He Quantified 200 Years of Disruption | Kai Wu on Separating Software Survivors from Value Traps

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**Kai Wu** (0:43)
Software stocks, at least on this basis, are trading currently at a 10% discount to the market, which has never happened before over the course of this sample.
What you find is that when you apply the value factor in the insulated sectors, actually, the performance has been great, been just fine. You almost see no difference between 2010 on and the beginning period. These companies survived and then ultimately thrived, despite being in the cross-section of disruption. How did they do it? Two things. I think for many of these companies, say software stocks, I think the takeaway is that the code is not the moat. For many of these companies, code is one of the many things they do, but we as investors need to look beyond that to ask the question of what other intangible assets or just most in general do these possess.

**Justin** (1:31)
Hey Kai, welcome back.

**Kai Wu** (1:33)
It's good to be back, guys.

**Justin** (1:35)
Our audience is familiar with you. You've been in the podcast a few times. We always like having you back because in addition to running Sparkline Capital and managing the ETFs that you run and that you've built on this intangible value framework, you're also consistently putting out very interesting deep pieces of research on where the markets may be misunderstanding disruption innovation and the way that you look at sort of intangible value and your recent piece that you put out in May titled AI disruption motes and value traps is looking at the recent sell off in software and this possible opportunity that it has created and there's this idea right now in the market that AI is gonna be this existential threat to these software names and not necessarily an opportunity but I think as we work through this great piece that you did you know we'll kind of get into what the setup might be in some of these software names and sort of how you know you're using your unique aspects of natural language processing and research to sort of uncover these possible opportunities and so this is one of the episodes where we're going to be pulling in a lot of charts Kai is gonna be working through these with us he shared these charts with us in our audience so we can get like really down to the nitty-gritty detail on the research that he's done so I just thought we'd start Kai with you know your exhibit too which kind of shows how the software where the software premium or lack of premium is today and how unique that is in terms of you know software stocks after this sell-off so I guess the first thing just to set the context is that historically software stocks have commanded a premium valuation or historically investors have liked software stocks more than say the average industrial and the S&P 500 because their asset light because they have predictable SAS style revenues and for a variety of other reasons that you know fast growing and such so over the past roughly 20 years since this data began, their forward PE ratio of software relative to the S&P has been at a 32% premium, right?

**Kai Wu** (3:49)
So that's been the historical average. And there have been some fluctuations. So it kind of dipped a little bit in 9 and then went on kind of a secular bull run and peaking in 2021 If you remember, that was kind of the COVID bubble, right? People were working from home and interest rates were at all time lows and stimulus was coming to the market. So software stocks were kind of at their all time high valuations and then 2022 things started to reverse. Valuations started to fall and they went through their historical average around 23 and then the past two years they've been continually falling, kind of reverting back to first parity with the market and then more recently over the course of this year have actually fallen to a discount to the market. So software stocks, at least on this basis, are trading currently at a 10% discount to the market, which has never happened before over the course of this sample.