NCM Core Global - Fifth Anniversary

February 19, 2021

As I reflect over the last five years, I think about the evolving dynamics of the stock market. So much has changed but some things haven’t changed at all. As the saying goes, “the more things change, the more they stay the same”.

If there is one thing that has not changed, it would be speculation. Looking back in history there have always been periods of exuberance. Although the assets in which the bubbles are formed tend to change over time, bubbles appear to be a recurring phenomenon. In the 1970’s we had the Nifty Fifty, and in the 1980s there was the bubble in Japan’s real estate market and its stock market. In the 1990s we had the Tech Bubble and in the 2000s there was a bubble in U.S. housing. Fast forward to today and we can observe speculation in many different areas of the market including cannabis, Bitcoin, Tesla, non-profitable Tech companies…and let’s not forget what happened with GameStop! Suffice to say, there is no shortage of speculation in today’s stock market.

In terms of what has changed, I have observed a significant acceleration in disruption throughout the economy and the stock market. Disrupters have gained increasing amounts of attention as companies across various industries are being disrupted at an ever-increasing rate. According to Innosight’s article, ‘Creative Destruction is Accelerating’, the average tenure of an S&P 500 company declined from 33 years in 1964 to 24 years in 2016 and is forecasted to shrink to 12 years by 2027. According to the article, half of all public companies could disappear in the next 10 years. Although disruption is accelerating, it isn’t a new phenomenon for the stock market. It has always been about survival of the fittest. Numerous studies have shown that a small number of companies have generated the lion’s share of stock market returns over the long-term. A study conducted by Arizona State University analyzed stock market returns from 1926 to 2017. When stated in terms of lifetime dollar wealth creation, the best-performing 4% of listed companies explained the net gain for the entire U.S. stock market while the other 96% of stocks collectively matched the return of U.S. Treasury bills. The key takeaway from the study is that long-term stock market returns are highly concentrated in relatively few stocks. When our team conducts its research, we do our best to identify these stock market ‘winners’. We refer to these winners as quality compounders. Once we identify these compounders, we buy them for the portfolio but only if we can purchase them at reasonable valuations. These types of companies can typically compound in value for long periods and generate handsome returns for our unitholders. Microsoft is a good example of a quality compounder and it remains one of the largest holdings in NCM Core Global.

Back to the discussion about disruption. The global economy operates as a large ecosystem and it is always in a state of change. This has major implications for the companies that operate within this ecosystem. The companies that can adapt to change are rewarded while those that cannot adapt suffer the consequences. The concept of Social Darwinism can be applied to the global economy and the stock market. The basic premise of Social Darwinism is that the strong see their wealth and power increase while the weak see their wealth and power decrease. This is basically what determines the winners and losers in the stock market over the long-term and it has a significant impact on our investment process. When we search for investment ideas, we are looking for businesses that have a competitive advantage or a protective moat around the business as Warren Buffet likes to say. What we are looking for is companies that operate in businesses with high barriers to entry. This makes it difficult for new competitors to enter the market and typically enables the incumbents to earn above-average returns on invested capital for extended periods. Competitive advantages can take many forms including being a low-cost provider, having economies of scale, or benefitting from a network effect.

Companies that benefit from a network effect can be especially powerful. The simplified definition of network effect is that it occurs when a company’s product or service becomes more valuable as usage increases. Visa is a great example of how the network effect creates powerful competitive advantages for companies in the electronic payments industry. The more consumers that are plugged into a payment network, the more attractive that payment network becomes for merchants, which in turn makes the network more convenient for consumers. This explains why a handful of networks including Visa and Mastercard have come to dominate electronic payments. At this point, Visa has essentially reached universal acceptance across most developed markets. The highly scalable nature of payment processing leads to sizable cost advantages for the large incumbent payment networks, which in turn further solidifies their competitive positions. Visa is a large holding in NCM Core Global.

This leads to a discussion about the rise of the platform company. A platform is a business model that facilitates interactions and the exchange of value between producers and consumers of something that is not produced by the platform itself. Rather than creating value by making and selling things, platforms provide a mechanism for exchange. Given this phenomenon, platform companies are not capital intensive nor are they labour intensive. As a result, platform companies can become highly profitable once they reach critical mass. Platforms can also benefit from network effects. Greater scale leads to greater value for users, which in turn attracts other users and further increases scale. This self-reinforcing mechanism allows networks to scale rapidly once network effects set in. Alphabet is a good example of a platform company that also benefits from network effects through its Google search engine and YouTube video-sharing platform. Alphabet is held in NCM Core Global and it remains one of our larger holdings.

As I look ahead to the next five years, I believe that disruption will continue to play a critical role in the global economy and the stock market. Our investment team will continue to focus our research efforts on companies that can adapt to the rapidly evolving global economy. We will do our best to uncover the platform companies of tomorrow. Most importantly, we will remain disciplined and only buy these types of companies when we can do so at a reasonable price.

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Phil D’IorioPortfolio Manager, U.S Equity - Cumberland Investment Counsel Inc. Affiliate of NCM Asset Management

Phil D’Iorio is a Portfolio Manager in U.S. equities and is the Lead Manager of the NCM Core Global and NCM Core American. Phil is a CFA charterholder and holds a Bachelor of Commerce degree from Western University and an…

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