Client Portals

Where To Allocate New Capital4 min read

Pessimists, optimists and the innovator’s advantage

Jan 20, 2021 - Max Osbon ( 6 mins to read)

With markets hitting fresh highs, a perennial investment question remains: “where do investors allocate new capital in 2021?” Successful investing today is closely linked to an ability to embrace optimism and celebrate the coming waves of disruption and innovation. Broad skepticism and pessimism have not been winning strategies. As the internet age enters its cloud computing and artificial intelligence years, there are plenty of opportunities for investors to earn favorable returns on their investments. Here are considerations as you look to the years ahead.

It’s always a good time to invest in the future

We wrote about this back in June ‘20. Since then, equity markets have rallied considerably, especially companies directly related to our major themes. Those themes are: digital finance, e-commerce, semiconductors and AI, entertainment technology, cloud computing and digital health solutions.

The demand today for new semiconductor technology is extremely high and will likely accelerate from here. The largest global semiconductor company, TSMC, recently announced it plans to spend $28B in the next 12 months to develop the next generation of semiconductor technology, a 40% increase from the prior year. For context, TSMC makes the chips in your iPhone and provides half of the world’s supply of semiconductors.

The demand for more convenient banking solutions is also extremely high – verified by the attention and financial performance of companies like Square, PayPal and Adyen. The demand for a better and safer internet is verified by the rise of companies like Cloudflare and Crowdstrike. Companies that have a culture of innovation and are actively investing in the future have been highly successful over the past decade. These types of innovative growing businesses will continue to provide investment returns for many years to come. 

A new wave of multi-employee companies

It’s not easy to see major turning points in entrepreneurship rates as they happen. The volume of new company formations has doubled in the last year. It’s tempting to label those companies as small fish with only a few employees. If you look deeper, as Mckinsey has done, the number of high propensity new business applications is up 50% over the same period. High propensity means that these are companies that can scale quickly from tens to hundreds to thousands of employees. The big growth companies of today once started out that way and quickly grew. As a result, we have a large wave of mega-cap entrepreneurs coming our way. This trend is aided by the acceptance of software as a service, the ease of use of the cloud, and the increase in security of the internet. Scaling a business to a global customer base has never been more attainable or faster than it is today.

The Ballmer Test

Consider the Ballmer Test – do engineers love the company and the product? Snowflake, one of the most aggressively valued software businesses today, is valued at 85x sales. One data scientist friend said that Snowflake was, “hands down the best data software product I’ve ever used. It just works.” I wouldn’t say SNOW’s valuation is fully deserved, but I am happy to see that engineers love and respect the product. That admiration is important, along with expected revenue growth rates of over 100% for the next year. Their glassdoor rankings are high as well. It’s especially important today to consider how a company is respected and loved by their peers, the engineers.

Innovators have a lot to gain. Incumbents have a lot to lose.

Jaimie Dimon said last week that the banks should be scared s__tless by the coming wave of fintech solutions. He’s right. The incumbents, like JPM and Wells Fargo, will probably lose an enormous number of their consumer banking clients to fintechs like SoFi (which recently went public via one of Chamath’s SPAC mergers, ticker IPOE). As a personal anecdote, I was able to apply and obtain approval for a new mortgage at a favorable rate by SoFi within 10 minutes of downloading the app.

There will be many disrupters, adaptors and victims over the coming years as technology enables creative and forward-thinking entrepreneurs. For example, Goldman Sachs’s digital banking platform Marcus and Disney’s streaming solution Disney+ represent phenomenal adaptation by older mega-cap companies. A focus on digital scalable solutions for their customers is key to their future success.

Valuations, debt and the wealth gap

Take a look through the Pessimist’s Archive to see examples like overly rational and intelligent sounding pessimists calling the internet and computers “just a fad.” Valuations have increased substantially today. There will likely be incredible growth in innovation over the coming decade. Technology will help us close the health care gap as we make it cheaper and easier to apply preventative care to our entire population. It will also help us solve some of the most challenging problems today like climate change and medical advancements. Valuations and entry point matter a great deal these days. It’s also crucial for families to evaluate each investment in the context of the entire picture, with assets and liabilities taken into account.

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