fund in New York City.

One day, as he was researching markets, he came across a fascinating fact. This fringe thing that people called the Internet was growing at an incredible 2,300% per year.

Immediately, the opportunity alarm bells went off in Bezos' head. He thought to himself..."Things just don't grow that fast! The Internet must be a once-in-a-lifetime opportunity,"

Now, put yourself in Bezos' shoes for a minute. How often do you spot such a massive change? And how often do you take the plunge to act on such a change? Well, as we know Bezos did ...and the they say.. is history.

Now it is not always easy to spot the change. If you're waiting for the media to write about it and for people in your network to talk about it, you will miss the biggest opportunities. Counterintuitively, many of the biggest ideas look like toys at first and are almost universally ignored or written off.

For instance,, if we look at what happened in the US markets over the last 50 years, we see that earlier majority of index constituents belonged to the non-technology sectors.

Look at this table of the ten biggest American companies of the 1970s. You barely find any technology stock here.

Most are from like oil & gas, retail and telecom...the dominant sectors of the times. These companies were thought to be unbeatable at that time.

Almost everyone thought the stock prices of these companies could resist any market correction.

But just look at what happened in just a few decades.

Some of the biggest companies faded away. They eventually went bankrupt. Others had to sell assets to survive...or take a bailout from the US government.

Eastman Kodak, Polaroid, Texaco, Sears...all went bankrupt. Even mighty General Motors had filed for bankruptcy. Gulf Oil and Standard Oil were saved by mergers.

Who would have thought that the most powerful companies of the United States of America would be wiped out from the face of the earth in just a few decades?

But it happened.

Now, if we look at the top ten American companies on the benchmark indices, here's how it looks.

As you can see, all nine of the ten big companies today are technology ones.

You can observe a similar trend in China too over the past 20 years.

So the change is the domination of tech stocks in the benchmark indices of the developed economies.

What happens with such a change is that the pace of technological innovations gets steeper.

So, tech companies typically follow what is called a S curve in their lifecycle. But as the pace of innovations accelerate the gradiant of the S gets steeper.

And therefore it is important that you spot the change in innovations and technologies at an early be able to ride the upside.

If you want to know how quick do tech companies get obsolete look at this. It shows top internet companies in the US every 5 years since 1998. And if you see, barely few names like Microsoft, Google, Apple and Amazon are around today. The rest have faded into oblivion.

Now what you need to do here is study a bit of history. The history of innovations over centuries.

The chart here maps major technological breakthroughs in the last 250 years and their economic impact. I love it because it really captures how unique this moment is.

The invention of the steam engine, telegraph, telephone and computers were over gap of many years. But of late the innovations are literally piling over each other.

It looks like a tidal wave coming at us and, in many ways, it a hockey stick.

In fact I call it the hockey stick rule to finding disruptive businesses.

So, the last two decades have seen a rapid spurt in innovations world is very likely to continue.

But looking for change or innovations are not enough. Speculating on such trends is fraught with risks, So you must look for proof...proof of sustainability and profitability

For instance this chart shows how the so called FANG stocks in the US have managed to nearly triple their share of marketcap in the US indices over last decade.

But was this a fluke? Did the companies get the marketcap out of nowhere?

Not really ...for even in the Covid times, there are the companies that witnessed the maximum surge in their revenue and operating income. So it is the resilience and downside protection in the disruptive stocks that matters.

What you also need to understand that the method of valuing disruptive stocks cant be unconventional

The traditional valuation multiples, like price to earnings and price to book value are, not ideal for valuing the upside in disruptive stocks. Being disruptive businesses such companies have a majority of their assets in the form of intellectual capital, patents, R&D edge, new product pipeline etc, which do not get accounted fully in the balance sheet

But most disruptive companies work in an ecosystem where they liaison with a larger and larger network of players as the business gets bigger.

What you can see in the slide is the network of a food delivery company Zomato and ride hailing company Ola Cabs. Both these networks lend considerable value to the business.

Plus, they have what is called optionality plays.. (for instance Infoedge has stakes in Zomato and Policybazaar...both of which got listed in 2021 and fetched big returns for the shareholders of Info Edge

Comparing Indian companies with global peers cam also give a sense of how these companies could function once the markets become more mature.

Therefore, to accurately apply the hockey stick rule, pay attention what stage of the business and profitability cycle is the disruptive company is in.

Tata Elxsi for instance spotted the opportunity in AI and electric vehicles almost a decade before the idea became mainstream. TCS created a remote learning interface well before the pandemic struck. Both the companies were already on solid ground in terms of financials. But the inflection point was the pandemic while allowed these businesses to prosper much more than their peers.

So, do not let high growth opportunities slip away for want of historical evidence or low PE multiples. Rather stress test the companies to see if they can handle rapid technology catalysts. The easier it is for the businesses to overcome challenges... the better they are to follow the hockey stick rule.

Hope you like this video. Stay tuned for more such videos on the safest and most appealing permanent wealth creating stocks.

Tanushree Banerjee

Tanushree Banerjee (Research Analyst), is the editor of Stock Select and Forever Stocks. Tanushree started her career at Equitymaster covering the banking and financial sector stocks and scrutinising RBI policies. Over the last decade, she developed Equitymaster's research processes that helped us pick out various multibaggers, across all sectors. A firm believer of "safety first" when it comes to investing, Tanushree closely follows the investing philosophies of Warren Buffett, Jeremy Grantham, and Joel Greenblatt.

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