By MoneyMorning.com.au
Unless you’ve been living under a rock, you would have heard Apple Inc., [NASDAQ: AAPL] co-founder, Steve Jobs died on 5 October.
Your editor was living under a rock… well, a self-imposed news blackout anyway. So we didn’t read about it until four days later.
We’re not going to write a eulogy or obituary praising the man. That’s not our style. Besides, we never met him. And we never knew him. So we’ve no idea what he was like. Instead, we’ll focus on what we do know…
Entrepreneurialism.
In today’s Money Morning we’ll try to explain what are and aren’t entrepreneurial companies. And most importantly, why this is must-know information for investors.
Bottom line: if you’re a growth investor, finding innovative growth opportunities early on can be the best way to maximise gains on the stock market.
It can mean the difference between a steady and dependable gain of 5 or 10% per year in a non-innovative (or what we like to call, “copy-cat”) company… or potentially making 100%, 200% or 500% from genuine game-changing innovators.
But before we go on…
To be honest, different people have different ideas about it.
But here’s our definition: it’s about creative destruction or disruptive technologies. It’s about improving on an idea… replacing an old technology… or even just giving a technology, product or service a nudge and taking it in a new direction.
For instance, Apple is an innovative and entrepreneurial company. Steve Jobs was an innovator and entrepreneur.
By contrast, another well-known technology firm, Hewlett Packard [NYSE: HPQ] is a copy-cat company. It no longer innovates.
Now, don’t get us wrong. There’s nothing wrong with copying ideas. And there’s nothing wrong with copying an idea and offering it for a cheaper price.
In fact, for you as a consumer it’s great.
But for you as an investor it’s not so great.
Investing in copy-cat companies is usually a low-risk and low-return affair. Why?
Because unless the new firm is able to add value to the product and service, it’s unlikely it will be able to charge more for its product. In fact, it’s more likely the copy-cat firm will have to undercut the firm it’s copying in order to win customers.
Generally (but not always) this means a race to the bottom for revenues and profits… especially if the barriers to entry are low.
A good recent example is tablet computing…
Apple was the first to market. And because it had built a strong brand with its iPod and iPhone, it could charge high prices for a genuinely innovative product.
Firms that just tried to copy Apple by releasing a tablet computer have met with mixed success. Mainly because they didn’t have a “sticky” brand… they had spent years commoditising their products and training customers to buy on price (we’re thinking of the PC and mobile phone companies).
A classic example is Hewlett-Packard’s (HP) TouchPad disaster. After poor sales it withdrew the product. But because it had already made a bunch of the things it sold them off for a cut-price $199… a 60% discount to the original retail price.
Not surprisingly, at $199 the product sold out in hours… because that’s the price consumers would pay for a commoditised product.
Whereas consumers who buy for the brand and perceived quality are happy (or foolish) to pay three-times that amount for Apple’s iPad product.
The difference shows through clearly in the revenue and profit numbers for Apple and HP. For the last financial year HP made sales of USD$126 billion and net income (profit) of USD$8.7 billion.
That’s pretty good. But now look at Apple…
It made half the sales of HP – just USD$65 billion. Yet its profit was 60% higher than HP’s at USD$14 billion.
OK. The companies are different. It’s not a direct comparison. But it’s a good comparison between the returns you can expect from investing in an innovative and entrepreneurial firm like Apple… and the returns you can expect from a copy-cat firm like HP.
To show you even more clearly, check out the chart below:
Apple (blue line) shares are up 400% in five years… HP (red line) shares have halved!
Of course, it wasn’t always that way. In the early days HP was innovative too. But that’s long in the past. Today it’s just one of many computer companies scratching around for profits in a low margin business.
And maybe one day Apple will be a copy-cat firm like HP. Who can tell?
In short, the message is this: when you’re investing for growth you should avoid the copy-cats. Copy-cat investing is fine for a steady and dependable income stream. But it’s not for growth investors.
To get big triple-digit gains to boost your portfolio performance, you should always look for the innovating firm. Of course, these firms are riskier. And the punt won’t always pay off. But if it does the rewards can be huge.
That’s why, in our view, if you’re happy to take a risk, punting on innovators and entrepreneurs is a risk well worth taking. Who knows where or when the next Apple will emerge…
But that shouldn’t stop you from looking for it.
Cheers.
Kris.
PS. If you’d like more details on how I pick innovating stocks from the crowd, click here to view this free presentation.
