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Do Long Surviving Companies Make For the Best Investments?

Jun 14, 2016

In this issue:
» An Oligopoly in the Telecom Sector
» Will RBI be able to meet its inflation target?
» Today's market update
» ...and more!
00:00
Ankit Shah, Research analyst

Two weeks ago, I wrote a piece for the Research Digest; in which I spoke about what it takes for a company to survive long periods and whether such businesses make for the best investments..

The article was well received and thus we thought of sharing it on this platform.

Here it is...

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Going concern.

Have you ever come across this term in an annual report? I'm sure you have. And you have probably ignored it. But if you have an annual report handy, you are likely to find the following line in it...

  • The Directors have prepared the Annual Accounts of the Company on a 'going concern' basis.

Let's think about it for a moment. What is this 'going concern' all about?

'Going concern' is the assumption that the entity will continue its operation in the foreseeable future. It is assumed that the entity has neither the intention nor the need to liquidate or materially curtail the scale of its business operations. In short, the business is ALIVE.

Conversely, if a company is not a going concern, then it means that it has gone bankrupt. It's DEAD!

This brings us to an intriguing question...

The Lifespan of Companies

I came across a striking study on this topic by Professor Richard Foster from Yale University reported by bbc.com in 2012. Here are some highlights of his findings:

  • The average lifespan of a company listed in the S&P 500 index of leading US companies has decreased by more than 50 years in the last century, from 67 years in the 1920s to just 15 years today.

He estimates that by 2020, more than three-quarters of the S&P 500 will be companies that we haven't heard of yet.

That's shocking, isn't it?

Let me now show you the other extreme - the longest living companies.

Japan has some of the world's longest-living people. Incidentally, it is also home to some of the world's oldest companies.

As per credit rating agency Tokyo Shoko Research, more than 20,000 companies are more than 100 years old. Woah, right? But wait...

Japan even boasts of a few companies more than 1,000 years old!

You'd love to invest in companies that live forever, wouldn't you? Imagine buying a stock today that you pass on to your children, who in turn pass it on theirs, and so on.

We all dream of leaving a rich legacy for our descendants...

Now, I'm sure you're curious about the secret behind the longevity of Japan's businesses...and how you could pick everlasting companies in India.

Why American Companies Die Early and Japanese Businesses Live Longer

I mentioned earlier that the average age of listed American companies has declined to just about 15 years. Why does the average American company have such a short life span? And is it such a bad thing?

It turns out the age of businesses is not just related to growth and profitability. A key factor is culture.

Experimentation, innovation, and change are at the heart of American culture. Failure is not the taboo it is in Asia. On the contrary, failure is not only accepted, but celebrated. As Kevin Maney writes in Newsweek...

  • If enormous failure is the only sure path to creating tech superstars, no place in the world is better set up for failure than Silicon Valley; and Steve Jobs was perhaps the greatest failure who made good there. After getting the boot from Apple, he went on to found NeXT Computers and Pixar, and then returned to Apple in the greatest turnaround in corporate history.

The Japanese, on the other hand, even have a word for long-lived companies: shinise.

What makes Japanese businesses live longer? The answer is again corporate culture. The long-living companies are typically small, family-run, and focus on a central belief that is not tied to profit-making alone. Moreover, they tend to avoid the mergers and acquisitions so rampant in Western business culture.

A Correlation between Company Age and Shareholder Returns?

Does the age of a company have any relation to shareholder returns? Are old companies better than young companies?

There is no evident link between the age of a business and its profitability. On the contrary, research suggests otherwise. Could age be a hindrance?

A McKinsey study reports that of the 74 companies that have been in the S&P 500 for more than 40 years, only a dozen has managed to beat the average. In fact, overall performance would have been about 20% worse if the S&P 500 were made up of only the companies that were part of the index in 1957.

In short, old businesses are not necessarily great wealth creators...

Does that mean investors should look at young, high-growth startups instead?

Again, the answer is no...

Vivek Kaul on What It Takes for Businesses to Survive

A few days ago, our big-picture editor, Vivek Kaul, wrote a hard-hitting piece on the cracks in the Indian startup boom. This was after Flipkart was in the news for deferring the joining dates of fresh recruits from India's most premier institutions.

  • These are clear signs of trouble at the company. In fact, one of the first things the information technology companies did after the dot.com and telecom crash of 2000-01 was postpone the joining date of the fresh engineers they had recruited.

In the same write-up, Vivek talked about what makes businesses survive...

  • And this brings us back to the oldest business lesson - businesses need to make money to survive. Businesses that don't make money for an extended period don't survive. They shutdown. That is how it is.

    Of course, there is a corollary to this rule. There are businesses that can keep running even if they don't make money. They can keep making losses. This is only possible if they happen to be owned by the government of India.

    Take the case of the government-operated airline Air India ... The airline has made losses of Rs 34,689.7 crore between 2010-11 and 2015-16, and is still running.

In short, don't look at the age of a business...but the profitability and durability of its business model. That's exactly what Tanushree Banerjee (Co-Head of Research) does when she recommends safe, solid blue-chip stocks.

Do you believe long surviving companies always make for good investments? Let us know your comments or share your views in the Equitymaster Club.

02:55

'Consumer price inflation is at its 21 month high' read the headlines today. Coming in at 5.76%, inflation for the month of May 2016 was higher by about 0.3% from the preceding month's revised figure. The key culprit this time again is food. CPI food inflation in particular jumped to 7.55%, from 6.4% in the preceding month - led by higher vegetable prices.

Repo rate - the rate at which the RBI lends money to the banks - currently stands at 6.5%. It has gradually been brought down from levels of 7.75% from about a year and a half ago. CPI numbers on the other hand have been quite volatile over this period. Particularly from July 2015, when inflation numbers have started moving higher.

The RBI is targeting to keep inflation below 5%. And therefore a cut in the interest rate is unlikely to be on the cards anytime soon. That is unless of course a good monsoon gives enough buffer and has a benign impact on food prices. As an investor, you may not want to bet on the monsoon or the RBI's rate cut. But best to not discount the inflationary risk to GDP growth. A sharp up move in oil prices can only make matters worse.

03:50 Chart of the Day

Here's an interesting statistic. Did you know that the telecom industry is moving toward an oligopolistic situation? In other words, the top three players control three quarters of the market! Bharti Airtel, Vodafone India, and Idea Cellular garner about 75% of the industry's revenues. And this trend remains intact.

As today's chart shows, all other players have been steadily losing market share. This is an inevitable fallout of the clean-up that this industry was in need of. The 2G scam had resulted in an unsustainable competitive situation. After the Supreme Court cancelled 122 licences, it was clear to us that only the strongest will survive.

The good news for the consumer is that the growing dominance of these three firms has not resulted in rising phone bills. Competition is still quite fierce and the entry of RJio later this year will lead to even lower rates. This will be good for the consumer. However, RJio's entry will probably be the end of the road for the remaining small players.

Will Smaller Telcos Survive?


04:45

At the time of writing, the Indian markets were trading flat. The BSE-Sensex was trading up by about 5 points. While gains were seen in stocks from the consumer durables and realty spaces, those from the information technology space were least favoured. Mid and small cap stocks were trading firm, with their representative indices trading higher by about 0.3% and 0.8% respectively.

04:55 Today's Investing Mantra

"Do not take yearly results too seriously. Instead, focus on four or five-year averages.". - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Ankit Shah (Research Analyst).

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2 Responses to "Do Long Surviving Companies Make For the Best Investments?"

satya

Jun 15, 2016

Thrucost models is order of the day except in India tharis why Indian companies are unreliable

Like 

LOGANATHAN

Jun 14, 2016

The author is to quick to assume.

S&P 500 companies have a life span of just 15 years means, older companies are out and new companies are in. That should be a welcome development, since the world does not keep producing bi-cycles. There are lots of innovations in the last 60 years, starting with Computers in particular and Technology in general.

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