Episode summary
He Quantified 200 Years of Disruption | Kai Wu on Separating Software Survivors from Value Traps
Excess Returns
· · Guests: Kai Wu
Summary
Kai Wu argues that software stocks now trade at an unusually low valuation relative to the market, with software at a 10% discount on a forward P/E basis after decades of mostly commanding a premium. He frames the selloff as a possible setup for value traps: when disruption is real, cheap-looking stocks can still be deteriorating businesses, just as Blockbuster, Borders, RadioShack, and newspapers were before their fundamentals caught up to the market’s repricing.
Wu’s central claim is that traditional value investing has struggled because it has been applied indiscriminately to industries under technological pressure. Using patent clustering and natural language processing, he maps disruption across sectors and shows that exposed industries have dragged down the value factor since around 2010, while insulated industries have still behaved normally. In his telling, value investing is not dead; it is being distorted by disruption.
He then argues that the better framework is intangible value: intellectual property, brand, human capital, and network effects. Companies like Walmart and The New York Times survived disruption by leaning into the technology and by relying on complementary assets, a point he connects to David Teece’s framework. Applied to software, that suggests investors should separate firms with durable moats and AI adoption from those whose code-based business models may be permanently impaired.
Key takeaways
- Software stocks are trading at a 10% discount to the market on forward P/E, a level Kai Wu says has never occurred in his sample.
- Wu says traditional value has worked in insulated industries, but exposed industries have driven the factor’s weak performance since around 2010.
- His disruption model uses patent clusters and company documents to identify technologies that are both trending and pervasive across industries.
- Wu argues that intangible assets such as IP, brand, human capital, and network effects can help separate software survivors from value traps.
- He says AI could raise margins for surviving software firms by reducing the labor intensity of code production and easing stock-based compensation pressure.
Notable quotes
“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 poor performance has been great been been just fine”
“I think the takeaway is that look the the code is not the moat right”
“what I'm saying now is let's take David Tiss's framework and say hey look that's obviously important but it's not the only thing that matters right”
“AI is actually a boon um to to these companies”
How the episode opens
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 poor performance has been great been been just fine. You almost see no difference between 2010 on and the beginning period.
These companies survived and then ultimately thrived um despite you know being in the crosshairs 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 look the the code is not the moat right like for many of these companies code is one of the many things they do but you know we as investors need to look beyond that to ask the question of what other intangible assets or just moes in general do these possess.
Hey Kai welcome back. — It's good to be back guys.
Our audience is uh familiar with you. Uh you've been on the podcast a few times. We always like having you back because in addition to running Sparkline Capital and and and managing the ETFs that you run and that you've built on sort of 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 modes and value traps is looking at the recent sell-off in software and this possible you know opportunity that it has created and there's this idea right now in the market that AI is going to 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.
From the episode’s captions: roughly the first two minutes, lightly cleaned. Keep watching on YouTube →
Topics
- ai disruption
- software valuations
- value traps
- intangible moats
- traditional value investing
Companies and tickers mentioned
- WMT
- NYT
- AAPL
- AMZN
- M
- Sparkline Capital
- Blockbuster
- Borders
- RadioShack
- Walmart
- The New York Times
- Apple
- Amazon
- Macy’s
Watch the episode
Summary, takeaways and quote selection by Octagon. Quotes are short excerpts; the full conversation is in the episode.
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