The World Has Changed: Investing in the New Economy

Abstract

Today’s higher proportion of investments in intangible assets versus tangible assets is emblematic of a structural change in value creation. Investors have experienced that the digital network effects and other changes of the “New Economy” provide a different path for big winners, unlike that of the “Old Economy.” Moreover, the deterioration in the usefulness of generally accepted accounting principles (GAAP) accounting in general, and price/earnings ratio (P/E) in particular, pose a significant problem for investors. However, there is a sizable opportunity to be found by focusing on what has not changed. That is, the long-term life-cycle performance of firms is driven by the interplay of managerial skill (especially for nurturing a firm’s knowledge-building proficiency) and competition. This life-cycle framework is a uniquely useful guide for investors to navigate the New Economy. A key ingredient is a firm’s economic returns adjusted for GAAP deficiencies, for example, capitalization of research & development expenditures. This article provides an example of how life-cycle thinking leads to practical investment insights along with a case study of IDEXX Laboratories. This example represents the type of analysis needed to generate alpha via a portfolio of firms with skills attuned to the New Economy. TOPICS: Security analysis and valuation, portfolio construction, performance measurement