The Zen Innovation Investor Volume 5

The purpose of this weekly is to share thoughts about industries and companies that fit into powerful long-term investment themes. It is also a place to share insights into decision making, takeaways from the past week, and random thoughts that arise.

This week:

  • 990s Lessons Part II – Prosperity with High-Interest Rates
  • Mistake Minimization: Red Flags in Company Behavior
  • AI and Google’s Leap in the LLM Race: Infrastructure as the Potential Winner

1990s Lessons Part II – Prosperity and 5+% Interest Rates…? Yes.

Describing the prosperity of the 1990s tech era to those who weren’t there is challenging. It began with PCs and software, like Windows, then evolved with networking giants such as Cisco and Novell. Netscape’s IPO was pivotal, leading to the dot-com boom.

Reflecting on this, several points stand out:

  • It was a period of significant economic growth, particularly in the technology sector.

10-year T-bill rates were higher than today, beginning each year as follows:

(Source: Visual Capitalist, Macrotrends, Y Charts)

This illustrates that economic prosperity can coincide with higher interest rates. Higher rates make capital allocation more challenging, encouraging prudent investments over speculative ones seen in the pandemic period, where rates were close to zero and high levels of risk taking was the norm.

In this period that we are entering, the Data / AI Era, it is a period that sets up very well to be prosperous, just like the 1990s. Taking a step back, it is important to note that AI sits on top of existing infrastructure. As a result, it has the potential to be very prosperous at a more rapid pace than prior periods, which were marked by the need to establish new infrastructure and processes.

The pieces are in place for advances and high levels of spending right from the very beginning of this era:

  • There is a strong infrastructure foundation for this innovation to run on top – improving the way things are done.
  • There is a lot of data and content resident inside corporations and on the internet that could yield insights, but to date has not been properly analyzed or even used at all.
  • The industry leaders have cash rich balance sheets and are ready to spend like crazy in order to try and establish a lead in ths era.

One thing to note is that right now, it appears as though we do not have enough computing power to handle the pace of change and the demands for functionality of AI models. I get into this a little later in this piece (sse below).

So, the bottom line is that the backdrop sets up very well for a period of prosperity, even with higher interest rates. This was the case in the 1990s, and the pieces are in place to see a similar period despite higher interest rates. Also, even though rates are higher right now than they were the last several years, they are still below the 1990s!

Mistake Minimization: Avoid These Company Behaviors

Growth oriented companies invest their resources to evolve their businesses in a rapdily changing world. When successful companies make changes to their model, it is important to keep a close eye on the company and its management team. This is one of the hardest parts of the job as an investor, trying to decide if a once great company will remain great or will they make mistakes that cannot be reversed. Where many investors earn their stripes is in the early identification of these changes for the worse.

Great investors consistently make fewer mistakes, a principle I like to call “Mistake Minimization.” This involves avoiding companies with significant changes in management behavior. If they get off track, do they get it back on track? This can be tough to identify, so how does one do it?

Jim Collins’ “How the Mighty Fall” outlines five stages of company decline, with the first two being key for long-term investors:

1. Hubris Born of Success: Losing sight of success factors.
2. Undisciplined Pursuit of More: Unsustainable growth or expansion. 3. Denial of Risk and Peril.
4. Grasping for Salvation.
5. Capitulation to Irrelevance or Death.

For more on this, visit Jim’s website, which can be found here Jim Collins – Books – How the Mighty Fall.

Companies that are in growth mode are most susceptible to points one and two, that is where they can get off track. As an investor in growth oriented companies, I focus on new business lines, acquisition relevance, headcount changes, and

realistic future predictions in my ongoing observation of companies. Noticing these early signs of decline is crucial.

No matter how one looks at it, these signs can be hard to detect, especially for busy investors that have a thousand things pulling at their time. But, avoiding these before they become a problem can be more valuable to great long-term returns than finding the next big winner.

I have a theory that the very best investors are better at noticing these types of issues when they are in the early stages. They are just more adept at noticing things, perhaps they are more present when they are evaluating information, or they have better instincts. Whatever it is, they just do it better than others.

AI, Google’s Gemini: Infrastructure as the Potential Winner

Google’s newly announced LLM, Gemini, reportedly outperforms Chat GPT. This is another example of a large industry player who is spending large sums of money to try and gain competitive advantage in this next era of innovation.

While the LLM leader is uncertain, companies involved in computing infrastructure, essential for AI advancements, stand to benefit I believe. This mirrors lessons from the 1990s PC Era as well as the buildout of cloud infrastructure that has been happening for the last decade. In both of those eras, companies that were key players in the infrastructure buildout posted significant growth and increase in shareholder value.

The leaders in the semiconductor industry that have advanced technology and stable business models stand to benefit as much as anyone, even Big Tech. Specifically, one area that has shown early propserity has been semiconductors that power AI systems. Nvidia, the leader in GPUs, has been at the forefront of the innovation to date, and many others are racing to get to market. Right now, judging from the blowout results from Nvidia this past year, we need more computing power to handle the AI models.

This need for computing power and mobile hardware solutions will drive innovation, positioning the semiconductor industry for growth. It may not positively impact all players in the industry, as some do not participate in the innovation of this kind of computing power. I do believe that it will present opportunities for players that have solutions that directly cater to AI systems, as

well as those that support the inevitable buildout of a broader set of solutions to keep up with AI growth.

Companies like Nvidia, AMD, KLA, ARM Holdings, and TSMC, alongside design software vendors like Cadence and Synopsys, are well-placed to capitalize on this demand in the coming years. I will have a longer piece on this soon, and will share it when completed.

Note to readers: Arrowside Capital has positions in Nvidia, AMD, Monolithic Power, ARM, KLA Corp, TSMC, Cadence, and Synopsys.

My story

I am an investor and entrepreneur, having started two investment companies. I am the Founder and CIO of Arrowside Capital, based in Boston. I have more than 30 years of experience in the investment business, investing in mostly small and mid- sized companies, all geared toward innovation and growth. The blog is named The Zen Innovation Investor because I believe it is so important to remain calm and focused during the rapid pace of change in the world today. I am keeping a view of the long term while also keeping abreast of developments in the world of innovative companies. I view this as a place to sharpen my thinking and provide some insights that are thought provoking.


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