International Business Machines
Corporation (IBM) is soon set to celebrate its 105-year
anniversary — an astonishing achievement for any single company, let alone one
in the dynamic and changing technology sector.
“Big Blue” is a remarkable exception in a
world where companies come and go — and yesterday’s “heroes” become today’s
“zeroes.”
Yet,
this very “creative destruction” that makes companies come and go is a crucial
factor in the long-term success of any investment strategy.
That’s
also why — for your
long-term investment success — picking the right country, market or sector is
much more important than picking any single company or stock.
The Accelerating Pace of
‘Creative Destruction’
Austrian economist Joseph
Schumpeter popularized the phrase “creative destruction” in the 1940s. It is
the idea that the engine of capitalism is the continuous creation of new ideas
and new products, where the new pushes out the old.
You
see examples of creative destruction throughout the history of the U.S. stock
market.
In the
1920s, the Radio Corporation of America (RCA) was
the “Google” of its day — a fast-growing company with new technology that
changed the way an entire generation of Americans communicated. RCA actually
lived a remarkably long life, born in 1919 and passing on in 1986.
And in today’s world of exponential change,
the pace of this “creative destruction” is accelerating even as the average
life span of companies is shrinking.
A
mere decade ago, everywhere you looked, people either had Motorola phones (in
the United States) or Nokia (everywhere else in the world). Or they carried
Blackberries, manufactured by Canada’s Research in Motion.
Today,
Motorola’s cell phone business Motorola Mobility Holdings,
Inc. is part of Chinese-owned Lenovo, even as its market share
has all but disappeared. Nokia (NOK) was
eventually acquired by Microsoft. And the market share of Research in Motion (RIMM) has fallen off a cliff.
Indeed, the company’s market share in the businesses it dominated just a few
years ago continues to evaporate.
The fate of Research in Motion and Nokia echoes that of Palm — a once-high-flying company that hit a share price of $95.06 in 2000 — only to be acquired by HP for $5.70 a decade later. Once a company hits a death spiral, few make it out of the dive toward oblivion. Palm, a once-pioneering company in the world of “personal digital assistants,” was eventually sold to the Chinese electronics firm TCL Corporation. And it hasn’t been heard from since.
The fate of Research in Motion and Nokia echoes that of Palm — a once-high-flying company that hit a share price of $95.06 in 2000 — only to be acquired by HP for $5.70 a decade later. Once a company hits a death spiral, few make it out of the dive toward oblivion. Palm, a once-pioneering company in the world of “personal digital assistants,” was eventually sold to the Chinese electronics firm TCL Corporation. And it hasn’t been heard from since.
Even
companies that don’t disappear end up mere shadows of their former
selves. Cisco (CSCO), once expected to be the first $1 trillion
company, today is worth less than 15% of that lofty amount. Former tech giant
Lucent Technologies retired to the 7th Arrondissement Paris in 2006, acquired
by France’s Alcatel.
The surprising thing is that — from a long-term
perspective — the same fate likely awaits today’s tech-darlings Alphabet (GOOGL) and Apple (AAPL), as well.
The Myth of ‘One Decision’ Stock Investing
The Myth of ‘One Decision’ Stock Investing
The
fate of these former rising-star companies highlights the challenges of “one
decision” investing, espoused by Warren Buffett.
When Buffett buys a stock, his
ideal holding period is “forever.”
And this worked for him
remarkably well…
Until it didn’t…
Over the last 51 years — since he
acquired it — Berkshire Hathaway’s book value has grown from $19 to $157,000 —
a rate of 19.36% compounded annually.
That number, however, conceals more than it reveals.
First, Buffett’s average rate of
return up until about 2000 was right around 30%.
But Buffett’s long-term investment returns
have plummeted over 30% during just the past 15 years. The numbers bear this
out.
On June 19, 1998, Berkshire’s share
price was $80,900. On Friday, March 24 2016, it closed at $210,530.
That works out to a very
un-Buffett-like annual return of only 5.45% a year for the last 18 years.
And that’s more than just a streak of
bad luck. After all, 18 years is close to 35% of Berkshire’s entire lifetime
under Buffett’s stewardship.
Viewed through the lens of “creative
destruction,” you could argue that the lack of growth from new companies and
new ideas with potential exponential growth are behind Berkshire’s flagging
returns.
The Unexpected Lesson
Over the long term, the more a country
or a sector provides for an environment of “creative destruction,” the better.
And in practice, that means betting on
both tech and small-cap stocks, as both have the potential to generate
exponential returns old stalwarts simply cannot.
According to Yale endowment chief David
Swensen, had you invested your money in a U.S. small-cap index in 1932, you’d
have made 15,600 times your money between then and 2008.
And I bet there were very few
individual companies in that index in 1932 that made it to 2008.
After all, 1932 was a long time ago…
Warren Buffett was two years old. Hitler
had not yet come to power in Germany. The United States and the Western world
were in the midst of a Great Depression. Television, jet planes and computers
had yet to be invented.
At the same time, nowhere else but in
the United States, where “creative destruction” is part of the very fiber of
economic life, could you have generated those kind of returns.
So, the next time you invest, ask
yourself whether the companies in that sector will be the same ones tomorrow as
they are today…
And if the names aren’t changing, take
heed…
That’s because the greater the
“creative destruction” in a sector, the greater chance for potential profits…
Just make sure you bet on the winners.
In case you
missed it, I encourage you to read my e-letter column from last week about how behavioral finance can help explain shifts in the market. I
also invite you to comment in the space provided below my Eagle
Daily Investor commentary.
