C.J. Lawrence Weekly – In Libra We Trust?
It’s tongue-in-cheek note title, not meant to convey real conviction, but to highlight the issue that in the new economy, even money is being disrupted. David Marcus, former PayPal and Facebook Messenger executive and new head of Calibra, the digital currency consortium organized by Facebook, testified before Congress last week. Marcus really knew his stuff. But as is the case with most televised Congressional hearings, there was considerable political theatre and form took priority over substance. For us, the hearings reinforced the rapid pace of change in the technology industry and the challenges lawmakers face in trying to keep up. Government officials around the globe have responded to the success and growth of progressive technology industry participants by calling for them to broken up, constrained, and/or fined. Rep. Maxine Waters, Chair of the House Financial Services Committee has called for Facebook’s Calibra consortium to stop innovating and developing Libra, its digital currency. At times her demand sounded like a plea for the company and industry to slow down so lawmakers could catch up. Interestingly, after castigating David Marcus in public, most lawmakers quickly updated their Facebook and Instagram pages and Twitter feeds to reflect their concerns about the issues!
We’ve written in the past about innovators and disruptors and reiterate our bias towards owning shares of companies that generate significant cash flow, plow much of it back into research and development, and trade at reasonable valuations. We’ve described this investment strategy as buying “Innovation at a Reasonable Price”, or IRP investing. The thesis is that companies that spend aggressively on R&D and achieve good track records of generating attractive returns on that R&D maintain industry leadership positions and/or extend their leads. But not all R&D is created equal. In commoditized sectors of the economy, R&D spending is often a defensive imperative. Autos and semiconductors are two examples of industries where evolution and innovation separate leadership from also-rans. Industry participants that fail to maintain the R&D pace, quickly fall behind. During the past several years, technology companies like Amazon, Alphabet, Microsoft, Apple, and Facebook have ascended to the top of the R&D spending club, displacing perennial lead holders from the pharmaceutical and automotive industries. Amazon now spends almost three times as much on R&D as Johnson and Johnson! The combination of strong core business cash flows, R&D prowess, and competitive positioning in rapidly evolving markets make the leaders attractive investments in any market.
But with success comes attention and risk. Today’s technology industry leaders are under intense scrutiny and criticism from politicians, pundits, and regulators. Much of the damage has been self-inflicted. Fortunately for the leaders, their biggest fans remain their customers, users, and advertisers! While the regulatory outlook is murky, growth prospects remain attractive, and stock valuations may already reflect a good measure of regulatory risk. The average price-earnings multiple on 2019 forecasts for the top 50 R&D spenders in the S&P 500 index is 21.7x, only a small premium over the broader Index’s 18.0x. With broader growth slowing, and most stock indices near all-time highs, the list of companies warranting increased investor attention becomes increasingly small. But innovation rarely goes out of favor, and when priced attractively, increases the odds of outperformance.