One of the most challenging parts of investing is analyzing which companies will perform the best in individual sectors over the long term. Unfortunately, it is almost impossible to predict today the companies that will succeed in any particular hot new growth sector over the next 20 years. When it comes to tech, there will typically be just a few long-term stocks that will survive the initial bubble bursting, while the rest will never recover from the hype and crash.
The constant of change
The business world is constantly changing and developing, and companies must try and stay on top to maintain their market positions. This is much harder than it appears. Staying on top requires lots of capital spending and, to a certain degree, luck. There is no telling if another business will be able to come along and develop a technology the former incumbents have not yet discovered.
This is the issue the automotive industry has been grappling with for the past decade. Electric vehicles have taken the automotive industry by storm, and a whole range of new businesses have emerged to try and capitalize on the growing demand for electric vehicles. This change has left legacy companies in the dust after they once scorned EVs as fantasy.
Companies like General Motors (GM, Financial) have had to rush to develop new models to meet the EV threat head on. While the legacy businesses are in a better position to take on the new challengers with their global footprints, international distribution networks and manufacturing experience, they have a lot of catching up to do in this fast-paced market in terms of technological innovations.
Now, I am not going to speculate on which electric vehicle manufacturers will be able to ride to the top of the industry over the next decade. Instead, I want to use the current state of the industry as a case study to investors showing just how difficult it is to try and pick winners in any emerging sector or industry.
Year-to-date, some of the most promising electric vehicle startups have seen their valuations plunge. Tesla (TSLA, Financial) is down around 44%, while its newer peers, NIO (NIO, Financial), Rivian (RIVN, Financial) and Lucid (LCID, Financial), have lost as much as 70% of their value in the space of the last nine-and-a-half months.
This performance is not reflective of the broader electric vehicle market. Global e-commerce electric vehicle sales now make up around 11% of the market after increasing 60% in August alone. The market for electric vehicles is booming, suggesting sales and profits at the sector's most important constituents should be benefiting from this tailwind.
Clearly, the EV stock bubble has burst even as the industry itself is kicking into high gear.
Lessons from the EV bubble
First of all, it is becoming increasingly clear that many high-profile technology companies, and companies that appeared to be at the cutting edge of the renewable energy revolution last year, have quickly fallen out of favor with investors in 2022. As the investment environment has changed, the market has lost its love of these high-profile growth stocks and is unwilling to fund their growing losses.
That is one of the reasons why these stocks have been struggling in 2022. Another reason is the fact that incumbent automotive giants have started to catch up with EV-only startups. Tesla remains the world's most prominent electric vehicle manufacturer, but incumbents such as Volkswagen (XTER:VOW3, Financial), Ford (F, Financial) and General Motors are rapidly catching up.
And when I say rapidly, I do mean rapidly. In the past couple of years, these companies have gone from being behind the curve to having some of the best-selling electric vehicles in the world. As it turns out, the disruptors in this particular industry didn't have as much of a moat as many investors originally thought.
Competitive factors
The key lesson here is the importance of understanding competitive factors in the market. The automotive market has always been highly competitive, and it will always remain so. For most individuals, a car is a commodity where price and usability matter more than anything else. Most car buyers do not care whether or not they are acquiring a Tesla or a Volkswagen as long as it meets their needs.
Warren Buffett (Trades, Portfolio) tried to highlight the competitive nature of the automotive industry at the 2021 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual shareholder meeting.
The Oracle of Omaha pointed out that in the early 1900s, the future for the automotive industry in the United States seemed bright. Over time, 2,000 companies entered the business, but only three major players have survived. Picking out those three companies in the 1900s that have survived to this day would have been virtually impossible.
Investors face exactly the same challenge today. Trying to pick the companies in the electric vehicle space that will grow and prosper over the next couple of decades is almost impossible.
As we have seen with the history of the automotive industry, most of these businesses will struggle and will not be great investments. The companies that turn out to be the best investments may not even be alive today. These are the cutting-edge leaders in their space, and they will make mistakes. There's always going to be room for a late starter to come in and grab market share where they have gone wrong.
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