‘Look to the future’ is hardly an original maxim, and it’s a rare investor who doesn’t claim to live by it. More remarkable is how often the future is seen as a mere continuation of the past. What has been will continue to be.
According to this mindset, share prices are determined by extrapolating past operational performance into the future. It’s an easy mental shortcut, but a spurious basis on which to calculate a company’s worth. Such projections often ignore the potential impact of changes in the market, or of technology shifts in the wider world. From healthcare to energy, we’ve seen how the game can change completely.
We call ourselves Actual – not just active – investors, because the companies we seek are those investing to secure their place in the world of the future. The best companies adapt, evolve and innovate, and we encourage them to do that, not just to aim for quarterly earnings targets. For Actual investors, extrapolation is unimaginative and usually misleading. It can also be destructive of value for index investors as swathes of once-reliable stocks are displaced by businesses exploiting newer technologies.
Take energy for example. Solar and wind is becoming cheaper than fossil-fuelled energy, even without subsidies. Solar panels and wind turbines are cheaper than ever to make and more efficient to operate. They make sense economically regardless of carbon pricing policy, which is likely to toughen as greenhouse gas emissions attract political attention. Renewable energy is where future growth will come from. But despite the end probably now being in sight for the legacy technologies of ‘big oil’, investors remain rooted in the past, leaving the major producers still enormously valuable in stock market terms.
For Actual investors to ‘look to the future’ should be more than: ‘This oil company looks cheap this week, but the oil price will go back up and it still has billions of barrels under the Gulf of Mexico’. Valuing on the basis of reserves makes no sense. Oil likely to stay underground has no value.
As ‘the future’ will be unrecognisably different from the present, it’s better to invest in a business because of what it can become not because of how profitable it is now.
Many investors avoid yet-to-be profitable companies for fear of looking stupid if they never generate free cash. Actual investors don’t care so much. Or rather, we care more about how a company might make money in the future. If we can envisage that, we ask how much capital it needs to be able to sustain itself through its own cashflow.
Healthcare offers a good example of how our lives will be transformed. From trial and error methods of drug discovery, we’re getting better at understanding the genetic causes of disease and at tailoring therapies to the patient. The cost of the gene sequencing that enables this has collapsed thanks to firms such as Illumina. Along with telemedicine – turbocharged by the coronavirus pandemic – it points to a massive disruption of healthcare, so assuming the continued dominance of today’s ‘big pharma’ makes little sense.