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Why the US remains a source of thematic investments

by  Jerry Thomas  |  16 May 2019

Land of opportunity

The US stock market trades at a high multiple by comparison with the other major global equity markets. The paradox is that the US remains the largest source of good quality, thematic stock specific opportunities. Giles Money, who joined us recently from Bank J. Safra Sarasin, and I travelled to Orlando in March for a week focused on finding new investment ideas through which to express our themes.

A conference is an effective way of getting to know unfamiliar businesses, at the same time being a forum to engage with owners of companies we already invest in on behalf of our clients. The annual Raymond James conference brings 350 companies across many industries together over three days to meet 750 investors. Giles and I had interactions with over 50 of these companies between us, some of which we had little knowledge of before boarding the plane, and a number of these companies do not travel to Europe to meet with investors. We returned with our digital notebooks full of ideas to research, as well as valuable insights into companies already in our portfolios.

Researching automation

My priority for the week was our automation theme. Traditionally, the market indices and investors have differentiated between technology stocks that appear to offer huge growth potential and industrial companies that are seen as cyclical. This is outdated. Some of the most disruptive changes are happening as industrial companies benefit from the falling costs of processing power and advances in robotics, communications and software. This is creating niche industries such as machine vision, laser processing, or industrial software. Because the market struggles to pigeonhole these companies as ‘technology’ or ‘industrial’ they have potential to be misunderstood and consequently mispriced. This makes them a perfect hunting ground for a thematic investor.

Our portfolios have held shares in the Japanese machine vision company Keyence for many years. On this trip I had my first opportunity to meet Cognex, their main US competitor. Machine vision is a $3.5 billion industry growing at 8-10% per annum with high returns on capital due to the extensive software content and barriers to entry. The technology is primarily used in industrial automation and logistics, and replaces low value added or inefficient jobs. Cameras or scanners are used to record a process, make sense of it and then instruct an action. This is done at factory speeds, to microns of accuracy and in harsh environments.

High-powered fibre lasers are rapidly disrupting the machine tool industry with a faster, more efficient product that produces a cleaner cut in metal and a better quality weld between materials. I have spent many hours learning about this new industry and the market leader, IPG Photonics, in particular. The trip gave me the opportunity to corroborate this knowledge via meetings with a small competitor, nLight, which gave me more confidence that the technology is difficult to copy at scale. The applications for industrial lasers can also extend into new segments such as medical, communications and entertainment.

Software is becoming core to all companies

My favourite quote of the week came from the CFO of Roper Technologies, a company that acquires and operates niche engineering companies with high software content. He explained “We come to this Raymond James conference not the technology conferences; at the tech conferences the investors only want to ask us why we only grow organically at 5% and what a pump is.” Software is becoming core to all companies, even in traditional sectors. A meeting with Trimble explained how it is digitalising mature industries such as agriculture, construction and transportation where technology adoption has lagged for decades.

Applying this knowledge to portfolios

Giles spent much of his week learning more about new technologies in the medical device industry and building on his knowledge of pet care. A particular highlight was IDEXX Labs that is the clear leader in diagnostics equipment and practice software for vets. Not all the companies we met will prove suitable for our clients’ portfolios. Some will fail our process for stewardship reasons or an unappealing valuation. However, returning with such a long list of new ideas, I am confident that the US market will remain the richest source of thematic investments for our funds.