Gloom or Boom? Two Wildly Different Perspectives on Equity

Daniel Needham:

Great to see everybody, or maybe through the lights. It looks like there's people here. Welcome to the panel here today. So, we've got really two great panelists, and we're going to be discussing the investment opportunity set out there and really focusing in on valuation. And so, the two panelists today, obviously, Rob here and Cathy joining us via virtual link, and both are very experienced in managing equity-based strategies that are widely available through exchange-traded funds, which advisors and investors can use. But it's fair to say that they take a very different approach to managing money and identifying opportunities.

But from my perspective, if I could have summarized the investment approaches, I would say Rob is a diversified contrarian, value-oriented manager, and Cathy is a concentrated disruptive, technology-focused, growth-oriented investor. And so, I think it's fair to say that both are trying to beat a market-cap index. They're trying to identify companies that they think are going to do better than the market over the long term, but they go about that in a very different way, and I'm hoping that we're going to be able to tease that out today with Rob and Cathy. And they've both got very strong opinions on their investment approach. And hopefully, we'll be able to really dig in.

You made a very strong case for electric vehicles. You mentioned Toyota as an example, and obviously, they're the largest auto manufacturer in the world. So, why will Tesla be the one that benefits from that? Why won't the more traditional autos or the many other electric vehicle manufacturers capture that trend?

Catherine Wood:

Yes. The traditional auto manufacturers have to make a major leap. The vast majority of their sales today are gas-powered vehicles. They need to transition to electric. Tesla has already started electric and has four major barriers to entry--has created four major barriers to entry. One: battery costs. It built its cars on cylindrical batteries. Most other auto manufacturers have based their cars on lithium-ion pouch batteries, and the costs of lithium-ion pouch are much higher today--I think roughly 15%, 20% than the cylindrical batteries that Tesla uses. Tesla is riding down the cost curve of the consumer electronics industry; most other auto manufacturers are not. So, its battery costs will be lower for as far as we can see.

The second barrier to entry is the artificial-intelligence chip that Tesla designed. Now, Tesla is taking a leaf from Apple's book. As you will remember, Apple created the concept of a smartphone. It believed that we would have a computer in our pocket. Nokia, Motorola, and Ericsson did not believe that. They did not design their own chips, and you know where they are today. Apple is dominating the profits in the smartphone market.

The other barrier to entry is the number of real-world miles driven that Tesla has collected. It has more than a million robots out there collecting data and sending it back every day. My car is one of them. And therefore, it is able to discern corner cases and design its full self-driving system to incorporate these corner cases in a way that other auto manufacturers cannot. They don't have chips, and they are collecting millions, not billions and billions of miles with their pilot tests.

And then, the fourth barrier to entry, and it surprised me this one lasted as long--but I guess the dealer system was the reason--Tesla is still the only car doing over-the-air software updates to improve performance and prevent breakdowns. Since September of 2018, I have not had to take my car in for any reason except a nail in the tire. The tire went flat. Well, software is not going to solve that problem. But those four barriers to entry we believe have put Tesla ahead, and we think the distance actually is increasing.

Needham:

Rob, you've got some opinions on electric vehicles and also Tesla.

Rob Arnott:

I certainly do. We wrote a paper earlier this year called the "Big Market Delusion," which looked at industries that are up and coming that are disruptive. And kudos to Cathy on looking for disruptors. They're very, very important. But disruptors get disrupted. I'll come back to that in a minute. The thing that we found very interesting is you find these cases in the Internet bubble, in the supercomputer bubble in the early 80s, the list goes on and on, where every company in the industry is priced at lofty multiples as if they are all going to succeed, and yet they are competing against one another. So, there will be winners and losers, and the market is pricing things as if they are all going to be winners.

I mentioned disruptors get disrupted. Palm was spun off from 3Com back in the year 2000 at an initial value that was more than 3Com was valued at before the spin-off, and within a day or two was worth more than General Motors. Palm was disrupted. BlackBerry came along with a better product. BlackBerry was disrupted. Apple came along with a better product. And so, what we find is, again and again, disruptors are massively important to the economy and to economic growth. But you have to look at: A, how disruptive are they; B, how much of a premium are you paying for that disruption; and C, are they vulnerable to being disrupted themselves?

When we looked at the electric vehicle market--and incidentally, electric vehicles with very few exceptions have come down sharply since we published that report--when you look at the electric vehicles market, you find that as of the end of 2020, Tesla, which I think at the time was about 25 times sales--Cathy can confirm or correct that--but about 25 times sales. Out of eight specialists in electric cars worldwide, it was the second cheapest. The highest multiple was well over 10,000 times sales because it was a company that had aggregate sales from the previous year that was measured in three digits. I don't mean three digits of production; I mean three digits in dollars.

Needham:

So, from that perspective, we can say that you think the valuations are stretched within the EV space?

Arnott:

Yeah. Cathy and I have both been around the industry for a long time. And we saw in the Internet bubble that there were countless disruptors, and they were radically reshaping the way we communicate, the way we transact, the way we interact with our clients. And thank goodness for that Internet revolution because when COVID came along, all of those innovations turned out to be massively important to all of us. But the market got ahead of what was likely to happen. Briefly, Cisco was the largest market-cap stock on the planet. Since that time, for 21 years, they've had 12% annual earnings growth, 13% annual sales growth, and their share price is lower than it was at the peak in 2000, with double-digit growth for 21 years. So, the market was expecting stupendous growth. It got impressive growth, but it was priced to reflect expectations of stupendous growth.

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