HOLT Expert Q&A with John Talbott

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This is part one of a Q&A session featuring select members
of the Credit Suisse HOLT Community and HOLT sector
specialist John Talbott.

 

Mayur Kumar (India), HOLT Champion
Indian Institute of Management Lucknow, India

Q1: Disruptive innovation is a buzzword in every industry, but not every disruption is a market success. How should one analyze the potential of a disruptive technology and, more importantly, how do we calculate the future potential stock value of a company which promises disruption.

Excellent question Mayur. There are two important aspects to consider with regards to your question; namely will the disruptive technology also be a viable business and how should we value companies that possess this disruptive technology. Admittedly, valuing such companies can be a difficult exercise, but even so, we can use the HOLT framework to benchmark what the market is implying versus the CFROI® levels (or returns on capital) of more established peers in the industry.

For example, when Twitter (TWTR) IPO’ed in late 2013, market expectations implied TWTR would be successful like Internet Titans such as GOOGL, EBAY and AMZN. Said differently, expectations implied future CFROI levels near best-in-class operators. If this is already implied and priced in, upside in the share price can be more difficult to achieve.

 

Jason Chen (USA), HOLT Champion
Baruch College, Zicklin School Of Business, City Univeristy of New York, USA

Q2: Looking at the relative wealth chart on HOLT Lens, CFROI seems to be moving into a period of Fade. Given Apple’s past performance do you think this is a temporary phenomenon or will the company’s CFROI continue to decrease over time?

Great point Jason and certainly a point that is highly debated. On the one hand, HOLT has empirically found that CFROI levels (or returns on capital) tend to fade towards a long-term average level of 6%. As such, when firms such as AAPL earn CFROI levels above 6% one could empirically argue that AAPL is destined to fade. It is also interesting to note, AAPL in the early to mid-1980’s earned CFROI levels well above 20% only to fade to negative levels in the 1990’s. On the other hand, AAPL is an extremely well-run company with a tremendous brand and ecosystem of products. While HOLT does generally observe fade for most companies, there are a handful of companies that do beat the fade and generate consistently high CFROI levels year after year. In AAPL’s case, they appear to be doing all of the right things in the foreseeable future as they relate to keeping elevated CFROI levels.

 

Edo Duran (Serbia), HOLT Partner
Union University Belgrade, Serbia

Q3: Over the past 4 years the HOLT warranted price is on average two times higher than the actual price, why do you think there is such a significant difference?

Interesting observation Edo and something I am asked quite often. To state your question a different way, what is HOLT’s valuation (or warranted price) missing compared to the market’s assessment of AAPL? If you pull up Nokia’s or Blackberry’s relative wealth charts in HOLT Lens, you can begin to understand why the market has discounted AAPL so heavily the past few years. Nokia and Blackberry’s CFROI levels both peaked around 30% only to fade drastically thereafter. If AAPL were to experience a similar fate and fade (which the market appears to be discounting on some level), then HOLT’s valuation would ultimately prove too optimistic. Put another way, the fade HOLT is applying to AAPL’s valuation is much lower than the fade the market is implying; hence why HOLT’s warranted price has been so much higher than the actual share price.

 

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