Narrow And Wide Aperture Ideas

I used to think that the narrower a company’s scope, the better the investment opportunity. Now I’m not so sure. Ideas with “narrow” footprints attract investors because they have fewer layers in the value chain to investigate and fewer products to understand. It’s far easier to get to “the answer” of an investment hypothesis when it involves a single product made by a single supplier and purchased by a narrow scope of customers. These are narrow investment ideas.

Incentives are perverse in investment management because analysts are compensated for being “right.” This reality nudges analysts to focus on situations where they stand to be right more often, even if those situations don’t necessarily offer the highest absolute returns.

Want to know what an analyst’s worst nightmare looks like? Imagine being told to research a company with four separate divisions, each with a wide array of products, a diffused supply chain, and few sizable customers. That’s about as bad as it gets. Such a project demands the research equivalent of four separate businesses coupled with the limited upside of a single investment. Further, good luck pitching this idea to an investment committee since complicated stories with multiple moving parts rarely inspire anyone. You're far more likely to intrigue an audience if your investment thesis revolves around a narrow, focused idea based on a fundamental insight. “Wide” aperture ideas look and feel like a waste of time.

Although companies with few moving parts are the easiest to research and build an investment case around, they typically offer limited long-term potential. While narrow aperture ideas often tempt fantastic rates of return in theory, in practice, their total returns often come up short because they don’t last the test of time. In the compound interest equation, the hardest variable to optimize is the duration of the investment. Narrow aperture ideas act more like sprinters than marathoners.

This high return yet limited duration pattern appears often because narrow aperture ideas rank highly in “researchability" and poorly in robustness. The feature that makes a narrow aperture idea appealing to an investor also makes the business fragile. If an investment hinges on a single product, raw material, supplier, customer, or technology, these "features" act as singular points of failure and are hallmarks of a fragile company. These vulnerabilities make fragile companies more susceptible to external shocks, competitive threats, and tail risks, leading to permanent capital loss.

To be clear, I’m not advocating that every investment should look like Berkshire Hathaway–a diversified conglomerate of many uncorrelated businesses–instead, I’m suggesting that certain companies can exploit their competitive advantages while dispersing their risks across their value chains. These are robust businesses.

While narrow aperture ideas require less upfront work and offer more certainty of "being right," they come with the cost of monitoring their failure points over their investment lifespan. If we define successful investing as owning compounding businesses for long periods, these monitoring costs are enormous. I’ve unfortunately fallen into this trap numerous times.

Given enough time and the brutal nature of capitalism, a company's weaknesses will eventually get exploited, and its profits competed away. Accepting more uncertainty over the life of an investment in exchange for more certainty upfront is a stupid thing to do. Narrow aperture ideas are easier to understand today and harder to understand tomorrow.

Seeking Robustness 

Applying the lesson above, we typically avoid fragile businesses that rely on critical dependencies within their value chains. If there’s an underlying rationale for robustness, it is this: the toughest problems we face will come from risks we can’t anticipate. We rely on robustness as a guide because it is a powerful hedge against the unknowable. Robust businesses married with pragmatic leadership are purpose-built to make it through difficult terrain. 

So, how do we identify robustness? I believe robustness exists in two forms: diversification and control. A robust business either spreads its risks across its value chain or owns its key processes outright. Robust companies reduce their reliance on others. 

While most attention is paid to supplier, distributor, and customer concentration risks, the risk associated with a company's product portfolio is frequently overlooked. Investors often fail to see fragility at the product level for the reason mentioned earlier: selecting businesses with fewer products is desirable because they're easier to analyze and build an investment case around. Further, these opportunities often entice investors with high theoretical rates of return. 

Robustness at the product level exists differently than in other layers of the value chain. Product diversification follows the same principle, but product control isn’t related to vertical integration. Product control exists in multiple forms, such as switching costs or happy customers who don’t want to buy elsewhere. However, one often overlooked dimension of product-level robustness is adaptability. Some businesses offer goods and services that behave like shapeshifters; they naturally adapt to the market's needs regardless of how the world changes. Adaptability also serves as a hedge against the unknown. 

Consider a company such as Taiwan Semiconductor (TSMC), which enjoys a highly adaptive product portfolio. If we compare TSMC to a fabless chip maker such as Qualcomm, an investment in Qualcomm is a bet that its products will retain their technological advantage over time. Meanwhile, TSMC sells a service that naturally produces whatever the end customer believes is the best technology. Therefore, there is little need for brilliant product-level foresight; TSMC just needs to maintain its process and service level advantages, which allow it to manufacture whatever the market demands. TSMC’s product portfolio is robust compared to most other semiconductor companies because it naturally adapts to technological and market-driven shifts. Instead of product-level risk, TSMC's core risks are geopolitical. 

In the past, I would have been more drawn to a company like Qualcomm, but if I'm honest with myself, I don't know if their technologies will retain their dominance ten years from now. Qualcomm’s products express a relatively high degree of rigidity in a fast-changing industry, and this is something I prefer to avoid. 

While robustness isn’t a guarantee of company survival, it acts as a natural buffer that insulates the companies we invest in against the unknown. The better we are at identifying robustness for our portfolio, the longer we also will endure.