Investing in change

The enthusiasm and excitement of a new technology has on many occasions captured the imagination of the supposedly hard-nosed investment community, and encouraged them to overstate its profit potential.

The ‘hype cycle’ introduced by Gartner, the technology research firm, is a framework for thinking about technology change which also provides an apposite framework for investors. In essence, it maps a curve that describes the way in which new technologies are adopted, isolating the difference between expectations and reality.

As illustrated below, there are five phases to the cycle:

• Technology trigger - Breakthough, product launch. This is pure thought leadership territory. Trademark proprietary technology and products that are new to the market
• Peak - Overhyped by the market, leading to unrealistic expectations and an exuberance of optimism
• Trough - Technology quickly becomes unfashionable after disappointing the market. This reaction can be hasty and over-stated. However, for good companies this can provide a compelling entry point
• Slope - Benefits and practical application of technology gradually realised. Start to see adoption of innovation
• Plateau - Benefit of technology now widely demonstrated and has seen mass adoption (both corporate and consumer level). Attention has been well-earned, now we see the reward.

We find this to be a helpful framework for thinking about investing in technology change, and tend to focus on three potential entry points to generate positive returns.

Shooting stars

Identifying the ‘new, new thing.’ These are companies capitalising on breakthrough technologies with enormous, but often unproven potential. The trick is to identify them early, ahead of the wave of optimism around the new technology that can lift valuations towards the peak. Typically, this approach is best suited to the small cap equity fund manager, or to private market investors, and often it requires a very forwardlooking approach to valuation: these breakthrough technologies rarely come with an established revenue stream, let alone profits and cashflows.