Time to embrace robots?

Robotics and automation are no longer sci-fi, they are a fast-growing and profitable sector

The technology sector is evolving at breakneck speed and will only accelerate from here as unprecedented computing power is harnessed to Artificial Intelligence (AI). AI will enable robots to act autonomously, giving them the ability to learn, reason and recognise emotions, pictures, languages and maps. While advanced robots continue to revolutionise manufacturing processes, now they are set to change the way we live by assisting in daily household tasks. Within a few short years, it is likely that robots will cut your lawn, serve your meals, do your shopping and even take care of grandma. And when we need surgery, it will mostly be carried out by robot-assisted procedures. These so-called service robots are only started to be deployed, but could potentially become as important as industrial robots in the coming decade.

Just as in previous industrial and technological revolutions, huge wealth will be created. The question for investors is how to tap into this wealth.  

From sci-fi to profit

Considerable value has already been created in robotics. This value sometimes resides in large, multi-national, multi-product companies – such as Google, Facebook and IBM -  in which case the robotics opportunity might be harder to spot from an investor perspective. But, it is also found in smaller, innovative companies, which can offer a pure play route for investors to the growing industry. Opportunities also exist in the guise of familiar brands, which have refocused or reinvented themselves to become automation specialists. Take Delphi, which began life as part of General Motors and is now independent and a leading player in the fast-developing world of  autonomous and electric  vehicles.

Meanwhile Palo Alto, widely known for its next-generation firewall  software, has refocused its technology to detect and prevent advanced cyberattacks, and to enable diverse applications such as online payments, datacenters, industrial control systems and mobile phone networks to operate safely.

Then there is John Deere, the largest producer of agricultural equipment, which is reinventing its legacy products. It has already autonomous tractors in the fields, equipped with sophisticated software that measures nutrient application, works out the most efficient planting patterns, optimises fuel consumption, and so on.

These and other companies have hugely outperformed over the last decade, returning more than 200% to investors, while the MSCI World has barely moved over the same period.

Finding and valuing the next market leaders

Clearly not all companies in this nascent sector are worthy of investment. Investors may well ask whether automation and robotics are the latest incarnation of the high-tech boom of the late 1990s when some companies went on to become blockbuster brands while others are long forgotten. Much has been learnt since then, and when modelling companies it is important to be conservative when extrapolating current growth. At the same time, it should be remembered that 1990s’ predictions of topdown growth of mobile devices, online shopping and electronic payments have been exceeded many times over.

An important metric when assessing a company is market share. Companies with stagnant or falling market share can no longer be classified as fast-growing and may have peaked in terms of their ability to disrupt the market. Investors in Nokia will be acutely aware of this and there is currently much debate whether some social media and technology market leading brands can maintain their exalted positions.

Not just US-centered: Asia and Europe are also leading the way in robotics

There are a large and growing number of stable, publicly-listed companies with market capitalisations of at least $250m. Investing in these companies lowers portfolio volatility compared with taking stakes in smaller companies or start-ups.

While companies specialising in automation exist across the globe, Asia and Europe punch above their weight. In particular, South Korea, Japan and Germany are far ahead in the use of industrial robots. Japan has long excelled in this area, partly because as a way to support its huge manufacturing base, but in more recent times it has looked to robots to support its rapidly-ageing population. There are fewer companies specialising in automation in China, mainly because labour has been so cheap in the past. But as China’s demographics shift and wages rise, it too is likely to join the automation revolution.

Is there still juice in the strategy?

After a decade of outperformance, it is reasonable to ask whether returns are sustainable going forward. At the moment, valuations appear reasonable, with average price-earnings ratios at about 20. This is higher than the S&P, which contains very mature companies, but is considerably lower than for companies during the high-tech boom, when price-earnings ratios for some stocks soared above 200. Moreover, many of the considered companies have already a proven track record and have been profitable for several years in a row.

So the fundamentals appear sound. At a thematic level, the trend towards automation is only just beginning and it is hard to imagine that well-selected companies will not deliver strong topline and bottom line growth over the longer term. The industry, we think, is entering a sweetspot where a number of radical technologies are moving from the design phase to full implementation – autonomous vehicles, personal service machines and robots operating alongside humans in the workplace.

Of course, any investor in this strategy needs to have a strong buy and sell discipline. Decisions about whether to buy or sell shares in this sector, should be based on a rigorous fundamental analysis, rather than on sentiment.

It is important to minimise timing decisions and to invest according to durable trends. It is helpful to have a mix of technology and financial skills to do this, as well as experience of combining larger companies and smaller, niche companies within the same portfolio.

Conclusion – time to join the “fourth revolution”

Gaining exposure to the secular growth theme of robotics and automation is not a bet on a sci-fi future. Value and wealth has been created for years and this is likely to accelerate and become more mainstream in the coming years as the “fourth industrial revolution” becomes a significant driver of the global economy.

Although the strategy is a satellite rather than a core exposure for most investors, perceptions may change as robots come to operate in the majority of households and the sector is regarded as mainstream.

Like many exciting, emerging sectors, this one can experience short-term volatility, but the ongoing development of revolutionary products that positively alter the future should ensure that longer-term gains are substantial.