February 13th, 2012
by Martin Hutchinson, Global Investing Strategist, Money Morning
The recent bankruptcy of Eastman Kodak reminds investors they don't make companies like they used to. Follow up:
Founded in 1892, Kodak shows that very few of these 19th century giants exist anymore.
Companies, like washing machines, just don't have the staying power they used to. Even the largest companies these days are unlikely to outlast a 40-year investing career.
The evidence for this increased corporate mortality rate is both substantial and startling.
According to John Hagel III, Co-Chairman of Deloitte LLP Center for the Edge and author of "The Power of Pull" (Basic Books, 2010), the lifespan of such companies is now about 15 years. That's a stunning change from 1937 when the average life expectancy of the companies in the Standard and Poor’s 500 Index was 75 years.
A similar 1983 study of the 1970 Fortune 500 found the life expectancy of its companies to be around 40 years, with a third of them vanishing in the intervening 13 years.
Thus the progression from 75-year corporate lifespans to 40 and now to 15 since 1937 has been clear and more or less smooth.
The Kodak Bankruptcy is One of Many
Of course, not all these corporate deaths are due to bankruptcies - some of them are takeovers, which are much more common since the 1970s.
Even so, bankruptcy is not even enough to kill some companies. Think of the airlines, which have survived multiple Chapter 11 bankruptcies, staggering on like zombies through a fog of losses until - like PanAm in 1991 - somebody mercifully puts a silver bullet in their corpse.
Other companies disappear because they cannot cope with technological change. That is Kodak's problem, even though 120 years is a pretty good run.
However, entrepreneurs' motivations are different today.
Estate duties, which reached their current punitive level in Herbert Hoover's misguided 1932 tax increase, are another cause of short corporate lifespans. After all, if your company will be broken up on your death, you'd be wise to sell it in your lifetime and turn the money into a more liquid form.
The younger generation of entrepreneurs seems to have internalized this idea. Today, they go for repeated entrepreneurship rather than old-style empire-building.
Peter Thiel, for example, made his first billion when he sold PayPal to eBay Inc. (Nasdaq: EBAY ). Then, instead of building a corporate behemoth, he used his money, skills and company-building know-how to jump-start several other companies, including Facebook and Palantir Technologies.
The corporate lifespan is thus much shorter than it was, and not likely to lengthen again.
As investors, that means we need to abandon traditional techniques of value investing. That's because in a short-lived corporate world, there are no long-term values in the traditional sense.
When companies do initial public offerings (IPOs), their first few years will be devoted to allowing the founders and venture capitalists to cash out. In this period, you can expect accounting shenanigans and short-term stock-price boosting games.
Then, after the founders have sold, the company may become a zombie, with their research and innovation capabilities sucked out, existing only until its cash pile runs out. Research in Motion Ltd. (Nasdaq: RIMM) and Yahoo Inc. (Nasdaq: YHOO) may have reached this stage, for example.
Short-lived Corporations and Your Investments
That has important implications for workers, but it can affect our investment decisions even more.
In a world of short corporate lives, here are a few investment strategies to consider:
- Dividends: If a company pays a 10% dividend yield and lasts only 15 years, and liquidates for 20% of its current value, that would still give you an overall return of 7%, which beats fixed-income these days. Plus, if you're smart, you may be able to sell it for full value about eleven years later, before others have cottoned on to its decay. Energy Master Limited Partnerships (MLPs) like Linn Energy (Nasdaq: LINE) are excellent examples of this type of investment.
- Bargains: If you buy something for 50% of its net asset value, and the company is making profits, you will probably end up making out on the deal when it is sold off or wound up. In this case, the income may not be worth much, but the assets are.
- Fast growth: If you are really convinced the company's profits are going to explode, and you're buying on a fairly cheap price/earnings (P/E) ratio, you may be able to ride the rocket. But don't pay too much, and don't forget to jump off when the rise seems to be slowing.
- Family companies in family-oriented cultures: Other countries don't have the same estate taxes, are more family-oriented, and are less attracted by get-rich-quick schemes. In Germany or Japan, corporate lifespans have not shortened to the extent they have in the United States. In general, emerging markets are more long-term oriented than the U.S., although their political and economic risks may kill companies before their time.
In general, avoid companies that do not pay dividends. There will be cases of companies, especially in the tech sector, which enjoy an entire corporate lifespan of say 20 years without ever paying anything to investors who are not insiders with stock options. Don't be the sucker that buys these empty bags at high prices.
Also avoid well-established blue-chips, the equivalent of Kodak, which tend to be priced as if they will last forever, and whose dividend yields are not enough to compensate you for their now-shortened lifespan.
To take one example at random: The Procter & Gamble Co. (NYSE: PG). PG has been around since 1837. It is a perfectly good company, but its 2.1% dividend yield won't compensate you adequately unless PG makes it to 2060. History tells us it may not.
So while, shorter corporate lifespans may well speed innovation, they make being an employee or an investor much more difficult and dangerous.
Investors should recognize this and adjust their strategies accordingly.
When the times change investors need to change with them. That's the lesson behind the Kodak bankruptcy.
[Editor's Note: Today, S&P 500 companies have a record $5 trillion on their balance sheets. That's twice the total of just a year ago.
But it's how those companies use that cash that will determine whether the stock is a buy, sell or hold.
In today's Private Briefing, Martin Hutchinson shares a secret showing you how to determine which cash-rich companies will provide maximum gains. To find out more, please click here.]
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