Income from innovation investing to supersede traditional sources
Originally written by Storm Uru on What Investment
It might come to a surprise to many that periods of global turmoil often lead to periods of unprecedented innovation. Looking back over the last three centuries, major economic and societal shocks have acted as catalysts to the development of exciting new technologies. At times of stress, businesses either fall by the wayside or embrace innovation. This is a pattern that Carlota Perez recognised and catalogued in her book, Technological Revolutions and Financial Capital. It has been repeated through the age of steam and railways, steel and electricity, mass production and the era of the automobile. Put simply, when only the fittest can survive, a culture of innovation creates new global leaders.
The covid-19 pandemic blindsided many investors who have seen the stalwarts of income funds cut or suspend dividend payments. But this is not the first black swan event to rock the world economy, nor will it be the last, and as with all major market crises its impact will continue to reverberate throughout all sectors for years to come. However, rather than being an impediment, this shock to the system could prime the pump for a surge in new advancements and provide compelling opportunities for those investors who can identify them.
Information and telecommunications are to the 21st century what steam and railways were to the 19th. Before the outbreak of covid-19 and all its horrific consequences at a personal and an economic level, business leaders and investors could get away with overlooking the importance of innovation and the rise of the new economy. As we reach a new crossroads, tired, old companies, many of which were reliable income-payers over preceding decades, can no longer maintain their competitive edge. It is more important than ever for investors to identify companies that embrace a culture of innovation – those companies that have the potential of being the global leaders of the future, and avoid the dinosaurs that belong to an earlier generation.
A culture of innovation is a key characteristic investors should look for when hunting out the best-in-class operators within an industry. Innovation drives a company forward, defending it from competitors and seeding its next leg of growth. Innovation should imply a relentless focus on product improvement, a customer-centric mentality and disciplined investment in the business to generate further success.
Income investors frequently focus too heavily on dividend yield and fail to interrogate the quality of the business they are investing in, paying scant regard to whether it seeks to continually innovate or is resigned to a moribund business-model. A more financially rewarding approach might be to place greater emphasis on those businesses that use innovation to carve out a niche as a global leader within their sector. These are robust, growing companies that are able to increase their dividends year-on-year and thereby deliver the higher income that can be so elusive under current market conditions.
What does this all-important innovative culture look like in practice? An excellent example would be accounting services provider, Intuit. With its relentless focus on product improvement, it spotted the changing landscape in accounting software from off-the-shelve software packages to cloud SaaS products. It reacted by quickly pivoting its business model and products to the cloud, and thereby disrupting its own core accounting products.
Intuit understands that true innovation starts with its own culture and its success is built on a philosophy of embracing rather than fearing change and of empowering its employees to implement transformation. This has helped future-proof the company as well as secure its place at the small and medium-sized enterprise table alongside stalwarts like Sage and SAP or unseat them altogether.
Another important characteristic which goes hand-in-hand with innovation is a customer-centric mentality. As a company extends its lead in a market, the expectation is that it will consistently focus on delivering lower costs and better service to its customers. Wales-based car insurer Admiral stands out as a business with this customer-centric mentality. Its chief executive officer, David Stevens, runs a tight ship with a focus on driving down costs resulting in an industry-leading expense ratio for the insurance company. Cost efficiencies and increased productivity are passed onto customers, ensuring it retains its cost-leadership market position. When you speak with employees from Admiral, you could be forgiven for assuming it is a small family run business, such is its laser focus on cost control and customer service.
Disciplined investment in a business rounds off this innovation wish list and Brookfield Infrastructure is an excellent example of how this can drive long-term economic value. Considered a best-in-class hard asset investor, Brookfield developed a robust investment framework that is well-documented and transparent. For Brookfield, it is essential that investment is not programmatic but is focused on the very best ideas within a company. It has set clear business objectives for each operating division coupled with stretch goals for returns on invested capital. These objectives are met by investing in only the very best ideas and selling divisions or assets as they hit maturity. This creates a culture of innovation by allocating capital to business leaders within the company thereby driving its future growth and success. Examples of this approach range from seeding new investments in data centre infrastructure to selling South American utilities assets that have hit maturity.
As we start to look beyond the covid-19 crisis and tentatively consider any investment opportunities that might fill the dividend void left by the trusted behemoths of yesterday, innovation should play an influential role in our decisions. Rather than accepting the status quo, those businesses that have innovation at their heart will be rewarded by being marked out as leaders in their sector. As such, they will be well-positioned to drive earnings and reward their investors with growing dividends while their competitors wither and die.
Storm Uru is manager of the Liontrust Global Dividend fund, Liontrust Asset Management
Further reading: Innovation you can trust