One of the earliest lessons that many of us have learned since
starting investing is to invest in Innovation, to seek out the
most Innovative companies in the market and Center, our
portfolios around those companies.
After all, some of the most Innovative companies throughout
history have been pretty impressive companies.
We have ones like apple and Tesla.
Highly Innovative companies making new products pushing the
world in a New Direction and they attract investors
attention. Not only that but they've also
had very good. Good returns.
This leads a lot of us to look for companies that are highly
highly Innovative but the truth is a little bit different when
it comes to investing. Innovation, doesn't matter.
That's a harsh reality, Innovation doesn't matter.
I say that with a caveat it does matter in some instances but not
in the way that you may think. And that's what we're gonna be
discussing in this episode of the Joseph Carlton show when
Innovation matters. And when it doesn't, now I first
want to dress this Charles claimed the Innovation doesn't
matter a lot of you might think that that's a provocative
statement and that I can't possibly believe that's true.
Well, for the most part, I believe that, that's mostly
true. A lot of people cite examples of
Highly, Innovative companies have had good returns like
Tesla, for example, highly Innovative.
And if you invested in it 10 years ago, you've done really
well. But there's a lot of other
companies that I could cite as counter-examples companies that
I consider not Innovative at all.
All Costco. Being one of them Costco for the
past 20 years, has not made any significant Innovations, they've
done minor improvements, they've improved their Logistics,
they've gotten better at opening up new warehouses.
There's some things that you can call subtle Innovations but
Costco hasn't done anything, groundbreaking anything
disruptive and looking at Costco over the past 20 years, it has
been one of the best investments rising up since its all-time in
1986. 447 percent. It's pretty good returns for
company that largely doesn't do much Innovation Costco keeps its
business model. The same.
That's what they're known for having consistency being the
same. They do the same old principles
year after year after year treating employees well paying
them. Well treating customers.
Well having a great return policy and offering Shoppers a
great experience that's all they're doing.
In fact Costco keeps things so much the same that they haven't
raised the price on their hot dog drink combo for.
The years, the company Remains the Same all the time but it's
been one of the best investments and this is true throughout a
lot of different companies. I can name a few different ones
off the top of my head, Texas Roadhouse is another example.
What does this company really innovated over the past 20
years? If you ask the company they'd
say not much not much as change they offer good value, good
portions and good service, that's what they're known for
good value, good portions and good service.
That's the same thing that they've done for the past 20
years. We look at this company and even
over the past 10 years. If you include dividends it's
out performed Google since 2004 is given eight hundred and
forty-three percent. Not including dividends this
company has crushed the market, crutch the queue and it's done.
So without much Innovation, there are so many companies that
haven't done any substantial Innovations at all over the past
decade and they're doing and credibly, well as stocks.
So the first piece of evidence is very clear if Innovation were
a requirement for great returns. Then why are there so many
companies that aren't really Innovative?
That have such good returns. It shows it Innovation is not a
requirement for great returns and if investors narrow their
search to only Innovative companies, they're going to miss
out on potentially a lot of great Investments.
Now, moving on to the second piece of evidence here, not only
our companies not required to be Innovative to be good
Investments, but in many cases, highly Innovative companies are
terrible Investments. Let me give you a couple
examples. One of the best Innovations.
It's happened over the past 100 years, is the innovation of
commercial airline travel. Think about that for a moment,
think of a world where we don't have commercial airline travel
where we have to travel by train car or boat to get to one
continent to another may take weeks for everyone to be able to
travel easily by air is a massive Innovation being able to
go from one part of planet Earth to another part in a matter of
hours is a massive Innovation yet these Open.
He's that offer this product commercialized at Mass scale are
not good Investments. So one of the most highly
Innovative things that's happened over the past 100
years, which is commercial airline.
Travel is one of the worst Investments.
We look at an example here, like a Delta Air Lines.
We can look at the all-time returns of this company. 62% 62
percent returns since 2007, with a ton of volatility as well.
And then more importantly, when we go down to the actual
financial ratios of Company, they are terrible.
Let's look at the Returns on Capital employed.
It has terrible financial ratios, terrible.
Gross, margins, terrible, operating margins, terrible
profit margins are lines are terrible Investments and I'm not
nitpicking, one particular Airline here we can search any
of them. JetBlue, for example, this is
another one supposed to be even more Innovative than Delta
Airlines. We look at this investment and
it's down 47%. All time since 2002 Airlines.
Cross the border awful Investments, even though they
offer consumers, one of the best Innovations of all of humankind
and this isn't exclusive to just the airline industry this
follows with a lot of different companies.
For example, we can look at Spotify Spotify so far has
proven to be not the greatest investment, it's up a little bit
year-to-date but looking at the grand scheme of things.
Since 2018, it's down to percent.
So it hasn't really given investors any real returns since
IPO the company has been around. 17 plus years.
So Spotify is an older company that's never really produced a
lot of profits. Most of the cash flows that it
produces are eaten up by stock-based compensation.
This is a company that's not very profitable and it runs into
the very same problems that the airline industry does.
The operating margins are very low, the profit margins on.
The company are very low and that's perplexing because
Spotify is an Innovative company.
Look what they've done with their app.
It's incredible. The algorithms and the mixes
they put together all of the different Different features and
the user interface, nobody can claim that Spotify.
Doesn't innovate this company innovates all the time.
They're always layering upon new features.
Changing things, improving things, improving their
Discovery algorithm. Unfortunately, for Spotify, all
of their Innovation is work on behalf of a different company,
which is universal music group. So, Spotify finds new customers
they innovate, they do lots of different things to grow their
customer base. And then after Spotify, does all
of that hard work to create this great.
User interface and experience for customers Universal music,
group, and other labels are the ones that get the reward.
They're the ones that economically benefit from the
relationship, they own the music.
So, everything spotify's doing benefits them and what has
Universal Music Group done? In terms of innovation over the
past 10 years, can you name anything a single Innovation?
That Universal music group and these other companies have done
it stuff you might be able to name one but they're not nearly
as Innovative as Spotify. Bye.
But they're the ones that have so far benefited the most, and
that's the secret here. That should be the takeaway.
It doesn't matter whether or not a company innovates.
It matters whether or not they can keep the economics of their
Innovation, whether they can capture the economics.
In the case of Spotify, they are a highly Innovative company, but
they have not been able to capture the economics of their
Innovations. Another company captures it,
which is universal music group, and the other labels Spotify
innovates. These companies capture the
economics of their Innovations, and this is happening all the
time, put another way, an Innovative companies, only a
good investment if it can capture the economics of its own
Innovations. And the best investments, the
absolute best ones are the companies that can capture the
economics of their own Innovations, and capture the
economics of other people's Innovations.
When a company is able to do that, it is an incredible,
incredible investment. And I have an example for you,
Apple's a company. That not only captures the
economics of their own Innovations, but they capture
the economics of other companies, Innovations.
And I want to show you how they do that.
This is the product category chart and I'll blow it up here
for you. We have the Mac, we have the
services, we have the wearables, which are things like the Apple
are tagged the earpod. The Apple watch, then we have
the iPad and the iPhone, every single thing.
The Apple sells, whether it's the Apple watch or the air pods,
or the iPads, every single thing they sell, they make a fortune
on. They charge a very healthy
margin. They make a killing on it.
When they create something new, like the new are pods are the
are tags. They capture the economics of
those Innovations. No other company does other
companies might create phone cases and they might in some
ways benefit from Apple's Innovations, but Apple largely
is the one that captures the huge majority of their
Innovations. So they have that checked off
the list, but Apple does something more than capture the
economics of their own Innovations in the service.
Revenue. Apple has figured out a way to
capture the economics of other companies.
Innovations. How do they do that in the
service Revenue? Apple charges a fee for every
single company that sells in-app purchases or subscriptions in
the App Store. So, not only do they sell their
devices and make money on selling them.
But once you have the device, you have to go through the App
Store and the App Store, Apple, shaves off a profit.
And that profit is part of the service Revenue.
It's a huge part of it. So you think about the companies
that have to do business through People you have gaming companies
consider all the various Mobile gaming companies that innovate
and innovate creating new levels.
New characters, new skins, they have to hire employees.
They have to Market it, they have to try to sell it and
spread their game on social media and everywhere to sell
their game. These are Innovative companies,
creating new gaming experiences creating entirely new
developments. And while all these gaming
companies are working endlessly, creating new Innovations, Apple
benefits they shave off 15 or 30%.
They are taking the hard work from other companies
Innovations. This is such an incredible
thing. That apple is manufactured that
many companies like epic games founder.
Tim Sweeney have sued Apple because he realizes that he's
doing all of this work to create epic games in the crepe
Fortnight to create new levels and season passes.
And apple makes a bunch of money from his work, they shave it off
with their in-app purchases and season passes, Apple benefits
from all the work that Tim Sweeney does with his games and
from every other game developer that works through the Apple App
Store and it's not just Mobile gaming industry.
You can take match.com any company that has mobile dating
apps has tons of in-app purchases, all of those.
All of those contribute to Apple.
So, as match is innovating and creating new mobile dating apps,
and experiences, and algorithms to match people, they're working
hard with thousands, even millions of employees.
They're benefiting Apple in the process.
Apple benefits both ways and that's part of the reason this
company has been such an incredible investment.
Now, you might be sitting there saying that Joseph this Seems
unfair. In fact, it seems ridiculously
unfair. Why should Apple this massive
company be able to benefit so much from all the hard work and
innovations that other companies do.
And to that, I say that you're right.
It is unfair, in many cases, business relationships are not
completely fair, I would say that the case of Spotify doing
all of this work. So the labels can benefit is
also unfair. It's not a representation of
which company is really providing the most value, but
that's how the world works. And Is not about determining
what's fair and unfair. It's about determining.
What companies, a good investment which one makes money
which one is found out how to capture the economics of their
own Innovations, and the economics of other people's
Innovations, in the case of Apple.
They've done both, they've mastered this craft of capturing
economics. So to put this more thoroughly
innovation in, and of itself, doesn't matter.
But being able to capture the economics of a given, Innovation
matters a lot. So investors would Be better
served to instead of focus on finding companies that are
highly Innovative focus on finding companies that are the
best positioned to benefit economically from a given
Innovation. And in many cases, they're not
the same company. I'll give you an example of what
I'm looking at. Right now, we know that there is
chat GPT and it's highly Innovative.
It's being invented by Microsoft and Google and these different
companies, the large language models and the Machine learning
behind it. This is incredible attracts.
A lot of eyes and To Google and Microsoft but there's other
industries that are going to benefit from this Innovation
immensely. Maybe even disproportionately
high compared to Microsoft and Google alone.
This might not be the first thing that comes to mind when
you look at what's going to benefit from artificial
intelligence, but consider it for a minute.
Now, I believe that quick service restaurants, fast food
places are uniquely positioned to benefit disproportionately
from the Innovations in Ai. And I think it's going to come
down to the amount of employees that they can replace with.
Nai engines software Engineers with Windy's have been working
with the search giant Google to tweak its large language model
for key words and phrases specific to the menu or during
the company's milkshakes are known as Frosty's for example
but some customers might refer to them as milkshakes.
Other Wendy's sling includes biggie bag is also being
integrated into the chat Bots vocabulary.
So here we have wind, he's working with Google and the AI
chatbot that they created to integrate this into the menu.
Drink where it can versus back and forth with you.
It has to be trained specifically, with some of the
sling at Wendy's, and there's other little nuances, they have
to take into account. It talks about the fact that
there's other people talking in the car, there's background
music. There's the exhaust or loud
engines. There's indecisiveness with
people changing their minds. The bot needs to be trained for
all of that, the whole drive through ordering experience, but
I think it will happen. I really believe that AI is
going to nail this. It's going to be so good at
taking orders from fast food. And this fits in with my overall
thesis of fast food restaurants that they're basically vending
machines for hot meals. That's all they are.
They're not there for social interaction there there for a
quick meal with the least amount of friction possible.
If Wendy's is successful in integrating this Innovation into
their business model, this could be a massive game changer for
both Windy's and the entire quick service restaurant
industry. A massive Game Changer consider
the fact that for every single Wendy's location, one single
location, they probably have to have around two to three
employees. On hand to take orders, that's
how many they have to schedule for, to take orders.
So, we take the amount of restaurants that Wendy zones, we
times that by three, and that's the amount of employees that
they could potentially reduce with this simple Innovation.
A massive employee reduction, further reducing the head count
increases the margins of the company, the margins of Wendy's
goes up, the profitability goes up.
It makes a company much more attractive to investors so this
could make it. So a low margin industry
suddenly becomes a higher margin.
Industry. So fast food restaurants.
Like Wendy's is an industry that I'm studying and looking at
right now because I think there is going to be massive
Innovations in the future. I have a watch list that I call
a quick service restaurants and it's a lot of what I think are
the best fast food restaurants. And I'm going through and trying
to figure out which one could potentially benefit the absolute
most from, if this type of AI, ordering becomes commonplace.
Because in my opinion, it's only a matter of time.
I do not think that 10 years from now, there's going to be
humans taking your orders. At McDonald's.
I think that's going to be a thing of the past.
You will be talking to robots when you order at McDonald's
already when you go in the store you order from a kiosk.
So McDonald's has fully signaled that they want AI to take your
orders. So what does it do to
McDonald's? If every single person working
the window working? The ordering is replaced by a, i
what does that do with the margins?
That's a question that I want to answer the same thing for
Chipotle, for Domino's, for Starbucks for Wendy's for
Wingstop. For Burger King for Taco Bell.
What does it do to all these companies?
So I am studying fast food right now because I do believe it's a
category of stocks that will benefit dramatically from these
Innovations. But overall, that's my thoughts
on Innovation. I hope you enjoyed this episode
and diving into these type of deeper topics.
Let me know if you like this type of video and I'll see you
in the next one.