Disruptive innovations have explosive share price power

You really can believe it: In the not-too-distant future self-driving cars will dominate the streets, packages will be delivered by drones, robots will take over the house cleaning and eyeglasses will make fantasy worlds look real.  

You disagree and you consider this as utter nonsense? Think twice and look back at the history. Despite initially widespread doubts and often considerable start-up difficulties, many technical innovations prevailed over the years and have become an indispensable part of our daily life. One of the most prominent and still topical examples is the replacement of analog by digital photography. An even better example is the displacement of landline phones by mobile phones. Younger readers probably cannot imagine it, but even in the year 2000 only 10 percent of the U.S. population owned a cell phone – a technology that was used for the first time in 1973. 

 

Many innovations are entering the market  

If history repeats itself, we will witness enormous technological changes in our daily lives in the next decade. At present, more innovations are pushing simultaneously into the mass market than ever before. In science, innovations that have what it takes to displace an existing technology, an existing product or an existing service, are called disruptive innovations. The current list of innovative technologies is indeed very long, as the following most prominent examples prove: Internet of Things, autonomous driving, biosimilars, commercial and personal drones, automatization/robotics/artificial intelligence, cloud computing, fintech/digital banking/mobile payments/robo-advisers, sharing economy, virtual and augmented reality, 3D printing or floating LNG.  

The market sizes and the growth rates we speak about here can easily be demonstrated with the help of the forecasted development for the robo-adviser market. In a June study looking only at the U.S. robo-advised market (excluding virtual advice services where there is a human adviser), consulting firm A.T. Kearney projected robo-advised assets of $0.3 trillion by end 2016, and $2.2 trillion by the end of 2020, citing Citi research. 

From an investor’s perspective, these emerging developments not only offer great opportunities, but also harbor substantial risks. As a prime example of what can happen even to former market leader, the example of Eastman Kodak can be used. The inventor of the hand-held cameras missed the digital transformation and as a consequence, more than 130 years after the company was founded, had to file for bankruptcy in 2012. By contrast, Apple serves as a model that successfully climbed the technology ladder. In that case, extremely popular self-developed new products, like the iPhone, made Apple the world’s largest company by market capitalization. 

In order to successfully separate the potential losers from the future rising stars, from an investor’s perspective, it makes sense to be familiar with the typical schedule patterns in the introduction of disruptive innovations.  

For example, it is important to be aware that success of the challengers, despite their technological superiority, is far from guaranteed. This has a lot to do with the often long time-period until a disruptive innovawtion has penetrated the mass market. Until this has been achieved, many pitfalls have to be avoided.  

Among other things, a newcomer can run out of money or the company from the old guard, with the help of its financial strength, simply buys the necessary know-how to stay ahead of the competition. But the incumbents should also not feel too secure, since management errors and overconfidence often lead to situations where developments are underestimated or overlooked. These are mistakes that the market usually does not forgive, and once a company has failed to keep abreast of the latest technological developments, its market share starts to shrink permanently.  

In this context it is necessary to recall the forecast made in a study by Washington University, which found that 40 percent of the Fortune 500 companies will no longer exist in 10 years. 

Breakthrough time is accelerating  

Emerging as well as endangered companies are forced to speed up. This applies all the more nowadays, since statistics confirm that the pace of technological change has been speeding up. According to Citi research, the U.S. has seen a rapid increase in the rate of adoption of new technologies, while globally there has been a drop in the average technology adoption lag, as well as a convergence between Western and non-Western adoption times. In addition to an expanding pace, the costs of innovation have been falling, as Citi research highlights in a report, which in turn lowers the barrier to entry and the price of failure. 

With the attempt to earn money by betting on disruptive innovations on the stock market, another important problem arises. This has to do with the hype that usually surrounds long-term investment mega-topics like disruptive technologies.  

The usually promised high growth rates typically lead to great interest among investors at an early stage. The investments made in the mood of euphoria often are accompanied by high valuations which no longer take into account the involved risks that also exist. 

An example that underpins the assumption that this valuation risk exists today can be seen in the number of unlisted startup companies with a value of at least US$1 billion. Their number has almost tripled from the beginning of 2014 until August 2015, from 42 to 113. This seems like an exaggeration and also suggests a selective approach with investments in already listed disruptive innovations companies. But it would be wrong to ignore this investment topic completely, since the stocks of the winning companies promise to make their shareholders really rich.  

That means investors can benefit from the spread of disruptive innovations, but in order to do so, they must avoid the pitfalls. Or as Citigroup Global Product Head Robert Garlick puts it:  

“For corporates and investors, the increased pace of innovation change creates both higher opportunities and increased risks.” 

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