Think in Terms of Societal Themes Rather Than Sectors When Building a Portfolio

Several Real Money contributors and I recently participated in a Real Talk Re-opening Webinar in which we discussed the rising vaccination rate in the U.S., and the easing of restrictions, with an eye toward what it means for the economy and certain stocks. Spinning out of that webinar were a number of subscriber questions, one of which was, What is a good theme to invest in for the next 2-3 years? As regular Real Money readers probably know, after spending more than a dozen years in Wall Street equity research departments covering machinery capital goods, homebuilders and building products and the mobile phone business, I found myself realizing the shortcomings and pitfalls of sector investing. Years later and even after S&P jiggered its Global Industry Classification Standard (GICS) to 11 sectors, I still think that framework is left wanting. For example, Amazon.com is classified as a Consumer Discretionary company even though much of its profit and earnings power is generated from Amazon Web Services. Walt Disney Co. falls into the Communications Services sector, which also includes AT&T and Verizon , even though pre-pandemic its Parks, Experiences & Consumer Products segment generated a significant slice of its operating profits. Cybersecurity companies such as Fortinet and BlackBerry land in Information Technology, a sector that also contains IBM , Accenture and Oracle . I would argue these 11 catch-all categories don't properly reflect the respective business drivers of the companies I just rattled off nor do they do the same for dozens of others. If you're suspecting that I think sector investing is outdated and outmoded, you would be spot on. In my view, a thematic framework that identifies companies based on the changing landscapes of economics, demographics, technology and psychographics as well as from time to time regulatory mandates captures the tailwinds and headwinds to which management teams are responding. Of course, not all companies recognize these tailwinds as they unfold, while others capitalize on them. When a company does catch a tailwind properly, it powers its revenue, operating profit, earnings and cash flow growth, driving valuation multiple expansion. In short, it drives alpha. Where things become a little tricky is separating theme from trend or fad. In my book, a trend or fad is short-lived, while a properly constructed theme captures a structural change that unfolds over several years. Well-constructed themes are also relatable and recognizable to us in many aspects of our lives. For example, when we walk down the grocery aisles today, we see more shelf space dedicated to natural, organic, low-sugar, paleo, non-GMO products. Consumer packaged goods companies are bringing more such products to market, while others are snapping up privately held companies to reposition their product portfolio to appeal to this changing consumer preference. That is one aspect of our Cleaner Living investment theme, which focuses on the companies that will benefit from consumers becoming more conscious of the ingredients and materials used in the foods they eat and the products they surround themselves with on a daily basis. As we saw during the pandemic, digital infrastructure and connectivity became essential as we looked to work and learn from home or other locations. In today's increasingly connected society, if that infrastructure goes down we can no longer work, stream, use social media, shop, message, TikTok, communicate or anything else we do in the digital world. At the same time, we are in the early stages of the next iteration of connective technologies that are 5G, WiFi 6 and gigabit fiber that have considerably higher data speeds than their predecessors with lower latency, which will enable new applications and expand the connected device market. And for those wondering, work is already being done on 6G, which is expected to begin testing in South Korea in 2026. Here's the thing with our digital lifestyle: The more data we have access to, the more we want, the more we create, and it's this virtuous cycle that drives continuously expanding demand for digital infrastructure. Imagine what will happen when autonomous cars hit the road and generate what is expected to be 4,000 GB of data per hour of driving a day. Add in the Internet of Things market as well as augmented and virtual reality applications. Same goes for telemedicine. This firmly suggests the digital infrastructure will be the backbone of our increasingly connected lives. For investors there are a number of ways to invest in this theme, from the mobile infrastructure companies such as Nokia and Ericsson to the data center companies such as Equinix and Digital Realty Trust and to chip companies such as Qualcomm , Skyworks Solutions and Nvidia . There are also mobile tower companies such as American Tower and companies such as Dycom Industries that construct the back-haul and mobile networks as well as companies such as InterDigital that have rich-patent portfolios for mobile technology.

Think in Terms of Societal Themes Rather Than Sectors When Building a Portfolio

For example, consider stocks that should benefit from our ever-increasing digital lifestyle.

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