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New economy drive

When the tech bubble burst in March, one thing was clear – investing in just any TMT stock or the latest dotcom idea was not a wise way to invest in the long term. TMT stocks turned out to be no different to anything else. Just because a company had .com or .co.uk after its name did not mean the business would be a success.

Technology continues to change fundamentally the world we live in and the way business is done. We work in an environment where the way a company uses its people and resources can directly determine how profitable it is.

What is the best way to make use of your people and information? Use technology properly. This contrasts with the traditional view that machines and buildings, also known as physical capital, are what create value in a successful company. This fundamental change is vital and what we believe is the basis for the new economy.

But what does this mean in the real world? Traditionally, companies have made big profits by using physical assets such as heavy machinery or by producing and selling goods more efficiently than the competition. But in the new economy, profits are created by manipulating information – ideas, designs and brands.

An example is ARM Holdings. It designs components that other companies use when they build computer chips. You will find ARM designs in mobile phones, digital cameras and cars. Every time a product with an ARM design is sold, the company gets royalties.

However, the new economy does not just include computer software firms, mobile phone manufacturers or other technology. Many businesses are benefiting from the exploitation of new technologies to service their customers better and grow their businesses.

Charles Schwab has successfully used new technology to transform itself into a market leader. It saw the benefit of the internet early and has become the leading online retail broker in the world. But simply developing a website has only been part of the story.

It has retained a high-quality level of service offering a broad product range with a powerful brand. Schwab is adding 400,000 new custom-ers every quarter and, unlike many other online businesses, it is improving its margins and returns.

Unlike factories and buildings, in the new economy, the important assets – people and computers – are cheaper and more flexible. What they produce can be copied and distributed at almost no cost.

This means companies which move fast and increase profits rapidly are changing the business environment. It is increasingly becoming a game of winner takes all but, of course, not everyone can be a winner.

Companies in all industries are being forced to invest in technology to stay competitive. Those which do it reactively by following the leaders are running hard to stay in place. Those which do not do it at all may find their market has been swept out from under them. The question for an investment manager is how do you pick a good new economy company?

Picking winners is not new in the investment business but some of the rules that apply in the new economy are. Because of this, a good investment manager should have evolved its investment process to cope with the demands of the new economy.

As well as the increased importance on evaluating a company&#39s competitive advantages, barriers to entry and return on investment, there are a number of other points that should be considered:

l New approaches to evaluating companies. Many new economy companies will not be profitable for a few years so conventional measures of valuation simply do not apply. You have to look further into the future for cashflow in order to work out stock values in the present and be aware that forecasting so far into the unknown is rarely accurate.

l We have to pay more att-ention to business models. It is becoming increasingly clear that a good tech idea is not necessarily a profitable one.

l Keeping up with industry trends means you have to stay in closer contact with companies&#39 management, customers and suppliers. Many of the same old rules apply. Can computer chip manufacturers keep up with demand? If not, then what are going to be the effects both upstream and downstream?

l Do not miss the wood for the trees. While it is easy to get bogged down in the detail of different technological developments, you must focus on how the developments may affect mass markets and where value is being created and kept.

l What about risk? No matter what the economic environment, picking stocks is only part of a fund manager&#39s job – portfolio construction is equally important. Fundamental to this is how a fund manager manages risk.

In many cases, new economy companies are not designed to make profits in the short term. The further away those profits are, the more risky the investment. In constructing portfolios, fund managers have to take this into consideration and monitor exposure to different technologies, sectors, and macro-economic factors.

What does the new economy offer? In many ways, you can think of the new economy as a more sensible opportunity for investing in technology. You do not just invest in technology for technology&#39s sake but only when it imp-roves how a company works or allows a new opportunity to be developed.

The potential is huge. Many of today&#39s existing applications have not been used to their full potential and many new technologies are still on the drawing board. Internet-based services will soon be able to rec- ognise your voice.

Internet use is only in its infancy. When the cost of accessing the internet falls, the number of people using it will increase dramatically.

The stockmarket today does not fully recognise the opportunities presented by the new economy. We believe today&#39s technology is only the start. The biggest gains are yet to come.

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