Think and Invest Like a Venture Capitalist

The Chinese central bank has finally broken its silence over the country’s cash crunch, telling banks the onus is on them to better manage their own balance sheets.’ – Financial Times

Until about 10 years ago, whenever an African soccer team conceded a goal at the World Cup, the analysts would say the team was ‘defensively naïve’, and give a knowing wink at the TV audience.

It was a discreet way for the commentator to say what they knew they couldn’t say: that those African folks don’t get soccer, and never will.

Things have changed. Now players from the African continent appear in all of Europe’s major soccer leagues. And they’re doing very nice too…not so naïve after all.

In the same vein, perhaps we could say the People’s Bank of China (PBoC) is being somewhat naïve when it says the onus is on banks to better manage their own balance sheets.

That’s not how things work. Don’t they get it?

It’s up to the central bank to print lots of money, buy lots of its domestic government bonds, all the while trying to convince the market that they know what they’re doing and that everything’s under control.

So, what should China do? Should it leave the banks to it? Should it intervene? Should it print X billions…or maybe it should go with Y billions?

You know what? If we’ve learnt anything over the past five years it’s that central banks can do as much or as little as they like, there will be winners and losers…just as there were winners and losers before the market crashed in 2008…

Yesterday the Australian market tumbled again. Down 69.7 points. That’s annoying, because we hoped it would go up.

The US market fell again overnight. The S&P 500 went down 1.2%. We thought it might go up. Oops.

But we got one thing right. The gold price in Australian dollars fell $17. So we guess one out of three isn’t bad!

In yesterday’s Markets and Money you heard from Sam Volkering. Sam is the technology analyst for Revolutionary Tech Investor, the new technology investing service we’ve set up to identify and research the world’s most leading edge and investible companies.

Sam suggested that there’s a lot to be positive about in the future. That for every bad news story, there’s one good news story behind it.

As an example he used the NSA spying scandal.

But with all due respect to Sam’s argument, we disagree. The story is nowhere near as bad as that. The reality is for every bad news story there are hundreds, probably thousands of good news stories.

Take the stock market. What are the roots of almost every story related to stocks? You can break it down into just four subjects: US, Europe, Japan and China.

That’s it. Everything derives from that.

When stocks fall it’s because of the US, Europe, Japan or China.

When stocks go up it’s because of the US, Europe, Japan or China.

Even when Aussie stocks rise or fall it’s not because of Australia, it’s because of the US, Europe, Japan or China.

In short, any stock that’s sensitive to the wellbeing of the economy is hostage to the words of central bankers in any one of those four economies.

It makes trying to pick individual stocks a nightmare. Or does it?

This is NOT a Technology Stock

When you stop and think about it, the reverse is true.

The last thing you want to do at the moment is buy an index. The major indices rise and fall based on nothing more than what’s happening with central bank policies.

That’s because the indices comprise the biggest and most established companies. These are typically companies that have hit or passed their major growth cycle.

They’re now in the business of keeping hold of what they’ve got. That makes them highly leveraged to the broader economy…to interest rates, government policy and international trade.

This is the same whether it’s a stodgy old industrial stock, a retailer, or even a mature consumer electronics company such as Apple [NASDAQ: AAPL].

These are the stocks that comprise the blue-chip indices. And for most of them their best years of growth are over. That’s why in this volatile environment it pays to look at stocks that aren’t established market leaders. Instead it pays to look for the disruptive companies that plan on upending the economy with innovation.

We’ll explain more on that in a moment. But first, when most people think of high growth technology stocks, they think of Apple.

We won’t go into the specifics of whether Apple is actually a technology stock. We’ll just say the argument that Apple isn’t a technology stock is pretty compelling.

Think of Apple in the same way you’d think of Ford [NYSE: F]<, General Motors [NYSE: GM], or even a bank. They all use technology, and a lot of what they do requires technology or comes with inbuilt technology…but that doesn’t make them technology stocks.

But as we say, we won’t dwell on that. Instead, we’ll look at the idea of Apple as a growth stock. There’s no doubt that Apple has built a strong brand over the past 10 years.

It has sold a lot of product, and the share price reflects that:

Source: Google Finance

Even after Apple’s fall from USD$700 last October, the share price has still gained 4,093% over the past 10 years. That’s nothing to sniff at.

But that’s the past. What about the future? The problem for Apple is simple maths and the limits of exponential growth.

A big reason for Apple’s growth was that it could develop new products and roll them out one after the other — iPod (and all its variations), iPhone, iPad, and the iPad Mini.

The growth and product release schedule was unrelenting. But then two things happened. First, competition. The smart phone market is now much more competitive today than it was even just five years ago. The iPhone is no longer the go-to smart phone.

Along with competition is the realisation that Apple’s products are rather more limited than other comparable products. Microsoft [NASDAQ: MSFT] has a great ad comparing the iPad to the Microsoft Surface and other Windows 8 tablets.

For instance, it highlights the inability for the iPad to handle more than one task at a time. Switch from one app or task to another on the iPad and odds are you have to login to the first app again.

Simple Maths Working Against Apple

But that’s by-the-by. As an investor, Apple’s biggest problem is growth. The Apple share price climbed so high because investors believed that each new product would out-do and out-sell the last.

They were right. Apple was a growth machine. But not anymore. With a current market capitalisation of USD$378 billion, investors look at the stock and wonder where the next growth spurt will come from.

The only hint they’ve got so far is the Apple iWatch. To say the initial response to that potential is underwhelming is an understatement.

But it’s not just the iWatch, it’s the simple maths of what this or any other new product would need to achieve. Apple has reached the stage in its growth cycle where in order to achieve the same growth rate investors demand, it would need to make profits equal to everything it had made over the past four years — more than USD$80 billion.

Seeing as Apple has ‘only’ made profits of USD$22 billion for the first six months of its financial year…it will have to clock up a big second half to even meet last year’s annual net profit.

The fact is, Apple is no longer (if it ever was) a cutting edge technology firm. It’s now an ingrained establishment consumer products firm. Because of that it has now begun to trade in line with the broader index.

For most of the past decade it vastly outperformed the S&P 500. For the past year it has vastly underperformed the S&P 500 as its rapid growth phase ended.

But now the S&P 500 and Apple are starting to move as one.

That’s why regardless of the sector, it doesn’t make sense to only invest in supposedly safe blue-chip stocks during a volatile market like this.

We know that’s contrary to what most pros tell you. They talk about rotating your portfolio into big safe stocks. But frequently that can be the worst advice due to the factors we’ve explained above — these stocks move in line with the major indices.

That’s why we advocate investing in specific stocks where big macro-economic events aren’t so important. That’s not to say these stocks are less risky, because they aren’t.

Their advantage is that because they are disruptive upstarts — companies that haven’t yet gained a mass-market presence — their share price tends to move based on the companies’ individual factors.

You Can Invest Like a Venture Capitalist Too

We’re talking about breakthrough or revolutionary technology and biotechnology companies. These are the disruptive companies seeking to change the current market dynamics rather than conform to them.

So when the economy takes a turn for the worse, or when the stock market is volatile, this can be a boon for disruptive stocks.

While big lumbering established stocks have to fight to hold their market position and perhaps struggle to pay debts, revolutionary technology companies are fighting off venture capitalists with a stick.

Venture capitalists will invest in revolutionary companies because they figure if they back the right company with the right idea at the right time (from a consumer perspective, not an economic perspective) they can earn back many times their money.

Compare that to the returns you can make by backing an established blue-chip stock. Sure, you may double your money over a couple of years in a bull market. But what about in a bear market, or a volatile market? Could you still double your money then?

We guess it’s possible…anything is possible. But it’s not likely.

In short, with the market as volatile as it is the answer to investing isn’t to put all your money in cash or gold or blue-chip income stocks.

Yes, you should have some exposure to all three of those. But don’t expect any of them to make you even double-digit let alone triple-digit gains during a volatile market.

If you want any chance of boosting your returns you need to think and invest like a venture capitalist. And that means taking risks and investing in some of the most exciting stocks on the market.


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From the Archives…

The Gold Bull is Dead. Long Live the Gold Bull!
21-06-13 – Greg Canavan

Marc Faber: People With Assets Are All Doomed
20-06-13 – Jason Farrell

The Holden Moment
19-06-13 ­– Greg Canavan

The Pressure is Building in China’s Economy
18-06-13 – Greg Canavan

3,000 Year Old Logic: Don’t Sell Your Gold
17-06-13 – Byron King

Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Markets and Money e-newsletter in 2005. He is the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service, Markets & Money.

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