April 2019 CROCI Focus

Marketing Material

CROCI Focus Intellectual Capital Main Contributors: Francesco Curto, Head of CROCI Investment Strategy and Valuation Group Sarvesh Agrawal, Vice President, Investment Strategy and Valuation Group

The combination of lukewarm top line growth, rich valuations companies with intangible assets, an anomaly if the former and high profitability may well mean low single-digit equity group is as structurally challenged as it appears. returns for the foreseable future—perhaps unsurprising, Ideas have always contributed to economic growth, but in the given the high returns enjoyed over the past decade. But past the relationship between the idea and economic growth although the economic environment appears to be manifested itself through hard assets. Think of railways, stagnating, many underlying changes have been taking shipping, large chemical and steel plants, auto place, both in the broader economy and within equity manufacturers. The economics of an idea required significant benchmarks. Companies with apparently little capital have investment in plant and machinery, as well as needing a managed to grow at a much faster pace than the rest of the substantial amount of labour. economy. In reality, these companies have made substantial investments in intellectual capital over the years. Over the past decade, though, economic growth and equity returns have been driven by companies with apparently little This report explains how companies with intangible assets capital and labour. If the future belongs to companies that are (R&D & Brands) have largely been able to defy a backdrop of able to deliver economic growth with little physical capital, lacklustre growth in the global economy. By contrast, investors in equity benchmarks will continue to have companies without intellectual capital have struggled to exposure to companies whose businesses are structurally generate any growth—their aggregate earnings are well challenged by these changes. below the levels of a decade ago. Investing in companies with IC still presents risks, though. This group represents two-fifths of the market (including Ownership of R&D doesn’t guarantee a competitive financials), which is likely to provide a real headwind for advantage or that profitability will come through. Within the investors if this trend is sustained. Nor is valuation supportive. last section we highlight a number of factors that investors Companies with only physical assets trade at a premium to should consider if they want exposure to what appears to be a structural change in the economy.

Confidential. For Qualified Investors (Art. 10 Para.3 of the Swiss Federal Collective Investment Schemes Act (CISA)) / For Professional Clients (MiFID II Directive 2014/65/EU Annex II) only. / For business customers. / For institutional investors only / For Professional Investors only. No distribution to private/retail investors.

2019 trading

April e strategies

the CROCI database. Unless

or informationalor purposes only

performance which is simulated by applying the rules rules the applying by simulated is which performance significant differences between simulated and actual and actual simulated between differences significant

can be bascktested

mendations with respect to the securities or investments mentioned. Past performance is not an

anner. There typically are diffences between (simulated/ model) and actual results results actual and model) (simulated/ between diffences are typically There anner.

calculated by applying the CROCI model to these consensus estimates. The CROCI team team CROCI The estimates. consensus these to model CROCI the applying by calculated

information document. end of the at this information ot be fully accounted for in the preparation of simulated performance results and all of which can adversely adversely can which of and all results performance simulated of preparation in the for accounted be fully ot s. Simulated performance results have many inherent limitations, some of which are described below. One One below. described are of which some limitations, inherent have many results performance s. Simulated / CROCI/ Focus

charts contain a mixture of historical and current data. This report does not have performance data on any of the CROCI CROCI the of on any data performance have not does This report data. current and historical of a mixture contain charts hisof datais as February 2019. CI and investments associated with CROCI are appropriate for them. for appropriate are CROCI with associated and investments CI tegies or client accounts in the United States. The charts that represent current and historical data is obtained from the the from obtained is data historical and current represent that charts The States. United the in accounts client or tegies

affect actual trading results. Simulated performance is therefore not a reliable guide to actual performance. actual to guide a reliable not therefore is performance Simulated results. trading actual affect program which cann which program important the to refer Please coverage in a retrospective manner and has the advantage of hindsight. Live does not represent actual actual represent not does Live hindsight. of advantage the has and manner retrospective in a of the CROCI coverage firm the had performance actual to similar be would returns index or strategy that represent not does DWS performance. m this in accounts managed actually index. or strategy any by achieved a or offer to invitation an an offer, or Strategies CROCI to connected product any of marketing constitute not does paper This various under strategies Investment CROCI Strategies. CROCI to connected product any into enter to ation recommend permitted is sale or offer an such where jurisdictions inthose only sold be or sale for offered and marketed be may wrappers strategies these about information and reasons, other and/or licensing to due jurisdictions certain in available be not and may jurisdictions. such any in located or residing investors those to directed is not or current Any be realised. not may projection or recast fo any and performance future of an indicator not is performance Past and up as as well down go can equities in investment Any metrics. future of indicative be not may metrics company past loss. a total up to risk be at may capital investor of Forecasts reported. yet not are that years financial to refers “E” document, this throughout sented pre charts and data the In CROCI L.P. Finance Bloomberg by asreported estimates consensus market’s on based are years these for data accounting are years for forecast the metrics reports company from derived are years historical for Data data. accounting of projections or forecasts any make not does sources. available publicly and other differ to results actual cause may that uncertainties and risks to subject are projections or statements oking lo Forward materially. result performance ition, add In hindsight. of benefit the with prepared generally are they that is results performance simulated of limitations the of of impact the for account completely can record trading simulated no and risk, financial involve not es do trading simulated specific any of implementation the to or in general markets the to related factors other and trading actual in risk financial and should not be construed as, investment advice or recom indicator of future results. Market and index performance data is sourced from 20 Bloomberg Finance L.P. Company data is from There data. performance simulated includes paper This The opinions and estimates contained herein are based on or derived from publicly available Information from sources that we believe to be reliable.We do not guarantee their accuracy. The underlying assumptions and these views are subject to change without notice. This material is f CROCI coverage being run on a live basis as opposed to to opposed as basis a live on run being coverage CROCI Please piece. this throughout used terms key of definitions for and CROCI to introduction a brief for A see Glossary Please Value. Real of definition the for B see Glossary Unless sectors. otherwiseand regions these in coverage CROCI’s of data show regions or sectors specific to referring Charts noted, stra stated t and views introduced in this paper and can form an independent view of them. CROCI represents one of many possible ways ways possible many of one represents CROCI them. of view independent an form can and paper in this introduced and views whether evaluate and methodology CROCI the of view own their form must investors Potential stocks. value and analyse to CRO who understand th understand who investors, institiotnal for the U.S. in and only, Investors Professional for intended is paper This Important Information 2019 April

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and should not be construed as, investment advice or recom indicator of future results. Market and index performance data is sourced from 20 Bloomberg Finance L.P. Company data is from The opinions and estimates contained herein are based on or derived from publicly available Information from sources that we believe to be reliable.We do not guarantee their accuracy. The underlying assumptions and these views are subject to change without notice. This material is f stated t emical and steel plants steel and emical ch large shipping, past the relationship between the idea and economic growth growth economic and idea the between relationship pastthe through itself manifested significant required idea an of economics The manufacturers. a needing as well as machinery, and plant in investment labour. of amount substantial equity and growth economic though, decade, past the Over have returns econom to contributed always have Ideas Introduction 2019 April capital and labour. capital M . For attention more and more , reading 7 (201 employed in such businesses, the result of investment in in investment of result the businesses, insuch employed adv cases, some in and, R&D accounting data tends to miss miss to tends data accounting recognised goods goods and services capital is no recent In able to replac performed performed of relevance increasing the of analysis comprehensive economies. and life in our capital intangible analyse the potential implications of economic growth growth economic of implications potential the analyse b that i.e. , 2016 for Outlook our in presented stagnation these issues in chapter in chapter these issues innovation

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highly valued companies are both from the Media & Entertainment subsector. construed as, investment as, construed advice or recommendations with to therespect securities mentioned. investments or Past performance indicator an is future of not results. Market indeand The The opinions and estimates contained herein are based on or derived from publiclyavailable from sources Information that we believe to be reliable.We guarantee do not their accuracy. The underlying assumptions and these views are subject to change withou 1 This strong market performance can be explained, however explained, can be performance market This strong through (i) central banks policies and (ii) growth in the IT IT in the growth (ii) and policies banks central (i) through sector. Financial The New Economy The New past the over strongly performed have markets Equity and GDP lukewarm given a surprise of —something decade growth earnings Equity benchmarks, listed companies and macroeconomi and Equity companies benchmarks, listed 1.Economic changes 2019 April has also also has market the of rest

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to the agrarian economy. It economy. agrarian the to transformation this calling are commentators Revolution Industrial person just as fundamentally as the as fundamentally just person vanguard of this trend are transforming the life of the of life the transforming are trend this of vanguard Modern day technology and knowhow have become the the become have knowhow and technology day Modern today of force driving

contained nine railway stocks ( stocks railway nine contained 30 the at looking by evident be not may This companies. looking by is evident it but DJIA, the up make that companies of weight the at were developed during during developed were that and infrastructure technologies economic of differentiators key the became period that Not innovation. transforming a were Railways performance. employed also they costs, transportation lower they did only markets, new to access opened and people of numbers vast all to changes brought historically have in an economy Changes is There benchmark. itsequity of components the of precur Its (DJIA). Average 2016. The First Industrial Revolution used water and steam power to mechanize production. The Second used electric power to cr production. The Third used electronics and information technology to construed as, investment as, construed advice or recommendations with to therespect securities mentioned. investments or Past performance indicator an is future of not results. Market indeand The The opinions and estimates contained herein are based on or derived from publiclyavailable from sources Information that we believe to be reliable.We guarantee do not their accuracy. The underlying assumptions and these views are subject to change withou 3 DJIA in the 1920s. After World War II, the pent the WarII, World After 1920s. the in DJIA 2 were included), underscoring the importance of railways to to railways of importance the underscoring included), were eclipsed subsequently was This time. the at economy US the changes structural deep brought also which automobiles, by to demand. consumer in boom a to led prosperity emerging and was This soared. therefore stocks consumer of valuation The repeated, businesses. their of structure capital the changed significantly & Internet in the 1990s. the in Internet & rs, Retaile sector. Technology the to limited not is revolution Industrial even and Goods Consumer Since then, the baton has been passed to the the to passed been has baton the then, Since operating model, by introducing tools and processes to to processes and tools introducing by model, operating of transportation and processing production, the accelerate . produced economy the that the goods The As new. not are changes leadership market course, Of change. growth their drive that factors the evolve, economies land, cultivable to access upon depend economies Agrarian produce. their trading for marketplaces and livestock labour, Industri Unlike in the technology boom of the late 1990s, the change change the 1990s, late the of boom technology inthe Unlike valuations high by driven been not has leadership in . growth earnings t companies, these 25.1x of P/E Economic 2019 combined to 2019 April

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themes, themes,

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Intellectual Capital Intellectual structural is as of February 2019. rnings fall (after inflation). inflation). (after fall rnings seeking Following accounting rules, rules, accounting Following There is plenty of evidence that that evidence of plenty is There .

a possible cause of stagnation that that stagnation of cause possible —a - middle with workers for challenging uation component. uation l Our analysis finds that finds analysis Our a v

-skills ay benefit by by ay benefit ssification. The economy is polarising between workers with with workers between polarising is economy The and low and

provide investors with exposure to this theme this to . exposure with investors provide viding potential exposure to to exposure potential viding vestors m vestors intangible assets is a stronger indicator of growth than than growth of indicator stronger a is assets intangible cla sector capitalising for rationale the at looks three Chapter assets. such on expenditure balance on reported not commonly are assets intangible ratios and valuation profitability distorts This sheets. also section This accounts. rted repo using calculated proportion (the intensity intangible of impact the studies on Capital) Intellectual by represented assets total of existence the is matters what Interestingly, performance. nt on spe is much how necessarily not and assets such of assets. those ‘ of impact the at looks four Chapter economy broader on the jobs few is generating growth economic of type this new and is particularly skills. high- decade. past the over seen been has used be can findings these how discusses five Chapter to In poor with companies removing (ii) IC, with companies profitability,(iii) systematica implementation that the weights (iv) future, the about views removes still thus delivery, earnings their to according companies pro over the without and Utilities have seen their ea their seen have and Utilities the not or whether on based growth this Analysing more presents assets intangible have companies intriguingresults.

t material This notice. is for informational only purposes should and be not . . . or

under under just

assets have lagged. lagged. have assets Much of the listed listed the of Much

past decade, the strategy strategy the past decade,

economic performance of of performance economic e physical the the much of th of much and Intellectual Capital. Capital. Intellectual and a knowledge driven economy driven knowledge a investors need to consider moving away away moving consider to need investors

. For , earnings growth since 2007 has come from from come has 2007 since growth earnings

for ’ / CROCI/ Focus assets s

used by the major index providers and commonly commonly and providers index major the by used

x performance datax is from sourced Bloomberg 20 L.P. Finance Company data CROCI is database.from the Unless stated this data physical companies Materials Energy, comparison, By Care. and Health IT Analysing companies based on their sector classification classification sector their on based companies Analysing insights. interesting provides of this group of companies has been to postpone fixed fixed postpone to been has companies of group this of improvements. margin on focus and investments asset likely are but remarkable been have sofar efforts Their cost to limits inherent the given unsustainable, prove to cutting. companies over the past decade. A significant portion of of portion significant A decade. past the over companies revenues their grow to struggled have companies listed and earnings Chapter two looks at at looks two Chapter thirds of the market. If this diverging trend in earnings earnings in trend diverging this If market. the of -thirds

construed as, investment as, construed advice or recommendations with to therespect securities mentioned. investments or Past performance indicator an is future of not results. Market indeand The The opinions and estimates contained herein are based on or derived from publiclyavailable from sources Information that we believe to be reliable.We guarantee do not their accuracy. The underlying assumptions and these views are subject to change withou Investment by market in the changes the analyse we report this Within is there that is conclusion Our database. CROCI the using primarily investing companies that evidence clear in grow to been able have that ones the are assets intangible with those whilst earnings

2019 April Companies with intangible assets now represent represent now assets intangible with Companies podge of companies with with companies of -podge hodge a are investors by followed hard The rest of the document is organised as follows: is organised rest The document the of . two continues growth from companies that don’t have intangible assets, assets, have intangible don’t that companies from Intellectual Capital as we call them in this report. Sector Sector report. this them in call as we Capital Intellectual sector the as help much of be to unlikely is investing definitions

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