As with any investment, your capital is at risk.
The economist Frank Knight first made the distinction between risk and uncertainty. Risk, he argued, can be measured but, as we’ve been reminded recently, uncertainty rules our world of trade wars, real wars and pandemics.
Prof Knight’s point was that entrepreneurs are rewarded for bearing the weight of the unknowable rather than taking calculated risks.
Having an edge comes from taking a different view of company potential. We aim to see value before others. That means getting comfortable with what can’t be known. If a company faces predictable risks, the market already agrees a value.
The trauma of 2022’s rising interest rate environment made Scottish Mortgage look again at whether portfolio companies are resilient enough to adapt to whatever’s thrown at them.
Our willingness to back blue-sky visions is unchanged. But we’re more aware it’s today’s business, not tomorrow’s potential, that must deal with inevitable bumps in the road.
However great the opportunity, if a company can’t overcome those, it won’t fulfil that potential.
Take Northvolt. We shared founder Peter Carlsson’s vision of a European battery champion. Our mistake was not foreseeing its vulnerability to weaker demand and operational problems, leading to bankruptcy in November 2024.
What resilience looks like in practice
Resilience is financial strength and cultural adaptability. Shopify exemplifies this. Previously running below break-even while investing in projects, it switched to keeping 20 per cent of revenue after operating costs. That cushion provides flexibility while maintaining rapid growth.
Meta took a similar approach with its ‘year of efficiency’, addressing weaker business parts and costs.
Cloudflare, previously loss-making, has steadily increased margins, helping it withstand shocks.
Companies need sufficient margins to withstand sales dips, generate cash and avoid excessive debt. But resilience extends beyond financial metrics to culture.
Companies that make their own weather
Ferrari shows how companies can make their own weather. Its brand power gives it levers to pull when demand dips.
Oddity thrives in a shrinking makeup sector by enhancing products with newly discovered molecules and using AI for personalised recommendations.
Netflix demonstrates how innovation creates flexibility. It has pricing options and can vary the rate at which it commissions new content.
China’s delivery giant Meituan exemplifies another kind of resilience. When rivals attacked its markets, analysts reduced ratings as growth and margins were hit. But fighting off competition proved business model strength. Its recovery demonstrates how investors can outperform by recognising that resilience is worth more than others think.
I realise that this emphasis could be read as Scottish Mortgage becoming timid. Not so. We’re still searching great businesses whose future is uncertain but which can be wildly more successful than anybody else believes.
But companies that hurt our performance were those whose vulnerability ended their chance of fulfilling potential. When the next crisis comes, we want to hold fewer such companies.
Amid turbulence, focus on what you can predict
There’s been no shortage of tough environments since I started investing in 2000. But you don’t survive for a quarter of a century without a degree of detachment and, yes, resilience.
However you prepare, things come out of left field you can do nothing about. Which is why it’s not a career for everyone, especially when markets move in crazy ways.
There’s always something to worry about. We focus on what we can predict. When backing companies doing new things, we need them to align with themes we’re confident about. We know AI will be more capable in five years. Electric vehicle batteries will be cheaper with greater range. Cloud software will become more powerful.
Our job is refining understanding of long-run developments, knowing only the most resilient survive to thrive.
Important information
This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.
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