When innovative companies disrupt legacy industries, new investment opportunities emerge. Mike Smith seeks to invest on the right side of change in U.S. equities.

 

Laurie King: I’m Laurie King, and you are listening to On the Trading Desk®. When innovative companies disrupt legacy industries, new investment opportunities emerge. Mike Smith, senior portfolio manager with the Fundamental Growth Equity team at Wells Fargo Asset Management, seeks to invest on the right side of change in U.S. equities, and he does this by taking a fundamental approach. He joins us today to explain. Mike, welcome to On the Trading Desk.

Mike Smith: Thanks for having me.

Laurie: Well, let’s talk about this idea of investing on the right side of change. Why is that important? What kind of change are you talking about?

Mike: Sure, Laurie. I think there are really two conditions that we see right now that are very important to understand and put into context as we go to differentiate between attractive and unattractive investment opportunities for our clients.

So first, growth is very slow and hard to find right now. We think the real reason for that just has to do with the demographics of our labor force. In hindsight, if you think about the growth in the labor force, it was basically turbo-charged for 40 years as more and more females entered the work force, starting in the early 1960s and sort of peaking out in the early 2000s. And what that really means is there was an economic benefit for 40-plus years that has come and gone. And the after effect is our labor force is now growing at roughly one-third of its historical average and moving lower. And so if you think about GDP as just being a function of the number of workers working times their productivity, we’re in for a period of prolonged slow growth in our labor force. That’s why it’s very difficult for us to see fast growth in GDP in our future.

Separate from that, the second really important condition to pay attention to is that the pace of disruption is accelerating. And the real reason we think for this is the fact that over the last 25 years, as a planet, we’ve now connected five billion people to the Internet. And we’re in the very early innings of figuring out what this really means. So the bottom line of all this, if you think about it, when growth is slow and hard to find, there is an increasing scarcity premium assigned to growth stocks. And that makes for an excellent time to have an allocation to growth stocks. Secondly, it’s also an excellent time to hire an investment team who knows how to identify companies on the right side of change and avoid companies on the wrong side of change, because the bifurcation between the winners and losers is likely to widen.

Laurie: OK, well thank you for that. So getting back to this right side of change, and as you just said, you don’t want to be on the wrong side of change. So you’re really talking about the industries that are being disrupted, and a large part of this is due to innovation that occurring.

Mike: Correct.

Laurie: Can you give us some examples?

Mike: Absolutely. What we’re most excited about is the opportunity to find undiscovered opportunities. And I think as the Internet moves from an infrastructure and connection phase into more of a usage phase, I think that’s where we see the disruptive impact really broadening out to nearly every sector of the economy.

One very important niche opportunity that we’re excited about right now is in the public safety market. There are 6,000 emergency command centers in the United States that are trying to coordinate with almost three million first responders—fire, EMT, and law enforcement officers. And if you think about the current state of communications and technology in that sector versus what’s possible in the future because of the Internet and all the new forms of communication technology that we have, there’s still transformational change ahead of us. 85% of the 6,000 command centers can only receive a voice call. They cannot communicate with the public via text message or any other means. And if you think about how young people communicate these days, most of them don’t even know what a voice call is anymore. That’s a big deal.

Local video surveillance networks can be transformed by using the Internet to connect both public and private cameras into one universal network. Artificial intelligence can be used to predict and prevent crime based on various sources of data including image recognition. So one company we think is positioned to benefit from this is Motorola Solutions. It’s a hundred-year-old company. They have 80% market share in public safety communications. They’ve built their business on selling expensive walkie-talkies to law enforcement on an every few years replacement cycle. But that’s changing. We see an opportunity to sell, instead of a hardware sale, a monthly subscription to a full suite of software and services that enables command centers to more effectively prevent, monitor, and respond to dangerous situations by using Internet technology. And that’s exactly the kind of example that we think a) is undiscovered and b) is a result of technology broadening out.

Laurie: Now, I was going to ask how does your team, how do you, identify a company that’s on the right side of change? What are the characteristics? And I’m curious, because of this example of Motorola, which is a legacy company, are the characteristics different for a legacy company than for a new company? Or do they need to have, kind of, the same characteristics for you to be interested?

Mike: Yeah, it’s a great question, Laurie. What I would tell you is number one, while we take every advantage ourselves to use technology tools and follow our process to get smarter and faster and more scientific at what we do, I would tell you it’s still more of an art than a science when you really get down to identifying the companies on the right side of change. What we’re really trying to measure is the moat of the business and its stability. And I think the easiest lens to look through is basically two things. Is it a company that’s able to add more customers, and are these customers spending more money? Some of the examples are hiding in plain sight, and others are not yet appreciated for what they can become, such as Motorola. But it really just comes down to back to basics. Does the business have a moat that is stable or can widen from here? And is the basis of that moat somehow tied to these big changes that we see happening in the world?

Laurie: Well, thank you. That’s all the time we have for this episode of On the Trading Desk. Learn more about the Fundamental Growth Equity team and their approach at http://on.wf.com/6129EwMDS. Mike, thank you for joining us.

Mike: My pleasure, Laurie.

Laurie: Of course there’s more investment insight on our blog AdvantageVoice® and right here on this podcast. Until next time, I’m Laurie King; take care.

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