In 1965, a company in the S&P 500 Index had an average life of 33 years. Incredibly, that number is now down to 18 years and falling.
What’s driving the change?
Technology has a lot to do with it as entire industries have been reshaped, from the way we shop for clothes to how we power our cars. If that weren’t already enough, businesses have had to fight off competition from global trade flows and easing regulations. Important in all of this is that the composition of businesses has changed, with many lacking the cash flows to survive. Consider that in 2018 over 80% of companies that went public in the U.S. were unprofitable, higher than even at the peak of the tech bubble in 2000.
While there’s noise in how corporate lifespans are calculated (e.g., some don’t die, they get acquired), the fact remains: investors have their work cut out for them. After all, it can be said that investing is the practice of predicting business outcomes. More central to the prudent investor’s goals of wealth preservation and long-term growth of capital, it’s figuring out where the pitfalls are so that we can avoid them. These days, it feels like those pitfalls have widened, with business disruption accelerating and more speculative companies cropping up.
"It is more important to wonder what a business looks like in a steady state—after motivated competitors have entered and the market is closer to saturation..."
With how quickly the corporate landscape is evolving, we think it’s more critical than ever to bring meaningful insight to business analysis. And that’s no easy feat. Getting to the heart of complicated business questions takes patience, a lot of deliberation, and searing intellectual honesty. It means figuring out what truly matters against an ocean of data points, each calling for our attention. For instance, while the market may be captivated by a startup’s rate of growth, we need to remember that trees don’t grow to the sky. It is more important to wonder what a business looks like in a steady state—after motivated competitors have entered and the market is closer to saturation—and whether, in that stage, the business can even cover its costs. Better insight also comes from seeking out opposing viewpoints, especially when we feel most confident—or worst yet, when we have spent so much time with a subject matter that our opinion has become fossilized.
But in an always-connected world, it can be very hard to maintain discipline. How do we stay focused when a firehose of data hits us from our phones and monitors throughout the day? How do we think calmly with media outlets racing to see who can form the fastest and loudest opinions?
While knowing there aren’t easy answers, our investment team adheres to two principles in our analysis of companies.
"We look for companies with resilient business models—ones that don’t have to undergo constant reinvention—and strong balance sheets that enable them to withstand shocks, whether from recession or unpredictable industry cycles."
First, maintain an investment identity. Identity allows us to stay the course while responding gracefully to the winds of change. Without one, investors risk losing their way, blown around by market fads and a constant torrent of news. At Clifford Swan, we’re exacting in the types of securities we’ll consider. We look for companies with resilient business models—ones that don’t have to undergo constant reinvention—and strong balance sheets that enable them to withstand shocks, whether from recession or unpredictable industry cycles. We also consider whether these businesses have a path for sustainable growth, not with a roll of the dice but through tangible means, whether through leadership in a consolidating industry or by applying existing strengths (e.g., brand power) in related markets.
"Maintaining our identity means we embrace innovation without losing sight of business fundamentals."
Maintaining our identity means we embrace innovation without losing sight of business fundamentals. For instance, we recognize the power of intangible assets—networks, smart algorithms, and customer lists—while realizing that as quickly as “idea companies” can scale, they may just as quickly be replaced. And out of our long-term discipline, we avoid chasing headline-grabbing companies, opting instead for businesses that may be overlooked but have proven ways of accruing value.
Take the example of daily deal sites (e.g., Groupon), which are matchmakers between customers looking for deals and businesses that need more customers. At the outset, that model generated tremendous buzz and drove valuations to incredible levels. Less talked about was whether they actually made both parties better off in the long run (which time has shown to be a resounding “no”). We would much sooner take interest in an operating model like that of business process outsourcers, which though unremarkable on the surface offers a stronger value proposition. They can be deeply entrenched in their customers’ operations—providing essential services like payroll processing and benefits management—with ways to grow an already resilient cash stream.
"...the better question to ask is: Does this business actually offer something valuable to customers? And if the answer is yes: How might that eventually change?"
Our second principle is to promote a culture of rigorous and open dialogue, leaving no stone unturned when considering an investment. To be sure, strong dialogue doesn’t assure us of an easy path to success. That path is more likely to be filled with false starts and dead ends. But it’s in spirited dialogue that we can begin to uncover the questions that really matter to a company’s inherent worth and thus uncover potential pitfalls. Instead of spending significant research resources trying to predict next year’s margins to the precise decimal, a team may realize the better question to ask is: Does this business actually offer something valuable to customers? And if the answer is yes: How might that eventually change?
"As an extension of the principle of open dialogue, we favor corporate management teams who spend as much time thinking about what can go wrong as they do what can go right."
As an extension of the principle of open dialogue, we favor corporate management teams who spend as much time thinking about what can go wrong as they do what can go right. Great managers speak comfortably about their business’s weaknesses, have respect for their competitors, and acknowledge their own missteps. It’s with a deep appreciation for both risk and opportunity that they can feel sure-footed in difficult times and make prudent decisions.
At Clifford Swan, we reflect often on the adage: “go slow to go fast.” Adding our own take, it means that to make real progress, move deliberately and with purpose. Those are sage words for the business environment that we’re in—filled with promise and also increased danger. To this end, we think maintaining an investment identity and promoting relentlessly honest dialogue are important pursuits—ones that permeate every corner of an organization and anchor us in trying times. In an age of business disruption that’s showing no signs of slowing, they help us steer towards calmer waters and stay in command of our clients’ investment goals.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.