Disruption has become one of the most used words in modern investing. The bifurcation of sentiment and valuations among those deemed as victims and those as initiators has often become extreme.
Investor fervour to 'be on the right side of change' has not only driven the valuations of the perceived winners to excessive levels, it has also resulted in the overlooking of many fundamentally sound businesses.
We have witnessed numerous examples of this in recent times and have taken the opportunity to buy into many high-quality businesses trading cheaply relative to any reasonable assessment of medium-term prospects. Below are three sectors where we believe it pays to look beyond the disruption hype.
Forget the FANGs
The 'disruption' dash is clearly evidenced in the technology sector, where we have stakes in incumbent stocks such as Netapp and Cisco Systems.
NetApp, one of the two dominant providers of enterprise storage systems over the past two decades, is a good example of sentiment temporarily trumping reality. The rise of Amazon's public cloud services, part of which comprised cheap commodity storage, began to eat into the market for dedicated storage vendors such as NetApp.
While this market shift was indeed real, the market by early 2016 had become convinced traditional storage was dead and NetApp's shares traded at just 4x free cash flow.
Fast forward two years and NetApp's business has evolved substantially. With the accelerated introduction of a new operating system, the company has leveraged this to become the fastest growing company in the 'all flash' storage segment, with hard disks giving way to solid state flash memory for many high-end corporate and web-scale environments.
Until recently, Cisco's shares traded at less than half the valuation of comparable companies.
The growth of web-scale vendors has placed different demands on networking providers - with the growing client preference for customised, rather than out-of-the box, solutions. It is entirely within Cisco's capabilities to address this need, as few are better resourced or know more about networking than Cisco.
Cisco's business model is also evolving as it layers deeper software capabilities into its solutions, providing a pathway to deliver its technology stack via subscription, rather than product sales.
While this has created a short-term headwind to reported growth, it will significantly grow customer lifetime value as subscriptions are adopted. For now, Cisco's valuation offers a significant margin of safety and recent tax reform has provided a further boost.
Autos charge on
Another area of the market under the disruption spell is the automotive sector - with Tesla one of the world's largest manufacturers in market capitalisation terms.
However, on almost any other financial metric it is an over-promoted niche automaker, with a nonsensical valuation and heavily challenged finances.
The perception of Tesla as a disruptor of the century-old global auto industry has left many companies trading on unjustifiably low valuations.
Hyundai Motor Company is one such example. Hyundai's stock is available for purchase on less than 2x pre-tax profits, once we conservatively adjust for the value of group investments and its $12bn cash pile.
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