Mainstream wisdom holds that all companies can be grouped into sectors. They say adequate diversification chooses stocks from multiple sectors without an overweighting in any one sector, for example, “tech.” What they're saying is that there is too much risk in holding multiple companies whose businesses are primarily dealing in technology. If we have a deeper look at the business models of individual companies in this sector some problems with the theory arise. 

Diversity of revenue streams within industries is immense

A screen of ASX-listed “technology” companies includes Altium, Seek, Realestate.com Appen, and Wisetech. Let's go one level deeper and look at how each derives its revenues.

Altium - Providing printed circuit board software, hardware and data management.

Seek - A service for job advertisers to post jobs and jobseekers to find jobs.

Realestate.com - A service for people to buy and sell real estate.

Appen - Primarily annotation of data for use in artificial intelligence systems.

Wisetech - Removes the friction of cross-border logistics through management software.

At this next level of detail, we can see that cross-border logistics can’t be grouped with jobseekers, or how printed circuit boards relate to real estate. No two of these companies can be correctly grouped together as drawing materially similar revenue streams. The truth is that all companies leverage “technology” to enable their operations. At one point in time, a sifting pan was technology that gold miners leveraged. 

Some companies are listed inaccurately

Just one more example. One of our recent investments, Hypebeast, is listed in a well-known global data provider as being in the business of commercial printing (physically printing onto paper). In reality, the business operates in ecommerce and promotes art, music, and streetwear through posts on its website. The content generates interest with frequent visitors to the website. Hypebeast writes articles on new streetwear items and receives advertising payments from brands. Commercial printing does not describe Hypebeast's revenues, it's actually e-commerce and advertising. The range of its revenue streams doesn’t allow a single label; you had to learn about it to know what it does.

Implications

Portfolio Allocations

Don't think in terms of sectors. Think in terms of products and revenue streams. In many cases it is hard to find a true competitor; the market will take care of that. Each product or service must have its own merit if it is to be competitive. Learn about the products or attributes. Why do customers choose them? What are the trends in the industry? What is the company strategy and does that align with, or drive, trends in the industry? Know the competitors in that industry and analyse them in the same way. Now you have a picture of industry risk - you don't if you simply run a scan of companies in a given sector.

Scan Manually

When scanning for new investments it's not logical to filter according to sectors. One must come down to the next level of detail and individually assess the drivers of the business model. At Blue Oceans Capital, we look at each business model manually and think in terms of what drives price and volume and what the future prospects of those drivers are. This means manually poring over thousands of companies. Going to their website, understanding their products and who their customers are. Yes it's a lot of work, but we know there's not a great opportunity sitting out there that we didn't see because we set a high level filter that screened out certain sectors.