Leaders vs Laggards and the Value of Curiosity
Despite the emotional highs and lows, I’ve really enjoyed travelling along the equities investing learning curve over the last 5 years. Having done about 30%/pa compounding in that time focused on ESG and energy transition themes, its been financially rewarding also.
A quick ask before i get into the guts of the article — I’d love your help building an interesting data set that we can publish and discuss, and collectively learn from.
Which companies do you associate with leadership on climate, and why? And which do you associate with being a laggard and why? I’ll aim to come back to this post and update the data. Ping me your thoughts in a message, or in the comment thread. But for now, here is where I have got to with my analytical scratchings….
It is at times like these (broad brush panic selling to start 2022), that I’m glad I take an active interest in investing — because if you relied on the headlines and TV interviews, a bit like the climate debate, you’d be more confused than enlightened.
Recent market headlines use the dreaded “bubble” word, and some well known value investors calling for a massive market drop, so that valuations can catch up with reality. These commentators largely talk to growth in market indexes as a sign of a bubble, and then name one or two stocks or themes to back them up. Its a seductive narrative.
But this really misses important nuance — individual stocks have very little connection to indexes, be it on valuations or future growth prospects.
If you like, “the index” is the herd, thoughtlessly going in a direction based on one animal following the one next to them and so on. Good companies are not lost in the herd — they are out in front leading the pack, deciding which way to go next. Which makes good investors more akin to a top predator, picking out the strong and the weak from the pack.
Take the ASX200 for example. If you bought the ASX low in 1987, and sold the ASX low of 2020, you would be up 4.3x. If you bought the ASX high of 1987 and sold the ASX high of 2020, you would be up 2.7x. Mediocre returns if i do say so…even with perfect timing of the market, you could have generated ~ 6x in 33 years at best.
Compare that to buying a top performing company such as CSL when it listed in 1999 — you would be up 58x, or REA — you would be up 140x. That is a difference to index performance over the same 20-year period of roughly 25–50x. Or if you like, instead of your $100,000 in super going to $250,000 over ~ 20 years with the index, it could have gone to $2,500,000 — $5,000,000m with the best performing stocks.
Applying this lens of top performing companies vs the index, to climate leaders vs laggards, I have started to collect and aggregate historical revenue growth of companies that have been proactive innovators, with their goal being to develop commercial solutions to climate change, against those that have been laggards — companies that derive revenue from coal, oil and gas, that have failed to invested meaningfully in the future of energy supply.
The difference is stark.
Since 2012, my leadership companies that proactively tackle climate change, have grown revenues by 664%, with Tesla an outlier at 7600%, and others in my collection ranging from 300%-1800%.
The laggards have managed to collectively shrink by 45%, with only AGL and BHP in my collection showing small increases in revenue over 9 years. The gap between combined revenue of the laggards and those of the leaders, has closed from a difference of 43x, to just 3.6x. In another 5 years, these trend-lines cross.
It is staggering to think that my collection of laggards have gone from an extremely profitable $450b/pa revenue/pa, off investments made mostly decades ago, to just $246b within 9 years. Where have they been investing those profits? Why haven’t they been able to adapt to changing market demands?
When a value investor calls the Tesla valuation bubble territory (currently under 100x free cash flow run rate), just remind yourself they have grown revenue by 7600% over 9 years, and turned profitable with industry leading margins during a global pandemic complete with supply chain disruptions, while more than doubling future production capacity with factories that don’t yet produce cars (Austin, Berlin).
Volkswagen, not yet on my laggard list, has managed to eek out about 10% revenue growth over 9 years. Ford has gone backwards. Comparing valuations of incumbent autos to Tesla using market cap per vehicle, or backward looking multiples is non-sensical, but commentators do this all the time to justify their view of Tesla being a meme stock and in bubble territory.
Value has always been, and should always be, defined relative to future earnings. Somewhere along the line, the “value investing narrative” has become fixated on cheap as the measure of value, ignoring that companies are often cheap for a (good) reason.
To understand a companies value, what’s needed is a bottom up understanding of future prospects for earnings, relative to today’s price. Understanding prospective future earnings is why imagination and open-ended curiosity, are as valuable tools to the investor, as balance sheet critique. For example:
- what balance sheet analysis can imagine Tesla forward earnings, in a world with autonomous mobility of things (not just cars)?
- what balance sheet analysis can reveal the likely success of the tesla cybertruck or semi?
- what balance sheet analysis reveals a companies inherent capability for innovation and adapting to trends as they play out?
The challenge for the investor, is the same challenge faced by innovators — be they individuals going out to start a business, or teams inside larger companies, trying to transform products and services.
That challenge is to imagine the future as it may become — a set of probabilities mixed with personal ambition and desire. Working back from there, we need to figure out what action needs to be taken today to get there, and by who. Innovators then create that future themselves, bringing others on the journey with them. Investors place bets and ride the coattails of the creators. All of this requires a constant process of course correction, and sometimes re-imaging that future on the run.
Imagining the future is much more a creative and inductive process, than a rational and deductive one, and I suspect it is why so many companies, be they industrial conglomerates or fund managers, struggle with it.
If I had to sum up the key constraint on innovation (and by default, successful investing) in one sentence, I would say most companies (be they fund managers, industrial conglomerates, start ups and everything in between) value arriving at certainty over exploring the unknown.
If you want to succeed at innovation, be it for ESG or other goals, it starts with addressing that balance. It starts with valuing open ended curiosity, not as a privilege for those with idle time, but as a necessary discipline on the path to insight discovery and leadership.