Disruptive Technology’s Role in Investing

Courtesy of Capital Group, Posted 23 May 2017


Emerging technologies and innovation are creating new products and business models that are disrupting the old ways, and old business. From cloud computing to a new era of breakthrough drugs, we are on the cusp of a dramatically different world. Companies that are poised to take advantage of these changes have the potential to reap new profits, and provide investors with opportunities that few could have imagined a decade ago.

Yale professor Richard N. Foster, co-author of Creative Destruction, has a warning for executives whose companies are now listed in Standard & Poor’s 500 Composite Index: Your days may be numbered. At the current churn rate, 75% of the S&P 500 will be replaced by 2027. Indeed, since 2002, such household names as Sears, The New York Times and Eastman Kodak have exited the index, while Amazon, Netflix and Chipotle have joined the list of U.S. companies with the largest market capitalization.

Companies in the S&P 500 are replaced for a variety of reasons, including decline in market value (for example, RadioShack) or acquisition by another company. But many of the changes are due to “creative destruction,” in which companies that once dominated industries have seen their profits fall and their dominance vanish as rivals employed new technologies that disrupted the old way of doing business. One perfect example: The Internet’s impact on circulation and ad revenue in the newspaper industry greatly influences the performance of traditional newspapers like The New York Times.

The information technology sector in the S&P 500 is perhaps the most dramatic example of disruption. Among those that disrupted the status quo and changed behaviour include Google, Facebook and Apple, all now household names. But things change. According to Foster, corporations in the S&P 500 in 1958 lasted in the index for 61 years, on average. Today, it stands at just 18 years based on seven-year rolling averages. During the decade ended 2011, about half of the companies in S&P 500 were replaced.

 

Sources: S&P Capital IQ; Standard & Poor’s Analysts Handbook, 1980, and Stocks in the Standard & Poor’s 500, 1982, Standard & Poor’s Corporation;

Dow Jones Newswires, 1987, Dow Jones;

Reuters.com, 2015, Thomson Reuters.

Standard & Poor’s 500 Composite IndexSM and S&P 500® are service/trademarks owned by the McGraw-Hill Companies, Inc.