Listen to the podcast here. A transcript follows.
Stephen Dover: Aram, as a growth investor, markets are at a high level, P/E ratios are at a high level, inflation is now a concern, especially with growth stocks, so how do you feel comfortable with current valuations?
Aram Green: We believe that investors should not get vertigo when looking at stocks with high multiples. A low multiple or a high multiple isn’t a good predictor of whether a stock or investment is cheap or expensive. Oftentimes, we find that companies with low multiples are cheap for a good reason. There’s something structurally broken about the business, it’s laden with debt, various other reasons. And likewise, for a company that has a high multiple, there’s probably some good reasons why that business is trading at a high multiple.
We really need to understand all the fundamental dynamics of a business before looking at those multiples. And the way that we approach it is, and getting comfortable with some of these higher multiples, is looking at the addressable market for which this company fits into, making sure that there’s that product or service fit, spending time to understand the unit economics and the returns of the business in today’s market environment as well as future market environments, and spending a lot of time de-risking the business to understand the visibility and the durability of the growth and returns out of the business. And a big element of that is understanding the ESG [environmental, social and governance] risks as well, because that could seriously derail an investment if there’s underlying misalignment between investors and the company or management team in terms of how their incentive, where the company is deploying capital, environmental or social risks that are underlying the business service or product.
And so, it’s always all of those elements to understand and de-risk that helps you unfold where the opportunity is, and to put that multiple into context.
There always are areas or specific companies that are overvalued, where there is risk in buying a specific investment at a high multiple that isn’t improperly discounting some of those things that are underneath the surface. And so, we think it’s important to have a balance spread across a range of different industries and sectors, as well as having some companies that are very high multiple for good reason, as well as having more moderate multiples, but again, appropriately valued based upon those criteria that we discussed earlier.
Stephen Dover: So Matt, talk a little bit about how you think about potential risks with inflation and rising interest rates.
Matt Moberg: Our first thought, as it pertains to rising interest rates, is that it’s healthy from the standpoint of we want competition for capital. We want there to be many places to deploy capital, and we don’t necessarily want over investment in some of these brand-new markets that are just starting to develop because we want for them to be extremely profitable.
The second piece to that is we actually continue to think that we are in a deflationary environment over the long-term, and that is due to innovation. Last year we think we saw a lot of productivity gains. We’ve seen that there were 7% more units shipped with 2.5% fewer employees. That is productivity.
All this move we see, moving out to suburbs and low-cost [US] states, etc. I understand that, you know, housing prices on aggregate are rising, but what’s really going on is people are actually moving to lower-cost regions and that movement will be deflationary.
And then, you have some capital assets that are being utilized in ways that never were before. So, with companies like Airbnb or VRBO, you’re starting to see that you can add more hotel rooms to a city without using any capital at all. Same for like an Uber or a Lyft in which you’re able to have the utilization rates of our national auto fleet or international auto fleet actually start to increase in a way that’s actually meaningful.
I think a good analogy would be the truck driver. A 30-year-old truck driver today is experiencing higher wages, experiencing bottlenecks right now in the ports as we’re reopening the economy and business right now for that truck driver is really good. But over the long-term, over a 10-year period, my guess is that they are still concerned about automated driving and what technology is going to do to their jobs.
So, we sort of view it from a short-term basis and the long-term basis. On the long-term, we still think the level of technology is very deflationary, but we acknowledge that right now, during stimulus and during this opening period, we’re going through an inflationary period.
Stephen Dover: So, Aram, we’re just hearing so much about the private market, IPOs [initial public offerings] that are happening and especially SPACs [special purpose acquisition companies] having the market. What do you think the private market, how do you think that’s informing you and how do you take that into account in both your bottom up and macro decisions?
Aram Green: We spend a lot of time meeting and talking to private companies for a range of different reasons. All of our public investments started out one day as private companies. We think that that’s a great breeding ground to find those companies that will eventually be public companies. So, to build that relationship up early with the management teams, understanding how their markets are developing in the earlier days, makes us better public investors when those companies end up going public. Those private companies are also competing against our public companies. So, to understand how the competitive landscape is evolving, not only from the likes of Amazon or a Microsoft, but down on the micro level, those companies that are less worried about quarterly numbers, and thinking about really the longer term of planting the seeds today to produce bigger revenues and eventual profitability down the line, also helps us understand the entire ecosystem for which our companies fit into.
Having a good lens into that area of the economy, we think, makes us broader, more knowledgeable investors. And so, we’ve spent a fair amount of time in that space. We’ve seen also a blurring of lines between what is public and what is private. That’s most recently been more in the SPAC market where we’ve seen a lot of heavy activity there. But, we’ve also seen a lot of late-stage venture capital investing taking place. And so, we think it’s important to understand what’s going on in that market, what’s going on with themes and businesses that either are rising new markets or competing against our markets, and also understand what valuations are like in that area of the market, because there is a tie between what’s going on in the public markets on the growthier side and the developing side versus the later stage VC [venture capital] areas. And, we have definitely seen ebbs and flows in terms of markets getting overheated and cooling off and overheating and cooling off. And I think that speaks to why active management is crucial within the innovation growth space. When you take an active management lens to this area, it helps you weed out the risk of, really, running into an area that is overinflated and over-hyped, where the promise of growth and the visibility and sustainability of that growth is way overestimated.
Stephen Dover: Matt, you’re located in Silicon Valley. Where, right now, are you most excited about innovation and the future and opportunities?
Matt Moberg: I think the way we would phrase it is we’ve sort of developed these five platforms, and we’ve done that in an effort to try to explain and distill all the change that’s going on in the marketplace. They’re also things that we think will change over time. But we think that where there’s a lot of innovation happening is in disruptive commerce, in genomic advancements, intelligent machines—which is really AI [artificial intelligence] applied to our physical lives, in finance, and then within exponential data. We are enthusiastic about all of those. And I think what’s interesting about them is they really have different moments in which we think that they are going to hit. So, if you have a 10-year time horizon, our viewpoint might be different than what we think is happening over the next 12 months.
And the other thing that I think is instructive of those is they really reach and they really illustrate how much change is happening across the entire economy. We’re really talking about change that’s occurring in the retail space, in health care, in the industrial space, in finance, of course. And then, of course, within technology as well. But, it’s happening across the entire economy. It really depends on what the time horizon is. But, if the time horizon is sort of what’s happening now, I mean, clearly, e-commerce just inflected positively, payments are inflecting positively right now. COVID has really helped with vaccines, and a lot of that is based on gene sequencing and genomics, etc. And so, we’ve seen some things get moved forward, other things get pulled back.
But, what we really view is we’re going through a period of time of unprecedented change. In our opinion, it’s very similar to what happened over a hundred years ago in the second industrial revolution where you simply have so much changing throughout the economy, that you have absolute new leaders, where you have businesses that are now five times the size we have ever seen before, but they actually have those profits to back them up. And so, therefore we feel like we’re just going through this period of unprecedented change and it makes us very enthusiastic about the future.
Stephen Dover: I’m just wondering, what areas do you see that are, maybe, over-hyped that you’re, sort of, perhaps thinking are overvalued, or you might want to avoid at this point that others might think of as innovative or have opportunity?
Matt Moberg: Yeah, over the last five, seven years, it’s been really interesting to watch. I think in 2016, 2017, one of the number one questions we got was, “What’s going on with 3D printing?” And then, after that, the question was, “What’s happening with cannabis,” and then it was, “what’s happening with blockchain?” And, I think each one of those went through their own, sort of, hype-cycle, if you will.
The way we try to think about that, less of trying to identify that, it’s more, where does the new innovation click with a really good business model? Where is that intersection of having an innovation, which we think has a lot of durability and a lot of duration to it, and where does it tie in to also having a really good business model attached to it?
So, you can have something which is extremely relevant but very difficult to make money off of. I think blockchain is going to deeply change our life and be an innovation that changes our life. However, it’s very difficult to find a pure play investment in blockchain. And so, what we try to find are these areas where it clicks between new innovations and business models. And that’s the way we try to think about it as we look forward.
Stephen Dover: Aram, what are you concerned about right now? What keeps you up at night?
Aram Green: I think if you’re not worried about inflation right now, then you’re kind of missing something. That’s what worries me, is the talk out of the Fed [Federal Reserve] right now. They seem to have an insensitivity or lack of acknowledgement that we’re seeing broad-based inflation and we’re having a hard time getting people back to work—that’s a problem and there’s definitely some of that that is temporary, but it’s really hard to see how much is temporary versus much more structural given the big changes in policy in Washington. And so that, that has me worried because I think it’s been a very long time since we’ve seen something like that. And, once the Fed gets behind, it’s very hard to catch up. So, we’re not ignoring it. We’re definitely paying attention to it. And it’s something that’s a part of our conversation toolkit with all of our management teams to understand what the embedded risks are associated with that inflation and how they might be able to turn that into an advantage and specifically staying away from those companies which could be harmed due to ramping inflation with an inability to pass that onto their customers or end users. So that’s an area that we’re definitely more sensitive to and watching closely.
Stephen Dover: Matt, anything keeping you awake at night?
Matt Moberg: Oh sure, Stephen, plenty. Actually, I think Aram articulated inflation really well. And I think he’s absolutely right.
When you think about inflation, and then when you think about is e-commerce going to continue to grow? Are there still going to be advancements in genomics? Are there still going to be advancements in EV [electric vehicles] and automated driving? And, we really think, from our research, that these things are still marching forward, they are going to change our economy and that leaves us with a lot of different investing opportunities. And so, when we think out, three, five, 10 years, we’re actually very, very positive.
The last thing I would say from a greatest concern is, we just really approach the markets with this deep humility. I would not tell you that we saw COVID coming. And there’s many other things that have happened in the market that we didn’t necessarily see coming. And so, from that perspective, we just simply always have to have our mind open to the change that’s happening in the economy and the change that’s happening in society and that we’re always trying to layer in and layer in this humility of understanding that we don’t know everything. And therefore, we have to have an open mind to all the changes that’s going on. And I think actually, from a greatest concern perspective, that’s both how we deal with it, but it’s the unknown that actually we think about a lot of like, how are we going to deal with these different scenarios? And I would say, that’s what keeps me up most of the night.
Stephen Dover: That’s great. Well, I want to thank both Aram and Matt. It’s so interesting what the future might hold and what opportunities there might be there. And, of course, the humility you have to have in looking at that.
Host: That’s it for this episode of Talking Markets with Franklin Templeton. We thank you or listening. If you’d like to hear more, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about any other major podcast provider. And we hope you’ll join us next time, when we uncover more insights from our on the ground investment professionals.
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