Most of us who contribute on Seeking Alpha do so with passion about whether a stock or a sector is a buy or a sell; heading up or tailing down. Contributors advance fundamental and technical analysis and are usually supported by ardent commenters. However, as often as I am drawn to the opinions, there are times, when like an outfielder, I lose the ball in the sun or am distracted by crowd noise. Under the circumstances, I 'collect myself' for a moment to relock on the trajectory of the idea.
A Couple of Examples
The issue hit home for me as I wrote an article last year about a hot topic, climate change. Beyond exploring some causes and consequences of the phenomenon, I felt that companies that enable us to use power more efficiently might do very well in the years ahead. As I was investigating ABB (NYSE:ABB), I learned that it not only leads in grid management, but that its 'other business' is industrial robotics central to manufacturing productivity. Seeing a company on a double-boosted trajectory, I bought a full position. In a little over eight months, on top of an annual dividend of 3+%, I'm up 17+% on a stock that, so far, has beaten the S&P 500 by 5+%. ABB is somewhat ahead of itself in here, but I can't imagine many companies as well positioned for the times.
Then, a couple of weeks ago, I read an SA article about Iron Mountain (NYSE:IRM). I felt qualified to comment on it because I had been involved in contracting with it to archive confirms, statements, and 1099s for a top-ten U.S. financial institution when I was its chief information officer. Our IBM (NYSE:IBM) mainframes processed and fed data to R.R. Donnelley & Sons (NASDAQ:RRD) which printed those documents at the same time we made them available for viewing online. I understand most aspects of that supply chain.
That article touted IRM as a REIT to buy. It probably isn't. With digitization and e-signatures - including now for most real estate transactions - the need to archive paper is ebbing especially given that it can't be easily retrieved; storage without easy retrieval is suboptimal. Iron Mountain can hope to compete with its cloud offering but my experience tells me it won't because data storage and data processing are closely aligned and the firm is not differentiated in the latter. If you want to see a trajectory that may foretell that of Iron Mountain, look at the stock chart of "upstream" commercial printer R.R. Donnelley; it's within a couple bucks of its low at the beginning of 2009. (I'm not a short.)
S-Curves, An Old Paradigm
An arc is to a baseball as an S-curve is to products, services, and companies. I dare say that there isn't a business person, certainly not of my vintage, who hasn't encountered the concept of S-curves in their past. The construct was a darling of OD consultants who admonished us at planning retreats to think about growing established businesses, harvesting mature ones, and finding new ideas to nurture commercially. The concept is elegant in its simplicity:
Indeed, an S-curve is usually depicted as two curves, one representing the business 'as is' and the other representing the business as it may eventually transform. The chart is bounded on the horizontal axis by time or the progression of the business, and on the vertical axis by performance as measured by top and bottom-line growth.
The power of the visual is found in the trajectory along the curve. For example, early-stage businesses see flat to negative growth as investment is made ahead of success. If they survive introduction - and many don't - a business can enter a period of substantial growth. Most product/services eventually peak and slip into decline before dying out altogether; remember film cameras. If new products/services are not launched - if transformation does not take place - the company will eventually succumb; remember Polaroid.
Staying Ahead of The Curve
Calculus-level mathematicians refer to "the first and second derivatives", where: a) the first is the slope of a line tangential to a point on the S-curve - velocity, and b) the second derivative is the slope of the slope - how fast it is changing; acceleration or deceleration. The trick for investors is to stay 'ahead of the curve', to get into stocks before they accelerate up, and to get out before they decelerate or accelerate down. Simple, yes?
Simple, no. There are complex reasons why a product/service or company may not fulfill its promise, including a lack of talent and capital, or external factors such as the political and regulatory climate. However, assuming all these issues can be overcome, the fundamental reason that a business thrives or dies on its S-curve is because of better/substitute products - digital replacing hard-copy storage/retrieval, natural gas replacing coal-burning generators, batteries replacing petrol-guzzling cars, drones replacing piloted tactical jets, laparoscopic and robotic surgery, and so forth.
Looking at companies and sectors in isolation is limiting because businesses are so dependent on who and what is coming up behind them. The history of capitalism can be written by tracking the progression of better/substitute products and services.
I've seen pros refer to 100 m.p.h. fastballs as "aspirins". In the instant that the bat connects with a baseball, it is little more than an inanimate dot. However, as it approaches and arcs, the fielder's mind is constantly taking in data as he postures, runs, scoops, stretches, leaps, and dives until glove and ball finally meet. Marvel, if you haven't recently, at how fielders process in real-time to catch a baseball. Good investors do the same.
Forecasting is Possible
In their absorbing book, Superforecasting: The Art and Science of Prediction, Philip Tetlock & Dan Gardner explore how this can be done. They demonstrate that people who take in a lot of information and repeatedly tune their views can foresee the future better than those who don't, at least in the near term.
Superforecasters also employ mathematics. We see this occasionally in SA when contributors talk about "reversion", or regression to the mean, when a stock has swung too far one way or the other and is 'bound to' swing back. This technique carries some validity especially with established companies not operating under some existential flaw such as systemic incompetence or deceit; remember Enron. Believing that not to be the case, I bought BP (NYSE:BP) after the Deepwater Horizon/Macondo disaster seemed to have been fully discounted in the stock's price. I later sold it for a reasonable gain when I sensed that oil prices were softening. I bought the stock again when oil prices began to firm. Through it all, I was essentially working a reversion strategy.
Probabilities are another useful tool. If I sense the odds moving for or against me, I will adjust my positions but perhaps not categorically. I halved my positions recently in military defense stocks after a great run but against some sense that they were approaching full value. For similar reasons, I occasionally comment on REIT articles to remind others how income-producing real estate is valued and to caution that, while anyone can 'beat the house', investors may be better off asking, 'What are the odds that I will beat house?'
In an environment that after 30+ years may have finally swung to rising interest rates - as the Fed continues to forewarn - REITs likely will continue to underperform the market. One handy indicator is found at the bottom of SA's home page where "Market Performance via ETFs" is displayed. In that list, except for gold, U.S. real estate has performed the poorest over the last year as measured by the value of iShares Cohen & Steers (BATS:ICF). Even sweetheart Realty Income Corp. (NYSE:O) has fallen in price in the last 12 months.
Plotting Your Investments
For the purposes of this article, I have decided not to plot a lot of ideas on an S-curve. Rather, I have chosen one area for each of the five stages with links to articles, including some of my own, that delve deeper into specifics. Here goes:
- Early - CRISPR-Cas9 that is defining the frontier of gene-editing including to prevent very destructive medical conditions; CRISPR Therapeutics (NASDAQ:CRSP), Editas (NASDAQ:EDIT), and Intellia (NASDAQ:NTLA). These 2016 IPOs are still extremely risky in part because they are involved in an epoch patent battle. If you aren't prepared mentally and financially to lose it all, you have no business investing in them.
- Growth - Cyber-security where I foresee significant growth opportunities especially with "upstream" I/T outsourcers; Accenture (NYSE:ACN) and IBM. You know there is a major problem when Fortune 500 companies, government intel agencies, and even Dallas' Early Warning system gets hacked.
- Mature - Military defense which has done very well dating back to 2015 and following Trump's election but where, as I said earlier, I have harvested about half my gains; e.g. Lockheed Martin (NYSE:LMT), Northrop Grumman (NYSE:NOC), Raytheon (NYSE:RTN) et al. If the U.S. escalates with Russia, China, North Korea or Iran, I may well be proven wrong in having scaled back.
- Decline - Store-front retailers many of whom are going the way of the Dodo bird, clubbed toward extinction by online sales and onerous cost structures; e.g. Macy's (NYSE:M) and L Brands (NYSE:LB). As store-front retailers decay, so will investments in associated companies including, for example, retail-oriented REITs.
- Transform - Climate change investment where I trust that science, driven commercially and/or governmentally, will prevail over ideological objections; e.g. Ormat (NYSE:ORA) in geothermal and Siemens (OTCPK:SIEGY) for wind power. For those not aware of him, Keith Williams is the most competent and lucid contributor on SA on climate change, energy transition, and related matters - here's a link to his latest.
Notes on Trading
I'm an investor, not a trader. That said, following the principles of Tetlock & Gardner, I occasionally trade when dynamic information presents a compelling story. I've worked alongside a lot of traders over the years. In addition to being smart, I've observed one thing about the good ones - they are uninhibited. They have in their genetics the ability to act on moment's notice (not unlike a fielder who 'instinctively' snaps a throw to pick off a runner who left a base early).
The morning after they rebuffed Kraft Heinz's (KHZ) takeover bid, I bought Unilever (NYSE:UL). Frankly, I have no interest in owning the stock long term. However, I reasoned that to remain independent, Unilever would get its act together and, if it does not, it will be back 'in play' not long after the U.K. regulatory six-month timeout period expires before the end of the year. Voila, Unilever has begun to clean itself up having very recently announced brand sales, a stock buy-back program, and an increase in its dividend. Note the April 6th date stamp (European format, DD/MM/YYYY) and use of the word "accelerating" in this piece on its website. As forecast, I'm up 13% in two months or so.
Then, the day before President Trump first addressed Congress in February, I bought at-the-money March calls in General Dynamics (NYSE:GD) and Huntington Ingalls Industries (NYSE:HII). I sensed that Trump would reaffirm his intentions to ask for more money for military defense and, specifically, for ships. Indeed, his remarks were perceived as such, and the very next day, I closed out the options at an overall gain of not quite 40%. Lest anyone be misled, I do not recommend options trading and only mention the subject here to illustrate the point about forecasting.
S-curves are primarily a tool for value or value/dividend investors who are predisposed to harvest gains in companies/industries that hold less promise while redeploying funds to fresher areas that may 'take off'. The model is not entirely suitable for dividend-only, annuity-type, investors who have faith that, over the long term, 'everything will work out' and are wired for the status quo. For about half of our portfolios, I am not.
Disclosure: I am/we are long ABB, ACN, BP, CRSP, EDIT, IBM, LMT, NOC, NTLA, ORA, RTN, SIEGY, UL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Always do your own due diligence in consultation with a competent financial adviser who puts your interests ahead of their own. (All my proceeds from contributing to SA go to charity.)
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.