The Matrix: BCG Edition

Matt Brennan

Almost 30 years before Keanu Reeves aka Neo limboed in slow motion to avoid bullets in the sci-fi classic, The Matrix, the world renowned legacy of the Boston Consulting Group, the BCG Matrix, was born. Just as The Matrix set the standard for cinematic fight scenes to this day, so too has the BCG Matrix stood up to the toughest critic of them all. Time.

Not suffering the same fate as the floppy disk, which was also invented in 1970, the BCG Matrix is still compatible and worth using in the modern investment climate. The success of the BCG Matrix, is largely due to its simplicity, when combined with only a small amount of fundamental analysis research to determine market share and growth rate, and an analysis of the individual investors risk appetite and situation, can be used to narrow down the 2167 companies listed on the ASX to invest in (when this article was written), to a handful.

Let’s take Old Macdonald, who recently tweeted that he wanted to move away from agriculture, sighting the drought, feed costs and the rejection of his application to be a contestant on Farmer Wants a Wife as the primary reasons. He has indicated that his capital reserves are ample but with the Gillard government in power, understandably does not want to take too many risks.

Cash cows make an ideal starting point for Old Macdonalds share portfolio. With an interim dividend here and a final dividend there, he will be saying more than e-i-e-i-o, when come tax time, he receives franking credits on his low risk investment, which consistently can be milked regardless of price fluctuations. Using the BCG Matrix and his own independent research, Old Macdonald will determine that within the stable environment of the banking sector there are four banks that control an 80% interest, with further analysis a selection can be made.

Old Macdonald should diversify his portfolio in case the cash cows health deteriorates, a proposition that is not utterly ridiculous, just ask Lehman Brothers. This insurance against the unlikely takes form in question marks and star stocks. Just like casting stars in Hollywood, there is a premium for attracting the best. Oceans 12 had Catherine Zeta Jones and Julia Roberts, as well as Pitt, Clooney, Damon and Affleck amongst others. In total, $110 Million was poured into Oceans 12. Warner

Brothers made over 3 times their investment on this sequel, and this set them up to capitalise on the final instalment of the Oceans series.

There is a justified perception of safety when having a kaleidoscope of stars within a portfolio, especially across a broad paradigm of sectors as the economic cycle of each sector is not always strongly interlinked (think of the correlation between the mining services sector and health care). Old Macdonald may not have the deep pockets of Warner Brothers, but should consider selecting proven performers with diverse backgrounds at the right price.

The dog of the BCG Matrix is not man’s best friend, rather the type that has fleas and rabies, and will tear a chunk out of Old Macdonalds portfolio, should it be given time. In the model, Old Macdonald would not choose to have dogs; rather dogs are typically question marks, the risky, high potential stocks that have the potential to be stars, but then in this instance simply lost their way. There is no sentimentality in the BCG Matrix, if Old Macdonald ends up having a dog in his portfolio he should shoot it (metaphorically), dumping it in the appropriate financial year to mitigate or improve his tax situation, depending on whether the dog is worth more than when he bought it. Who let the dogs in, is the general cry of the unfortunate investor, and it’s just a matter of chance or poor stock selection whether an investor ends up with dogs. To prevent his portfolio from becoming an animal shelter, Old Macdonald would set an appropriate stop loss, a point at which he commits to selling, and inoculate his financial security by avoiding question marks altogether.

Whilst being useful, Old Macdonald only receives an indication from the BCG Matrix as to which industries to invest and what stocks to avoid. Additionally, the ideal proportion of cash cows to stars is not stated for Old Macdonald. This is dependent on a number of factors that are far more sensitive than the above model. But the golden rule of investing in star stocks, to ensure robustness even in negative times, is to identify the best of the best. Or as Smash Mouth put it in their 1999 hit song All Star, “Only shooting stars break the mould.”