There are many rules of thumb and well-intentioned advice for younger investors. One such “rule” says that it is better to buy stocks of older and proven companies. While I do not disagree with this on an isolated basis, I am missing the second part, namely that every business has a certain life expectancy. There comes inevitably a time for every company to either step into the background or to disappear altogether. History is full of examples.
Summary and key takeaways from today’s Weekly
– While it sounds nice that the longer the history of a company is the more robust and future-proof it is, this does not stand the test of time.
– A serious investor is not acting solely on what happened in the past.
– Every company has an end of life – while it is not possible to exactly time it in most cases, there are some signs for increased risks.
My longer-time readers will have already anticipated my motivation for this weekly.
Today’s episode is (again) based on some observations I have made, especially on Twitter / X. While browsing through the feeds that could be of interest to me, I often see posts about stocks where I frequently disagree with the assessment. And this is great, because we can think about this stuff and draw out valuable conclusions from it to improve our investment results.
With the risk of sounding like an unsatisfied grumbler, I am sometimes adding my two cents here or there as I believe opposite positions should be heard.
There can be many reasons for my contrary view, but one topic that repeats is the argument of the history of a business. Many people see a correlation between how old a company is and its safety for the future to continue its past success.
This is where the “Lindy effect” comes into play, but more on that later.
It might not be that surprising that I have a different opinion in this regard. I want to use this weekly to question this common narrative, because for me it is too short-sighted, leaving out a critical component.
Indeed, I am missing the risk part in this equation.
The same like this “wisdom” is known, people also can name several companies instantaneously which fell from grace, went into oblivion or that are even completely non-existent today, e.g due to bankruptcy. But weren’t among them many decades-old examples, contradicting this thesis?
It reads like that there must be some kind of a sweet spot.
Actually, I believe that this is the case. Although it will be difficult in practice to exactly hit this window of opportunity to leave the party at the best moment, there are some indicators at which I personally look to spot increased risks.
My track record is not that bad, as my chosen picks, exclusive to my members, so far also support the effectiveness of my selection process. I just almost always say no and remain as unemotional as possible. Not every dropped stock is a bargain – quite to the contrary. In most cases, the market is right, until facts don’t change.
How can one assess higher risks of a business?
There’s not a secret formula. It can even happen that a sold stock advances further, leaving you feeling unpleasant. But as a stock picker and fundamental analyst, one has to do the homework others shy away from.
Just looking at the past is not enough!
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The Lindy effect and looking at the past
This topic is not that easy as it might sound.
To put it into the right perspective, I am a big proponent of learning from history and looking at what happened in the past. The reason is that I am a believer in cycles. Everything and everyone has a cycle.
Not only people, animals or plants have a life-cycle. So do businesses!
Self-explanatory for me, this applies well to nearly everything in our everyday life, if you just open your eyes and ears. There’s no straight-line development forever.
Here’s an explanation of the Lindy effect I’ve found on Wiktionary (highlights by me):
The hypothesized phenomenon that the future life expectancy of certain nonperishable things (such as a technology or an idea) is proportional to their current age, so that every additional period of survival implies a longer remaining life expectancy.Wiktionary, see here
I also picked a piece from the BBC, to not only have one single source (likewise highlights by me):
What will remain in 100 years’ time of the city or town where you were born: which landmarks or buildings? What about in 500 years? The controversial author Nassim Nicholas Taleb offers a counter-intuitive rule-of-thumb for answering questions like this. If you want to know how long something non-perishable will endure – that is, something not subject to the limits of a natural lifespan – then the first question you should ask is how long it has already existed. The older it is, the more likely it is to go on surviving.BBC, see here
Put it shorter in my own words and applied to stocks: The longer the history of a company, the higher the chance of it to survive.
So goes the common narrative. The arguments are seemingly straightforward.
A company which has been existing for decades or even more than a century like Coca-Cola (ISIN: US1912161007, Ticker: KO), General Mills (ISIN: US3703341046, Ticker: GIS) or Procter & Gamble (ISIN: US7427181091, Ticker: PG) not only proved to have an enduring business model.
These companies have also survived many crises like big wars or recessions.
Somehow, there must be an element of truth to it.
But what if I tell you that companies like the following had long histories with decades of operations?
- Lehman Brothers (est. 1850, bankruptcy 2008)
- Sears (est. 1886, bankruptcy 2018)
- Kodak (est. 1888, bankruptcy 2012)
- Radio Frequency Systems RFS (est. 1900, bankruptcy 2022)
- Merrill Lynch (est. 1914, bankruptcy 2009)
- RadioShack (est. 1921, bankruptcy in 2015 and 2017 for good)
- Pan American World Airways (est. 1927, bankruptcy 1991)
- Polaroid (est. 1937, bankruptcy 2001 and 2008)
- Toys R Us (est. 1948, bankruptcy 2018)
- American Motors Corp. (est. 1954, bankruptcy 1987)
- Blockbuster (est. 1985, bankruptcy 2010)
Make no mistake about it, many of these have been market leading business with established and well known brands at their heyday. Unfortunately, the formula did not work for them.
Just a few unlucky single cases?
Personally, I doubt it, but you’re free to make up your own mind. I think you get the point I wanted to make. It can hit every company, at least theoretically. Or are you seeing something like the below pictured in your everyday life? What comes to my mind is the famous quote form Kaiser Wilhelm II about cars and horse carriages (that cars will never replace them).
Though I myself am not against some nostalgia – one has to be realistic.
So much on the hypothesis that the longer a company’s life, the better its prospects. People have been riding on horses not only for decades or centuries, as the Romans have already done that – has that saved this means of transportation?
It further does not distinguish between simply “surviving” for the sake of still being there on one side and continuing to do well not the other.
We likely do not want to pick stocks of dinosaurs without any positive development.
On the positive side, such disappearances seldom happen in just a day or two.
In fact, often these are even year long developments in the making. That’s why I am convinced that with proper fundamental analysis one can start to smell the rat, at least at some point where it might be the time to fold.
Personally, first signs of something not working properly anymore are:
- lumpy or no sales growth
- higher appetite for mergers and acquisition
- stories about reorganizations or restructurings which are not done in a few quarters, but tend to become the new business model
- no free cash flow growth
- margin pressure
- too much debt
- paying out and even worse raising dividends only to appease shareholders, even though the finances rather would advocate a painful cut
- frequent or sudden management changes
- single-digit PE ratios paired with a stock price that’s been falling for years, especially for otherwise non-cyclical businesses
Especially the latter is signaling a pretend-cheapness – but there’s often a reason for it (and keep in mind: PE is for TV, it does not say anything about the debt load nor about the prospects of the business).
Leave this garbage hunting for others.
I am sure that there are more points, but these are the first that came to my mind and which I quick-check when looking at a new potential investment.
Over the years, my selection process has become even stricter and more rigorous.
If I am not fully convinced, I throw in the towel, before I try to sell a case to myself which does not fit my requirements. A checklist or filter is one thing, but the holistic analysis process and also my gut feeling must complete the first impression.
What I am not doing (anymore) is to try to find something positive in a negative case, but rather I am searching for negatives that quit my analysis.
In several older weeklies, I have already written negatively about darlings stocks with massively lower stock prices (for a reason!) like:
- 3M (ISIN: US88579Y1010, Ticker: MMM)
- Verizon (ISIN: US92343V1044, Ticker: VZ)
- V.F. Corp (ISIN: US9182041080, Ticker: VFC)
- Altria (ISIN: US02209S1033, Ticker: MO)
and of course others more, but these are my favorite “targets” I’m throwing darts at to hit the triple-twenty.
On Twitter / X, there are other frequently discussed ideas like Bayer (ISIN: DE000BAY0017, Ticker. BAYN), Volkswagen (ISIN: DE0007664039, Ticker: VOW3) or W.P. Carey (ISIN: US92936U1097, Ticker. WPC).
Bayer is a company in existence since 1863, i.e. 160 years. Volkswagen since 1937. Are they great buys only due to their age? And can you safely say that both will still be there in another 30 years which would be just a fraction of their current age?
The frequency of them being mentioned in posts and discussion alone is already a strong warning sign. I don’t like frequently talked about ideas.
Also going through their published material, neither are valuations “rock bottom”, nor are the cases compelling. And these are all stocks that have dropped tremendously.
Only because a stock has dropped does not qualify it as a buy!
source: all TIKR.com
I know that I picked up some ideas for my members which also have not that good looking charts. But that’s the past. My picks have strong fundamentals, most often net cash, instead of huge debt loads (which is already worth pretty much in these days) and some even have tailwinds in their operations in otherweise troubled sectors.
To show you that my analyses have been not that bad, below you can see the performance of each of my picks (anonymized):
You can see that:
- my picks on average are well ahead of the benchmarks
- my worst pick is down only by 18.1% (with the bonus of still bing a take-over target)
All this in an environment where companies which fail to either deliver on their numbers or where the business development is not good, can suffer heavily.
Yes, even stocks of big companies can drop heavily.
Who’d have thought that PayPal’s stock (ISIN: US70450Y1038, Ticker: PYPL) would fall by 80% over two years? At least one could have clearly avoided it as there was no reason to buy it.
My two latest picks for example also have seen falling stock prices for years. The thing is, the first has 1/3 of its market cap in net cash and the latter has massive tailwinds, being even able to increase renting rates at almost 10% for new tenants while the whole industry is bleeding and even being on their knees for tenants to accept lower rates just to stay.
While it sounds nice that the longer the history of a company is the more robust and future-proof it is, this does not stand the test of time.
A serious investor is not acting solely on what happened in the past.
Every company has an end of life – while it is not possible to exactly time it in most cases, there are some signs for increased risks.
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