The Theory of Creative Destruction
By
Timothy Lutts, Chief Investment Strategist and Editor of
Cabot Stock of the Month ReportFrom Cabot Wealth Advisory 6/30/08
Sign up for free Cabot Wealth Advisory e-newsletterI paid $67 to fill the gas tank in my car last week. That's a record for me, but people with bigger gas tanks cite bigger numbers. And while I don't like paying that much for gas, while I stand there with the hose in hand and watch the numbers speed by I take comfort from two facts.
The first is that I've found I get a few more miles per gallon by inflating my tires to the high end of their recommend range. The second is the theories of Joseph Schumpeter.
Schumpeter (1883-1950) was born in Moravia—then part of Austria-Hungary but now in the Czech Republic—and was a gifted mathematician. But his love was economics, particularly as related to entrepreneurship, and he's best remembered for his socio-economic theory of creative destruction.
At the root of creative destruction, according to Schumpeter, are entrepreneurs, some laboring as individuals and some as employees of forward-looking firms, but all possessing a spirit of innovation that drives economic growth forward by improving on and "destroying" the old. And if the old is a hide-bound, monopolist entity or system that has long been a barrier to progress, so much the better.
According to Schumpeter, innovation tends to come from companies and individuals that provide any of the following:
– New markets or products
– New equipment
– New sources of labor and raw materials
– New methods of organization or management
– New methods of inventory management
– New methods of transportation
– New methods of communication
– New methods of advertising and marketing
– New financial instruments
What are destroyed by these innovations are companies and systems that have become entrenched, that are regarded as part of the status quo. The destruction is painful to those individuals who are part of the established system (look at how digital photography killed Polaroid and Kodak) but it's generally rewarding to society as a whole, because the new methods, technologies and systems provide more value at lower costs than the old.
The Slow Destruction of our Petroleum-Based EconomyToday, though it's not widely acknowledged yet, what's being destroyed is our petroleum-based economy. That it's an entrenched part of our global economy is obvious. But it's been entrenched for less than a century—oil replaced coal, remember—and it's time for something better.
That "something better" will apparently consist of a combination of solar power, wind power, biofuels, battery technologies, nuclear, hydroelectric and geothermal power ... and plain old conservation. The providers of these new technologies will thrive, while individuals, companies and institutions with stakes in the old petroleum economy will fight the transition. But progress, driven by innovation, will occur. It is unavoidable.
Perhaps the biggest beneficiaries of this change will be those people in societies that never had a stake in the oil economy. We've seen in recent decades how whole societies that never could afford the infrastructure of a wire-based telecommunications network embraced the cellular telephone. Now imagine how remote societies that couldn't afford to build a petroleum infrastructure will benefit from the technologies that slowly supplant petroleum.
As investors, our job at Cabot is to steer you toward the stocks that benefit from this long transition, and to steer you away from those that suffer from it. You may have noticed that
General Motors stock (GM) hit a 53-year low (!!) last week. It's lost 88% of its value since it peaked in early 2000, and while traders might play it for a bounce, that's a high-risk endeavor. The main trend is down; four years ago, more than 400 institutions owned GM. Since then, more than half have jumped ship.
So who's building this yet-to-be-determined future? Where are the investment winners? In recent months we've mentioned solar power stocks
First Solar (FSLR),
JA Solar (JASO) and
LDK Solar (LDK), as well as Chinese biodiesel firm
Gushan Environmental (GU) and wind-power company
American Superconductor (AMSC), to name a few. Why are these alternative energy stocks so strong? The answer, to me, is simple. An increasing number of investors, both individual and institutional, are expecting great growth of both revenues and earnings in these companies in the months and years ahead, so they're climbing on board now, in some cases buying with the proceeds of their shares of GM.
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