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Natural selection

06 January 2015

Businesses need to adapt to change or risk being left behind.

The rapid evolution this century of hand-held technology and devices – such as tablets and smartphones – has brought huge change to our day-to-day habits and experience. Artemis investment manager Adrian Frost, who is co-manager of the St. James’s Place UK & International Income fund, argues that the technology revolution is only now “coming home to roost”, with big implications for businesses that need to adapt to survive disruptive change. As he suggests below, no business is guaranteed to survive and stock picking comes into its own in such times of ‘Darwinian’ change.

 “The advent of digital and online commerce is having a profound effect on many industries. If you think this transformative effect is largely played out, I would beg to differ. Although the internet entered all our lives in the 1990s, it was the arrival of tablets and smartphones that brought the real revolution. For many people today, it is a case of ‘my device is my life’. According to global information analysts Nielsen, each of us now spends 41 hours per month glued to our smartphones – and all power to you if you are reading this in, as it were, the flesh.

“Just because a company has history, status and a platform of profits, it shouldn’t be assumed that these will last. Today’s stock market incumbents may have all the customers and all the profits; but surviving a transition while retaining both – or either – is no mean feat. It often involves a lot of pain for everyone involved, including shareholders. This has, possibly, been the problem for Tesco and the other UK supermarkets. Many of the food retailers must have had a sense of the threats they face. But how and when do you prepare your employees and shareholders for a disruptive change?”

Inertia or action?

“In the UK, the supermarkets, rather than answering these questions, opted for inertia or, at best, incremental change. This was not helped by the fact that shareholders ask for that which cannot be delivered. Did they really expect Tesco to retain a 28% market share in the UK and to continue to produce annual profits of more than £3 billion, while simultaneously seeing off challenges from Aldi, Lidl and Amazon and absorbing the costs of online shopping? Perhaps they should have added the parting of the Red Sea to their list.

“Contrast the experience of the established supermarkets with UK publishing group Pearson, whose much-admired chief executive, Dame Marjorie Scardino, had come to be regarded as all but immortal. Her successor, John Fallon, realised that he had to make haste and move this peerless provider of education information away from its reliance on printed textbooks and into the world online. This created costs in the tens of millions, redundancies and the closing of warehouses. It also dealt a sharp blow to the company’s share price as profits were clobbered. This no-nonsense ‘grasping of the nettle’ prepared Pearson for a different future. There is no guarantee that it will become a more valuable company as a result; but it did put Pearson in a position to survive and compete. Inertia or incremental change was never part of the plan.

“One should be wary of labelling stocks as ‘blue chips’: they can become ‘wood chips’ in no time at all. It is likely that further disruptive change awaits a number of industries. It is no small part of my job to resist the siren call of poorly-performing stocks that look cheap. The question most frequently asked by our clients recently has been: ‘Isn’t Tesco a buy now?’ Cheap stocks are likely to be endangered species that have not woken up to the reality of the dangers they face.”

Disruptive change

“Our belief that disruptive change will continue to reshape industries has a couple of implications. Firstly, if we do our job well, it should put us at an advantage versus index trackers. Remember that a tracker fund has no insight into, or fear of, a changing world; neither can it capitalise on the opportunities that arise from change. It is compelled to invest in history and it cannot prepare itself for the future: it can only grin and bear it.

“Likewise, the evolution of disruptive change will inflate pleasantly the value of those companies unaffected by change – or who have taken pre-emptive action to protect their future prosperity. Such companies will make their shareholders a lot of money. To conclude, this focus on change is all about finding companies able to pay sustainable and rising dividends over the long term; and, as with Tesco’s 70% dividend cut, avoiding those that can’t.”

The opinions of Adrian Frost are subject to market or economic changes. This material is not a recommendation, or intended to be relief upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place.


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