Is Your Equities Portfolio Susceptible to Disruptive Attacks? Part 2

By Amit Rupani

Quick Recap of Part 1: Blackberry, Nokia, Kodak, Polaroid, Blockbuster, Borders, Toys “R" Us were all market leaders that fell prey to disruptive technologies. There are good odds that fast-paced changes will continue and today's giants like Apple, Google, and Netflix will be challenged by newer companies which shall become future industry leaders. Today, the average lifetime of companies is shrinking. While the future is largely unpredictable, I shared predictable mundane industries with slower technological changes or disruptions like tires and food in Saathee's July edition. Both Tire and Food businesses meet basic human needs and wants, which are likely to continue for many more decades. Below I share my take on the next two predictable mundane industries: Healthcare and Insurance.

Healthcare: People are always going to fall sick and healthcare will be required all the time. An aging global population requires more healthcare than ever before. As per capita GDP continues to rise throughout the world, people are demanding better health care. From 1960 through 2016, health spending rose from $147 per person to $10,348 in the US, an average annual increase of 7.9 percent. US national health expenditure as percent of GDP in 1960 was roughly 5 percent which has increased to 17.9 percent in 2016. And recently CMS projected that US health care spending to reach nearly 20 percent of the GDP, spending nearly $5.5 trillion by 2025. Globally, every country's healthcare expenditure as percent of GDP is rising at a steady pace. There are many ways to be exposed to an eternal industry like healthcare. Hospitals, pharmaceuticals, diagnostics, medical equipment, and health insurance are all part of the healthcare industry. These businesses are complex with many wrinkles, but if one spends time to understand the underlying business and its industry dynamics, there are numerous businesses which if bought at reasonable valuations can provide excellent returns in the long-term.

Healthcare is also considered as recession-proof industry. People may not buy new cars, eat out at a restaurant or go on vacation when the economy slows down. But if they fall sick, they will have to go see a doctor, take medications, or get surgery for chronic conditions. Most of the healthcare spending is non-discretionary and isn't going away just because economy is shrinking. In economic terms, demand for healthcare has been relatively inelastic, which is why investing in “right" healthcare businesses can become part of “Buy and Forget" bucket.

Insurance: In most countries you cannot drive a car without insurance. One may not get a home mortgage loan, if proper insurance is not purchased for the underlying home. In a country like USA, one obvious risk faced by those who go without health insurance is bankruptcy risk given sky-high healthcare costs. Life insurance is an important consideration for an earning member of a young family. In short – there are certain insurance policies that one has to carry all the time. All these “must have" insurance policies provide tremendous amount of “sticky" policy premium incomes for the insurance companies. Insurance is here to stay and has become a basic human want.

The difficult part for insurers is properly estimating what future insurance claims will be and setting premiums at a level that will cover these claims, as well as leave ample profit for the shareholders. The beauty of the insurance business is that companies get insurance premiums upfront when they underwrite the policy. This upfront collection of premium is called float which in a way is “free money" that insurance companies hold but don't own until the policy period expires. Any float money left after paying for claims and operational expenses is invested in different financial securities like stocks and bonds and insurers try to make money out of it. In other words, insurance companies are getting paid to hold the “free money" until they pay for all the claims. Individual polices and claims come and go, but an insurer's float is usually steady and grows over time. As the insurer's business grows, so does its float.

Berkshire Hathaway's insurance float has grown from just $39 million in 1970 to about $91.6 billion in 2016. Investing the float has been Berkshire's primary mechanism of growth over the years and is how the company has grown into the massive conglomerate it is today. Buffett refers to the property-casualty insurance business as “the engine that has propelled our expansion since 1967."

Insurance companies benefit from normal inflation. As our home and new car values rise thanks to normal inflation, insurance companies get to increase their premiums accordingly to reflect increase in replacement costs of the insured asset. Considering normal inflationary environment, premiums or float collected by the reputed insurance companies is almost certain to increase. Not all insurance managements are great at both underwriting profitably and generating returns with their investments. Insurance is highly regulated business, but if run by smart management, it can do wonders.

Great businesses with sustainable competitive advantages and run by smart management in slow changing industries can compound wealth at above market rates for decades. Whereas, great businesses in mediocre fast changing industries can eventually succumb to the competitive forces slowing down the growth of the business as new entrants drive the market with new innovative products and services. To follow the mantra of “Buy Right Sit Tight" – it becomes very important to invest in businesses that are in slow changing industry with reasonably clear and predictable future earnings potential and provide above average return on invested capital.

Happy investing!


Amit Rupani, CFA is an Independent Investor, practices Value Investing principles, manages money for long-term wealth creation through Equities asset class. Email: