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The Search for Creative Destruction

Wasatch's Sam Stewart looks for companies that do things so differently that they can change an industry forever.

Liana Madura, assistant site editor, 08/03/2011

We recently caught up with Sam Stewart, manager of Wasatch World Innovators WAGTX. He answered our questions behind the fund's recent name change and how management identifies innovative companies around the world. He also explained whether Apple's recent move into the cloud-computing space will affect how the fund will position itself it that industry. Additionally, Stewart pointed out a few international companies worth considering as potential hidden gems.

1. Prior to April 1, the fund was formerly known as Wasatch Global Science and Technology. Why the name and strategy change?
Most investors see a name like Global Science and Tech and immediately think "You buy that fund because you like the tech sector right now." As active fund managers, we don't want to be identified with index trackers. So the first reason for the name change was simply to clarify that we are not a proxy for performance of the tech sector. We don't want to be boxed in to just looking for the next great innovators in one sector; we want to consider all the companies worldwide.

The other reason for the name change is that "World Innovators" is more inclusive and better reflects our investment strategy. Regardless of whether they are considered tech names, the companies that we favor are creative, improve on the status quo, iterate, and ultimately figure out how to do things better than they were done in the past. Some examples are technology companies like Apple AAPL, but companies like Ford F, McDonald's MCD, and Wal-Mart WMT in their prime were extremely innovative businesses and great investments, as well.

2. What do you look for when trying to identify growing and innovative companies around the world, and where have you had the most success in finding these opportunities?
We want our companies to be instruments of creative destruction, meaning that they do things so differently and so much better that they take an industry by storm and change it forever. We also look for consistent market share gains because this usually tells you that a company is doing something different and better than the competition. We don't, however, want to get caught up playing product cycles (such as a faster chip, a slimmer phone, or a hot fashion item) which tend to lead to short-lived market share gains that can disappear overnight. We look for commercial innovations with a clear path to real world application rather than discoveries made in a lab that might represent scientific progress but not a good business. And we're more likely to find the type of world innovator we are looking for among the trucking companies than among the biotech firms.

We find innovative companies all over the globe, of all different sizes and in many sectors. We have found Internet-related business to be a particularly fruitful area. Under this umbrella we have several online retailers, such as Amazon.com AMZN, Start Today (Japan), Zooplus (Germany), CTS Eventim (Germany). We also have a couple of online marketing specialists, such as Google GOOG and 1000Mercis (France). Coming from a very different angle, we own a basket of companies that sell equipment and services that power the network behind the Internet, including Finisar FNSR, JDS Uniphase JDSU, Akamai Technologies AKAM, Acme Packet APKT, and Riverbed Technology RVBD).

3. Although innovative companies have the potential for faster earnings growth, they also come with greater risk. How do you assess and mitigate growth risk on an ongoing basis?
There's no magic formula other than deep due diligence. At Wasatch, we call this process "onion peeling." We understand a company is a layered, complex organism, and all we can do is research it one layer at a time. After many calls, emails, and visits to management, after meeting with competitors, after lots of analysis, and after watching the stock price movements over time, we get a deeper understanding. We tend to own small weights of our newer ideas, and if each subsequent interaction with the company is positive, we work the position size higher over time.

4. Many companies, such as Amazon and Google, have been operating and offering products in the cloud-computing space for years. As a newcomer to this market, do you think that Apple will continue the streak of success with which it's familiar?
The cornerstone of Apple's philosophy is to design products that are easy to use, and this seems to be exactly what most consumers want in the devices they buy today. We don't think the shift to cloud computing will have a big impact on user demand for sleek, easy-to-use products, and so Apple should continue to succeed. The cloud does make computing, the Internet, and media more accessible anytime, anywhere, which should only stoke demand for Apple's products and open up opportunities for new device categories like tablets, such as the iPad.

5. Which two international companies that you're investing in would you classify as the next hidden gems?
One of our most exciting new discoveries is Zooplus, the Germany-based online pet-supplies retailer. We think Europe is a uniquely good market for the Zooplus concept: It's more densely populated, so warehousing and shipping costs are much less than they would be in the United States, which is important when you are selling bulky items such as dog food. Also, more people shop on foot making the purchase of heavy items more difficult and home delivery an attractive option. The company is still relatively small at a EUR 265 million market cap with few shareholders outside of Germany. But sales increased at a blistering compound annual growth rate of almost 50% during the last five years, and we think that pace can continue as the company pushes beyond the borders of its home market and into the rest of Europe. We usually favor companies with strong track records of both growth and cash generation. We make an exception for Zooplus because we also understand that there are times when the right move is to invest pedal to the metal and grab market share and scale first. Zooplus could be classified as a consumer staples company, a retailer, or a technology company (like most U.S. online retailers are); we call it an innovator.

Sartorius Stedim Biotech hits on all of our favorite parameters for an investment, one of those being that it is under the radar. The company is a Franco-German combination which provides tools used in the development and production processes of biologic medicines. Sartorius Stedim Biotech sells filters, hoses, and plastic bags, all the components needed to construct single-use bioreactors which are used to manufacture the most advanced therapeutic drugs in development and on the market today. The top biopharmaceutical companies in the world use the firm's products to make medicines which generate billions of dollars in revenue each year. Any mistakes could endanger patients and huge revenue streams. Customers are extremely risk-averse, while pricing pressure and new competition are nonexistent.

When we first found Sartorius Stedim Biotech several years ago, we loved the story and so did the market as the stock traded at more than 30 times forward earnings per share. We waited and watched until late 2010 when for whatever reason--such as concerns about European sovereign debt or pursuit of higher-growth emerging-markets stocks--the market forgot about the company, and we were able to buy shares at roughly 15 times trailing earnings per share. Sartorius Stedim Biotech is one of our largest weights today.


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