One of the earliest lessons that many of us have learned since starting investing is to invest in Innovation, to seek out the most Innovative companies in the market and Center, our portfolios around those companies. After all, some of the most Innovative companies throughout history have been pretty impressive companies. We have ones like apple and Tesla. Highly Innovative companies making new products pushing the world in a New Direction and they attract investors
attention. Not only that but they've also had very good. Good returns. This leads a lot of us to look for companies that are highly highly Innovative but the truth is a little bit different when it comes to investing. Innovation, doesn't matter. That's a harsh reality, Innovation doesn't matter. I say that with a caveat it does matter in some instances but not in the way that you may think. And that's what we're gonna be discussing in this episode of the Joseph Carlton show when
Innovation matters. And when it doesn't, now I first want to dress this Charles claimed the Innovation doesn't matter a lot of you might think that that's a provocative statement and that I can't possibly believe that's true. Well, for the most part, I believe that, that's mostly true. A lot of people cite examples of Highly, Innovative companies have had good returns like Tesla, for example, highly Innovative. And if you invested in it 10 years ago, you've done really
well. But there's a lot of other companies that I could cite as counter-examples companies that I consider not Innovative at all. All Costco. Being one of them Costco for the past 20 years, has not made any significant Innovations, they've done minor improvements, they've improved their Logistics, they've gotten better at opening up new warehouses.
There's some things that you can call subtle Innovations but Costco hasn't done anything, groundbreaking anything disruptive and looking at Costco over the past 20 years, it has been one of the best investments rising up since its all-time in 1986. 447 percent. It's pretty good returns for company that largely doesn't do much Innovation Costco keeps its business model. The same. That's what they're known for having consistency being the
same. They do the same old principles year after year after year treating employees well paying them. Well treating customers. Well having a great return policy and offering Shoppers a great experience that's all they're doing. In fact Costco keeps things so much the same that they haven't raised the price on their hot dog drink combo for. The years, the company Remains the Same all the time but it's been one of the best investments and this is true throughout a
lot of different companies. I can name a few different ones off the top of my head, Texas Roadhouse is another example. What does this company really innovated over the past 20 years? If you ask the company they'd say not much not much as change they offer good value, good portions and good service, that's what they're known for good value, good portions and good service. That's the same thing that they've done for the past 20 years. We look at this company and even
over the past 10 years. If you include dividends it's out performed Google since 2004 is given eight hundred and forty-three percent. Not including dividends this company has crushed the market, crutch the queue and it's done. So without much Innovation, there are so many companies that haven't done any substantial Innovations at all over the past decade and they're doing and credibly, well as stocks. So the first piece of evidence is very clear if Innovation were
a requirement for great returns. Then why are there so many companies that aren't really Innovative? That have such good returns. It shows it Innovation is not a requirement for great returns and if investors narrow their search to only Innovative companies, they're going to miss out on potentially a lot of great Investments.
Now, moving on to the second piece of evidence here, not only our companies not required to be Innovative to be good Investments, but in many cases, highly Innovative companies are terrible Investments. Let me give you a couple examples. One of the best Innovations. It's happened over the past 100 years, is the innovation of
commercial airline travel. Think about that for a moment, think of a world where we don't have commercial airline travel where we have to travel by train car or boat to get to one continent to another may take weeks for everyone to be able to travel easily by air is a massive Innovation being able to go from one part of planet Earth to another part in a matter of hours is a massive Innovation yet these Open.
He's that offer this product commercialized at Mass scale are not good Investments. So one of the most highly Innovative things that's happened over the past 100 years, which is commercial airline. Travel is one of the worst Investments. We look at an example here, like a Delta Air Lines. We can look at the all-time returns of this company. 62% 62 percent returns since 2007, with a ton of volatility as well.
And then more importantly, when we go down to the actual financial ratios of Company, they are terrible. Let's look at the Returns on Capital employed. It has terrible financial ratios, terrible. Gross, margins, terrible, operating margins, terrible profit margins are lines are terrible Investments and I'm not nitpicking, one particular Airline here we can search any
of them. JetBlue, for example, this is another one supposed to be even more Innovative than Delta Airlines. We look at this investment and it's down 47%. All time since 2002 Airlines. Cross the border awful Investments, even though they offer consumers, one of the best Innovations of all of humankind and this isn't exclusive to just the airline industry this follows with a lot of different companies.
For example, we can look at Spotify Spotify so far has proven to be not the greatest investment, it's up a little bit year-to-date but looking at the grand scheme of things. Since 2018, it's down to percent. So it hasn't really given investors any real returns since IPO the company has been around. 17 plus years. So Spotify is an older company that's never really produced a lot of profits. Most of the cash flows that it produces are eaten up by stock-based compensation.
This is a company that's not very profitable and it runs into the very same problems that the airline industry does. The operating margins are very low, the profit margins on. The company are very low and that's perplexing because Spotify is an Innovative company. Look what they've done with their app. It's incredible. The algorithms and the mixes they put together all of the different Different features and the user interface, nobody can claim that Spotify.
Doesn't innovate this company innovates all the time. They're always layering upon new features. Changing things, improving things, improving their Discovery algorithm. Unfortunately, for Spotify, all of their Innovation is work on behalf of a different company, which is universal music group. So, Spotify finds new customers they innovate, they do lots of different things to grow their customer base. And then after Spotify, does all of that hard work to create this great.
User interface and experience for customers Universal music, group, and other labels are the ones that get the reward. They're the ones that economically benefit from the relationship, they own the music. So, everything spotify's doing benefits them and what has Universal Music Group done? In terms of innovation over the past 10 years, can you name anything a single Innovation?
That Universal music group and these other companies have done it stuff you might be able to name one but they're not nearly as Innovative as Spotify. Bye. But they're the ones that have so far benefited the most, and that's the secret here. That should be the takeaway. It doesn't matter whether or not a company innovates. It matters whether or not they can keep the economics of their Innovation, whether they can capture the economics.
In the case of Spotify, they are a highly Innovative company, but they have not been able to capture the economics of their Innovations. Another company captures it, which is universal music group, and the other labels Spotify
innovates. These companies capture the economics of their Innovations, and this is happening all the time, put another way, an Innovative companies, only a good investment if it can capture the economics of its own Innovations. And the best investments, the absolute best ones are the companies that can capture the economics of their own Innovations, and capture the economics of other people's Innovations. When a company is able to do that, it is an incredible,
incredible investment. And I have an example for you, Apple's a company. That not only captures the economics of their own Innovations, but they capture the economics of other companies, Innovations. And I want to show you how they do that. This is the product category chart and I'll blow it up here for you. We have the Mac, we have the services, we have the wearables, which are things like the Apple
are tagged the earpod. The Apple watch, then we have the iPad and the iPhone, every single thing. The Apple sells, whether it's the Apple watch or the air pods, or the iPads, every single thing they sell, they make a fortune on. They charge a very healthy margin. They make a killing on it. When they create something new, like the new are pods are the
are tags. They capture the economics of those Innovations. No other company does other companies might create phone cases and they might in some ways benefit from Apple's Innovations, but Apple largely is the one that captures the huge majority of their Innovations. So they have that checked off the list, but Apple does something more than capture the economics of their own Innovations in the service. Revenue. Apple has figured out a way to capture the economics of other companies.
Innovations. How do they do that in the service Revenue? Apple charges a fee for every single company that sells in-app purchases or subscriptions in the App Store. So, not only do they sell their devices and make money on selling them. But once you have the device, you have to go through the App Store and the App Store, Apple, shaves off a profit. And that profit is part of the service Revenue.
It's a huge part of it. So you think about the companies that have to do business through People you have gaming companies consider all the various Mobile gaming companies that innovate and innovate creating new levels. New characters, new skins, they have to hire employees. They have to Market it, they have to try to sell it and spread their game on social media and everywhere to sell their game. These are Innovative companies, creating new gaming experiences creating entirely new
developments. And while all these gaming companies are working endlessly, creating new Innovations, Apple benefits they shave off 15 or 30%. They are taking the hard work from other companies Innovations. This is such an incredible thing. That apple is manufactured that many companies like epic games founder. Tim Sweeney have sued Apple because he realizes that he's doing all of this work to create epic games in the crepe Fortnight to create new levels and season passes.
And apple makes a bunch of money from his work, they shave it off with their in-app purchases and season passes, Apple benefits from all the work that Tim Sweeney does with his games and from every other game developer that works through the Apple App Store and it's not just Mobile gaming industry. You can take match.com any company that has mobile dating apps has tons of in-app purchases, all of those. All of those contribute to Apple.
So, as match is innovating and creating new mobile dating apps, and experiences, and algorithms to match people, they're working hard with thousands, even millions of employees. They're benefiting Apple in the process. Apple benefits both ways and that's part of the reason this company has been such an incredible investment. Now, you might be sitting there saying that Joseph this Seems unfair. In fact, it seems ridiculously
unfair. Why should Apple this massive company be able to benefit so much from all the hard work and innovations that other companies do. And to that, I say that you're right. It is unfair, in many cases, business relationships are not completely fair, I would say that the case of Spotify doing all of this work. So the labels can benefit is also unfair. It's not a representation of which company is really providing the most value, but
that's how the world works. And Is not about determining what's fair and unfair. It's about determining. What companies, a good investment which one makes money which one is found out how to capture the economics of their own Innovations, and the economics of other people's Innovations, in the case of Apple. They've done both, they've mastered this craft of capturing economics. So to put this more thoroughly innovation in, and of itself, doesn't matter.
But being able to capture the economics of a given, Innovation matters a lot. So investors would Be better served to instead of focus on finding companies that are highly Innovative focus on finding companies that are the best positioned to benefit economically from a given Innovation. And in many cases, they're not the same company. I'll give you an example of what I'm looking at. Right now, we know that there is chat GPT and it's highly Innovative.
It's being invented by Microsoft and Google and these different companies, the large language models and the Machine learning behind it. This is incredible attracts. A lot of eyes and To Google and Microsoft but there's other industries that are going to benefit from this Innovation immensely. Maybe even disproportionately high compared to Microsoft and Google alone.
This might not be the first thing that comes to mind when you look at what's going to benefit from artificial intelligence, but consider it for a minute. Now, I believe that quick service restaurants, fast food places are uniquely positioned to benefit disproportionately from the Innovations in Ai. And I think it's going to come down to the amount of employees that they can replace with.
Nai engines software Engineers with Windy's have been working with the search giant Google to tweak its large language model for key words and phrases specific to the menu or during the company's milkshakes are known as Frosty's for example but some customers might refer to them as milkshakes. Other Wendy's sling includes biggie bag is also being integrated into the chat Bots vocabulary.
So here we have wind, he's working with Google and the AI chatbot that they created to integrate this into the menu. Drink where it can versus back and forth with you. It has to be trained specifically, with some of the sling at Wendy's, and there's other little nuances, they have to take into account. It talks about the fact that there's other people talking in the car, there's background music. There's the exhaust or loud engines. There's indecisiveness with
people changing their minds. The bot needs to be trained for all of that, the whole drive through ordering experience, but I think it will happen. I really believe that AI is going to nail this. It's going to be so good at taking orders from fast food. And this fits in with my overall thesis of fast food restaurants that they're basically vending machines for hot meals. That's all they are.
They're not there for social interaction there there for a quick meal with the least amount of friction possible. If Wendy's is successful in integrating this Innovation into their business model, this could be a massive game changer for both Windy's and the entire quick service restaurant industry. A massive Game Changer consider the fact that for every single Wendy's location, one single location, they probably have to have around two to three
employees. On hand to take orders, that's how many they have to schedule for, to take orders. So, we take the amount of restaurants that Wendy zones, we times that by three, and that's the amount of employees that they could potentially reduce with this simple Innovation. A massive employee reduction, further reducing the head count increases the margins of the company, the margins of Wendy's goes up, the profitability goes up.
It makes a company much more attractive to investors so this could make it. So a low margin industry suddenly becomes a higher margin. Industry. So fast food restaurants. Like Wendy's is an industry that I'm studying and looking at right now because I think there is going to be massive Innovations in the future. I have a watch list that I call a quick service restaurants and it's a lot of what I think are
the best fast food restaurants. And I'm going through and trying to figure out which one could potentially benefit the absolute most from, if this type of AI, ordering becomes commonplace. Because in my opinion, it's only a matter of time. I do not think that 10 years from now, there's going to be humans taking your orders. At McDonald's. I think that's going to be a thing of the past.
You will be talking to robots when you order at McDonald's already when you go in the store you order from a kiosk. So McDonald's has fully signaled that they want AI to take your orders. So what does it do to McDonald's? If every single person working the window working? The ordering is replaced by a, i what does that do with the margins?
That's a question that I want to answer the same thing for Chipotle, for Domino's, for Starbucks for Wendy's for Wingstop. For Burger King for Taco Bell. What does it do to all these companies? So I am studying fast food right now because I do believe it's a category of stocks that will benefit dramatically from these Innovations. But overall, that's my thoughts on Innovation. I hope you enjoyed this episode and diving into these type of deeper topics.
Let me know if you like this type of video and I'll see you in the next one.