Asset-light businesses are companies that do not own large amounts of fixed assets. For example, a retailer that does not own the stores where it sells its products would have modest amounts of property, plant and equipment.
In my opinion, investing in asset-light firms could represent a more efficient use of capital. They offer the potential for higher returns on capital, greater scalability and more flexibility than businesses that have large amounts of fixed assets. This could provide them with a competitive advantage in an era where fast-paced industry change is becoming the norm.
The advantages of asset-light business models
Scaling an asset-light business has the potential to be a relatively fast process that does not require large initial investment. For instance, a company that does not need to purchase office space, warehousing or retail units may be able to quickly expand its number of locations and the diversity of its operations. This could mean it has the potential to offer a higher earnings growth rate compared to a peer that needs to purchase fixed assets in order to grow.
Similarly, companies with a low percentage of fixed assets may benefit from having a higher proportion of variable costs versus fixed costs than their sector peers. For example, they may be able to renegotiate rents to reflect market conditions. This may enable them to be more flexible in response to changing consumer tastes and demands. They could also have a higher chance of surviving a period of weaker sales growth, since they do not have large amounts of fixed costs to cover each year.
Buffett's view on asset-light companies
Many value investors have sought to apportion capital to companies that have a minimum amount of fixed assets on their balance sheets. Among them is Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) chairman Warren Buffett (Trades, Portfolio). He has previously noted his preference for asset-light businesses. In his 2020 letter to Berkshire Hathaway shareholders, he stated:
"The best results occur at companies that require minimal assets to conduct high-margin businesses – and offer goods or services that will expand their sales volume with only minor needs for additional capital".
This lack of requirement for additional investment in order to grow may be particularly relevant in today's economic environment. The Covid-19 pandemic is prompting significant change among consumer tastes that is causing a relatively fast pace of evolution in many industries.
Therefore, those businesses that can more easily adapt to changing trading conditions may find they have a clear competitive advantage over the sector peers. This may allow them to grab market share and assert greater dominance over rivals in the long run.
Investment opportunities
Of course, asset-light businesses are not perfect. They can exert less control and influence over their operations. For example, a company that owns its retail locations may have greater control over their appearance and layout than a firm that rents its retail units.
Meanwhile, variable costs can be higher than fixed costs for equivalent assets. For instance, renting premises may be more costly over time than owning them outright. This can lead to lower levels of profitability in the long run for an asset-light business.
However, in my view, the flexibility, return on capital and scalability opportunities presented by an asset-light business model outweigh its drawbacks. As such, rather than focusing on earnings forecasts or investor sentiment, drilling down into a company's balance sheet to ascertain its amount of fixed assets could be a prudent strategy in today's stock market environment.
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Howard Marks: Focus on the Present, Not the Future
- Li Lu: Forget Volatility, the Potential for Permanent Loss of Capital Is What Matters
- Benjamin Graham on the Dangers of Momentum Investing
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