This academic work helps inform our thinking and helps us as investment managers to focus on probabilities (investing) vs. possibilities (speculation) through applying a proper mindset based on the actual, real-world business dynamic of innovation creation and delivery.
Hortz: Are there common characteristics for innovative companies?
Berkeley: Typically, we look for investments in which the vendor is offering so much capability, reliability, convenience, and value-for-money that it can command high economic rents over many years. For example, we have had good success with software companies that are keeping the required books and records for a class of customers, say hospitals or apartment buildings. If the innovative vendor is delivering good value, the customer is unlikely to switch vendors. High switching costs make revenues more predictable.
If these vendors are continually re-investing to stay current, they can have decades long associations with their customers. Said another way, we particularly like recurring revenues, perhaps subscription revenues that free vendors from starting from scratch each year. We like companies that are solving so many and such complex problems for their customers that the vendor can earn high rents for decades.
These companies tend to have a strong commitment to research and development and also a strong ability to buy into adjacent markets. Cisco is a good example of a company that both invests in development and buys emerging research. We also like to see a well understood “catalyst” or “growth driver” creating demand for the product or service.
Hortz: Does your research tend to lead you to particular areas of concentration or types of companies that cluster in specific areas or themes?
Berkeley: A portion of the portfolios we design use both information and communications services and health and life sciences companies to harness growth. These are major segments of the U.S. and world economies with significant unfilled demand and both are driven by dramatic improvements in the capability of evolving technologies.
Looking at healthcare there are many different approaches to take but we tend to look for companies bringing scientific breakthroughs to the market. Particularly promising ones are in the areas of diagnostics and therapeutics. For example, there is a tectonic shift in diagnostics from radiography to liquid biopsies where cancer cells can be detected much earlier in a cancer’s progression in a much less costly and more accurate fashion.
On the computing and communications front, our insatiable demand as humans to communicate and the thousands of our activities still open to computing automation, demand looks solid and durable. We have many choices here as we can look at the “bill of materials” that goes into a product or service. For example, we can invest in rare earths through AXT which are essential to high performance communications, or components like color touch screens made by Universal Display, or telecommunications carriers, or cell tower companies. The point being that our research takes us into the various segments and suppliers of the industries we invest in.
Because the way we invest in equities is so very knowledge intensive, we tend to find new opportunities when we are maintaining our knowledge on existing investments. We also hold interests in many other industries, often more mature, more generally understood companies, that we buy for diversification of innovation opportunities.
Hortz: Can you share some more examples of the types of companies in your portfolios?
Berkeley: The compounding power of microprocessors applied to both computing and communications reaches much farther than the market share giants of Google, Facebook, or Amazon. The cellular radio telephone tower companies are a good example. They are a specialized real estate business or, essentially, digital railroads carrying data rather than freight. They typically see their revenues grow as telephone and data traffic grow. They offer investors less volatility in their share prices than do technology companies selling products.
In our healthcare holdings, we invest in both diagnostics and therapeutics. Big gains come from drug or vaccine discoveries that work, that cure or prevent disease. Large, solid businesses can be built on diagnostics as well.