Mobile Strategy Brief: Innovation Growth
Mobile Strategy Brief: Innovation Growth
Welcome to Lord Abbett’s Mobile Strategy Brief.
Brian Foerster: This is Brian Foerster, equity investment strategist with Lord Abbett. As equity markets continue to trade near all-time highs amidst a low-growth, low interest rate backdrop, many areas of innovation in the U.S. economy continue to thrive and lead market returns.
At Lord Abbett, we have a dedicated investment team focused on researching and investing in many of these disruptive technologies and concepts. Here with me today to discuss how we approach these opportunities is Matt DeCicco, portfolio manager and managing director for Lord Abbett's Innovation Growth team. Matt, thanks for joining us today.
Matthew DeCicco: Thanks, Brian. Great to be here.
Foerster: So, Matt, technology and innovation are certainly a big focus in the markets today, and you get a lot of opinions about how to invest in this space. What differentiates Lord Abbett's approach?
DeCicco: We think Lord Abbett's innovation team is differentiated by our process, our people, and our platform. So, just starting with our process, we think there are three important concepts that make our process unique. First, we want to identify innovative, superior businesses, and this is more a qualitative exercise as we're thinking about the potential for a company to disrupt and take market share.
Second, we also require that a company is exhibiting what we call operating momentum, meaning there are quantifiable metrics that indicate these businesses are executing at a high level and often better than the market expects.
So, this operating momentum confirms the realization of a company's potential. Finally, we focus on the price momentum of the underlying stock. We want to see that others are seeing the potential and the strong execution and realization of that potential and that they're agreeing with us.
And so that concept, which we identify with technical analysis, represents recognition of a company's fundamental success. These beliefs are grounded in fundamental biases we believe are persistent in the market, namely that innovation is persistently underestimated, investors often sell winners far too soon, and hold losers for far too long.
We continuously optimize our growth portfolios by assessing these three characteristics and the strengths of these characteristics relative to all of our investments and investment opportunities. The optimization process leads to a portfolio where the companies with the highest potential and strongest operating and price momentum earn the most capital.
Foerster: Matt, could you expand on a couple of those points? Namely, how do you identify superior businesses—and how are you defining both operating momentum and price momentum?
DeCicco: Starting with innovative, superior businesses: As we said earlier, this is more of a qualitative process, and we focus on four things in particular. The business model, the company's management, the competitive advantage of the company, and the industry conditions in which the company operates.
So, starting with the business model, we like companies where the assets are configured in such a way when that the revenues grow, the earnings grow faster. That is, we like scalable businesses. We spend a lot of time as a team evaluating company management, so it's critical that those management teams are credible and we can have trust that they're going to meet and exceed the expectations that they lay out.
The third thing I mentioned, competitive advantage -- this is important because it allows us to have a view that the revenue and earnings today are sustainable well into the future. So, this could be intellectual property that a company has or a product development pipeline that allows their business to be sustained many years into the future.
And the last thing I mentioned, industry conditions -- one can think of this as the backdrop in which the company is operating. It's much easier to operate as a company when your industry conditions are favorable. For example, think of a company that is facing new regulatory headwinds. This is a company that may not be very attractive to us even though the other underlying fundamental considerations are positive.
The second thing that we spoke about was operating momentum. We look at four key measures when we are evaluating a company's operating momentum, and you can think of operating momentum as the fundamental analysis that we do that is unique and specific towards evaluating innovative high-growth companies.
So, first and foremost, we spend a lot of time thinking about a company's revenue growth. We believe that, oftentimes, the revenue growth of our high-growth, disruptive, innovative companies is forecasted to decelerate, and that that deceleration is often too severe. That is to say, that our analysts can identify companies where the revenue growth, which might be very high, can sustain [that growth] at a higher level for longer than [the] consensus projects.
The second thing we evaluate each and every quarter is margin strength and, particularly, we look at gross margins. An immature company, or an emerging company can have very high gross margins but have near zero or negative net margins. And we think that's okay, because once that company stops spending on R&D or reduces their spending on sales and marketing, with very high gross margins, we can project out into the future that they will have high operating and net margins well into the future.
Third and fourth, we pay close attention to a company's [earnings] estimate revisions each and every quarter. And then we evaluate the company's total addressable market and how much they have penetrated that total addressable market as well as what products they're coming out with to expand that market.
So, again, these four metrics all are encompassed, in our view, of how to evaluate a company's operating momentum. The third and final step is our evaluation using technical analysis of price momentum. And we have developed systems to look at price momentum in two ways.
The first is we look at a company's absolute price momentum, which we define as the stock price compared to its own history. And the second thing we look at is the stock's relative price momentum, which is that stock's price compared to all other stocks.
Foerster: Going back to where we started, you mentioned people and platform as key differentiators. Can you expand upon that?
DeCicco: The process is carried out by an experienced team of exceptional people. The Lord Abbett equity innovation team is eight people strong with an average of over 20 years of experience. We are led by Tom O'Halloran, who has 32 years in the business, and whom I have worked with for the last 17 years.
The final point of differentiation is the platform at Lord Abbett. We are a boutique team that is cohesive, highly functioning, focused, and dedicated to our clients’ assets, but with a strong organization with significant additional resources. For example, we have an experienced trading group with a dedicated growth trader that has worked with us for over a decade.
We have a seasoned risk management team that regularly monitors our portfolios and the markets, and provides us with important insights. And, finally, we have over 150 other additional investment professionals spanning from value equity to fixed income who help to inform our views about companies and markets. With this great team and all of the resources available at Lord Abbett, Tom and I come to work every day feeling that we have an information advantage. And it is our job to turn that advantage into investment alpha.
Foerster: Thanks, Matt. So, as you think about the portfolio today, maybe you can comment on your general positioning and outlook, as well as your views on areas of innovation?
DeCicco: Sure. Well, we're bullish for the balance of 2019. And we are very bullish on innovation for the next decade and beyond. It's a thrilling time to be a growth investor because we believe that we are living in the early stages of the technological revolution. In time, we think this period will be viewed to have the same profound effect on the human experience as the Industrial Revolution.
However, unlike the Industrial Revolution, which transformed muscle power into mechanical power, the tech revolution is transforming cognitive power. Some examples of this transformation include artificial intelligence, autonomous vehicles, robotics, the internet of things, 3D printing, biotechnology, these are just a few examples.
All of these industries are in their embryonic stages and we expect that these industries will shape our world and our markets over the next century. Because this is a revolution of cognition rather than muscle, the sectors affected are different than those in the Industrial Revolution.
We believe that this is responsible for the outsized gains in the growth industries over the last decade such as biotech, internet retail, or e-commerce, fintech [financial technology], cloud computing, and semiconductors. And we expect this to continue in the decades to come. The tech revolution is directly impacting technology, communications, consumer, and health care.
These sectors are 70% of our investable universe in the growth indices and, in contrast, only 30% of the value indices. The positive effect of technology on consumer efficiency touches our lives every day. From our mobile devices, we can order a meal on GrubHub, hail a ride on Uber, and book a vacation rental on AirBnB. That is because the handheld device we are using today has the equivalent computing power of 5,000 desktop computers from 30 years ago.
Foerster: Those are some great examples of how technology is definitely influencing our day-to-day lives. As you mentioned earlier, you have an extensive background in health care. Can you maybe touch on some of the ways in which the tech revolution is impacting areas like biotechnology?
DeCicco: Sure. So, technology has enabled a dramatic reduction in the cost of human genome sequencing over the last 15 years. Recall, the Human Genome Project, which was completed in 2003, took over a decade to complete and cost $3 billion to sequence a single genome. Today, the process takes hours and costs less than $1,000 per genome.
This allows medical research enhanced with computational tools to more rapidly identify new targets for drug development. For example, one of our investments, a cancer drug discovery company, is developing a treatment for a specific protein mutation causing lung cancer that was discovered in 2011.
The identification of the genetic rearrangement led to the characterization of the affected protein and, ultimately, the intelligent design of a drug to specifically target this defective protein. The pace of this process from genetic discovery, to drug design, to FDA approval was unfathomable until now.
We are finding exciting new ideas like that every day in all of the growth sectors with huge open-ended growth opportunities that are still very early in their development. And that's why I said earlier it is such a thrilling time to be a growth investor.
Foerster: Thanks, Matt. One final question. You were talking very much about investing in innovation for the long term and the enormous opportunity over the next few decades. But how does a team incorporate views on the current market conditions and short-term considerations around, say, the Fed and the trade war?
DeCicco: We believe the current market volatility is healthy in context of an intact, secular bull market. That is, we don't believe this is the sign that we are at the beginning of a new bear market. The primary reason for this is that the direction of the stock market is most correlated with the direction of earnings, and the direction of earnings is driven by economic activity.
The key counterargument against the bullish view is that the global economy is slowing and margins are peaking, so earnings growth is decelerating. Well, that's fine, but that doesn't mean earnings are contracting. And that is what really matters for market returns. What is important for markets is that earnings are growing. The rate of growth is less relevant.
And on the topic of profit margins, peak margins occur in the early or middle of business cycles. Margin erosion occurs long before recessions begin. Margin compression, and this is important, does not mean EPS [earnings per share] is contracting.
If revenues grow, earnings can still grow with some margin contraction, and that is historically how the business cycle has played out. So, just going back to what I said earlier, what is important, what we believe is important, is that innovation is going to have a lot of durability over market cycles.
So, in sum, we have a modestly bullish posture on the near-term equity market and a much more bullish view of innovation for the decades ahead.
Foerster: Matt, this has been a great overview of innovation and how Lord Abbett invests in this area of the equity markets. Thank you.
DeCicco: Thank you very much.
VO: That’s it for this edition of Mobile Strategy Brief. If you wish to learn more about the topics covered in this broadcast, or have other questions about Lord Abbett investment strategies, please contact your Lord Abbett representative. Our audio podcasts are available on iTunes, Spotify, TuneIn, Stitcher, and other major streaming media services. Thanks for listening.
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