Can Investing in Innovation Companies be a Hedge?

In the past month or so, we have seen a lot of volatility in growth companies and technology.  There are a few main storylines that are carrying a short-term shift from some of the top performers with fast-growing revenues to older companies with limited future growth potential but trading at lower valuations:

  • “Inflation is going up! Buy stocks that make the stuff that is going to cost more!”
  • “Interest Rates are going up! Higher interest rates make investors less patient to wait for future growth.”
  • “Valuations are crazy in growth stocks! Better to buy cheaper stuff….it is safer!”

Any of that sound familiar?  Let’s tackle ‘em one by one…..

Inflation is going up!

Sure, it is pretty hard for inflation to not go up in the short-term. About this time last year, oil prices went negative! Yeah, it is likely that we will see some higher inflation now that the economy is on stronger footing, but technology and innovation are often cost reducers, so it would make sense that as prices go up, the demand for having cost reducing technology would also go up.

A perfect example here could be cutting the cable cord. If you are like me, you probably have cable, Netflix, Disney +, and so on. But at the end of the day, I watch VERY little cable. The conversation of cutting the cord happens here and there, but if gas prices and lumber prices rising is effecting our budget then we will be looking for places to reduce our spending. Say bye-bye to the cable. Poof, my cheap streaming solution (growth and technology) wins against my old stogey cable company (value).

At their heart, technology is used because of the benefits it brings in either making things easier, better, or cheaper.

Interest Rates Are going up!

Interest rates in the U.S. have risen this year to the levels we were at before the COVID pandemic hit this time last year. This makes sense as we have put a lot of stimulus into the economy and things seem to be improving. And, there seems to be an idea that as interest rates go up, indicating a strong economy, that cyclical companies will do much better and people will want to discard their beloved technology companies.

But wait, don’t value companies have a lot of debt on their balance sheets? What if they have to refinance that debt at higher rates? Wouldn’t that hurt their earnings?

The other aspect here is as we reopen, technology becomes a less important resource. Once we all get the vaccine, goodbye Zoom and hello flying and cruises and eating indoors, right!? Well, yes, of course we will do more of that, but many of these technology tools are now part of our lives and are unlikely to disappear. They also have been making a ton of money over the past year and have the flexibility to pivot, whereas many of these companies that are reopening have exhausted their reserves and don’t have any money laying around to invest.

So sure, we will all be excited for a return to something more recognizable as normal, but things are still going to be changing, and we rather stick with the companies that can afford to change with them instead of the ones that keep crossing their fingers that the past will return.

Valuations are crazy!

This is true; it is hard to argue that the market is not trading at an elevated valuation to its historic levels, and that some growth companies are also trading at levels that might seem “nosebleed”.

But when things are in high growth, it is harder to assess the right value because of compounding. If a company grows at 7.2% a year, it doubles revenue in 10 years. It used to be considered very rare for a company to grow at 15% for an extended period, and unheard of for a large company to grow at such a rate.

But then we all have to think about how Amazon has grown revenue at 24.4% per year for the last 10 years……or Alphabet (Google) has grown revenue at 18.1% in the last 10 years, or Facebook at a whopping 42.3% over the last 10 years.

The point is, with significant growth can come some crazy valuations. With that also comes volatility. Helping manage that is what we try to do, but we think that regardless of interest rates or inflation, you want to find growth and benefit from its compounding.

So, can technology and innovation be a hedge to these market concerns? Seems like we have an argument to answer, "yes, it can".

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