Technology changes everything
For months now we’ve focused our attention on the problems faced by stock investors, but problems like these create opportunities. If stocks are sold off, as we expect, excellent companies will be offered at reasonable prices, a combination that happens rarely.
The title above gives away the type of business we want to own. Service businesses have often been great investments—there’s no inventory, renting office space is cheaper than building factories, and repeat business stretches marketing dollars farther. Still, before the Internet, service businesses had two major weaknesses: growth unusually meant adding more employees and those same employees became more valuable, and expensive, over time. As an advertising executive once said, “Our assets go down the elevator every night.”
The Internet has changed the economics of service businesses. They still add people as they grow, but they also add servers and other technology which provides them with operational leverage for the first time.
Operational leverage refers to the ability to increase the productivity of employees, which can only be achieved by adding more capital (think tools) to the business. Manufacturing companies of the last two centuries were the first to enjoy this advantage. Today, the best service employees work with millions of dollars worth of technology allowing each one to reach millions of potential customers. And, unlike factories and heavy machinery, computer technology is cheap and can be added incrementally as the business grows.
We recently added one such business to our portfolios, Expedia (EXPE), the owner of multiple travel related websites. The company operates over a dozen major travel brands including Hotels.com, Travelocity, Orbitz and Home Away as it benefits from growing travel demand in all economies. As the Internet increasingly becomes the easiest and cheapest way to find travel opportunities, this remarkable company should continue to produce extraordinary results for shareholders.
How extraordinary you may ask? We focus on one measure of excellence, return on invested capital. The average company in the S&P 500 earns 38% by that metric, while Expedia earns 109%. Above average is an understatement. (Our portfolios already own some of these businesses such as Visa, Mastercard, Priceline, and FactSet.)
As we add these businesses to the portfolio over the next year or so, we will keep you updated on their opportunities and our expectations for them.
Daniel A. Ogden
Disclosure: Dock Street Asset Management, Inc. and our clients may own securities. This article is not intended to be used as investment advice.