TraderGordo

A blog to share my thoughts about trading, frugal living, money and the economy. Occasionally I might even throw in a few things about better living, technology, futurism, and science but these are always in some way related to finances or speculation.

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Location: Phoenixville, Pennsylvania, United States

"I have become all things to all men so that by all possible means I might save some."
-Paul

Wednesday, December 06, 2006

Buy and Hold or Buy and Hope?

Have you ever wondered what happened to all of the companies mentioned in the classic market related books? "Reminiscences of a Stock Operator", "How I made $2,000,000 in the Stock Market", and "The Money Game" for example - are all filled with the names of companies that no longer exist! I have scoured the internet looking for statistics on the average lifespan of a listed company; while I have not found a definitive answer yet (for numerous reasons this is a very difficult number to crunch!), the consensus seems to be that a listed company lasts less than 20 years (possibly much less). Unlisted companies on average die much younger. Average human lifespans have been getting longer and longer -- if you are healthy today, you may live to be 100 years old or even longer if the biogenontologists succeed.

To state it simply, you are going to outlive almost any company you could invest in today. The longer you hold any given stock, the closer you are to losing the entire investment. Virtually any stock you buy is headed to zero, its only a matter of when. An important concept you should understand is that of "creative destruction". Creative destruction is the term popularized in 1942 by economist Joseph Schumpeter (Capitalism, Socialism and Democracy) that describes the inevitable process of transformation that accompanies innovation. Innovation from entrepreneurs and new market participants IS what sustains long term productivity gains and economic growth, even as established businesses are destroyed (incidentally this is also why layoffs are actually a net "good" in a productive society, but I'll save that for another post). Rivals introduce improved versions of existing products or radical new products that make other technology obsolete. The most self-preserving corporations buy up the competition to perpetuate their dominance (or at least their survival), but even that strategy is prone to failure over the long haul.

If anything, I believe the pace of innovation is increasing today, in part due to the vastly improved flow of information and communication that has resulted from the internet age, but also due to sheer numbers (innovation, like population, is geometric). The greater the number of entrepreneurs, researchers, and scientists out there, the more innovation you can expect. This means that going forward, corporate lifespans should become even shorter than they have been historically. Furthermore I would expect people to work for more companies over their lifetime than they ever did in the past (this is a trend that is already well underway, the concept of working for one company for your entire career is absent from younger workers).

Look at a few of the stock market "superstars" of the recent past, companies like Kodak, Polaroid, Ford, Xerox, IBM, etc. These companies and their products all still exist in 2006, and at one time each was a dominant market force and stock market megastar. But they have all gone to the brink of bankruptcy or even gone though an actual bankruptcy. New companies with better products will continue to erode market share and put them all out of business given enough time. Today's market darlings are in the same boat. Many of the booming stocks I traded only a few years ago no longer exist, and the booming stocks of today will likely implode over the next decade. This does NOT only apply to high flying tech stocks.

The following quote comes from Adam Smith's "The Money Game", chapter 9:

"One of my biases is so strong that I have to mention it immediately, because it runs counter to an idea that is very common, i.e., that if you buy good stocks and put them away, in the long run you can't go wrong. Well, as Keynes once remarked, "In the long run we are all dead," and, as the line in the ballad says, everything is born to die. The best anti-testimonial to buying good stocks and locking them away was published by the heirs of one Timothy Bancroft. Mr. Bancroft was shrewd enough to ride out the Panic of 1857, which he diagnosed thus: "I blame the Dred Scott fiasco, the easy money policies of the past few years, and the far, far too overconfident speculation in the railroads and farm lands of the Western states." What one should do, counseled Mr. Bancroft, is to "buy good securities, put them away, and forget them." These good securities, of course, should be companies "dealing in essential commodities that the Union and the World will always need in great quantities." Sounds reasonable enough. Mr. Bancroft died leaving an estate of $1,355,250 [TraderGordo NOTE: This is approximately $44 million adjusted for inflation to 2006 dollars] and if you remember that those are untaxed mid-nineteenth-century dollars, and that a full eight-course meal at Delmonico's cost less than a dollar at the time, that is quite a fortune. Where Mr. Bancroft erred was in the locking up and putting away, for by the time his descendants managed to get their fingers on the portfolio, Mr. Bancroft's Southern Zinc, Gold Belt Mining, Carrell Company of New Hampshire, and American Alarm Clock Company were all worth 0, and in fact, so was the estate, an event which prompted one of the descendants to take to print as a warning to his fellow heirs."

In all fairness to the buy and hold proponents, not recognizing the name of an older company does not necessarily mean they went belly up. I did some research on the original Dow Jones Industrial Average (first published in 1896) which consisted of:
American Cotton Oil Company (a predecessor of Bestfoods, now part of Unilever)
American Sugar Company (now Amstar Holdings)
American Tobacco Company
Chicago Gas Company (now Peoples Energy Corporation)
Distilling & Cattle Feeding Company (now Millennium Chemicals)
Edison General Electric Company (now General Electric)
Laclede Gas Light Company (now the Laclede Group)
National Lead Company (now NL Industries)
North American Company
Tennessee Coal, Iron and Railroad Company (bought by U.S. Steel)
U.S. Leather Company
United States Rubber Company (bought by Michelin)

A casual glance at the list of original names only would lead you to believe that nearly all of them have disappeared. Well actually this group has not done so bad, only 3 are completely gone, GE would have been one of the best investments you could have made and is still part of the DJIA index today. The others have gone though many name changes, buyouts and mergers, but essentially still exist in one form or another as of 2006. So buying and holding these 12 companies from 1896 probably would have done pretty well. Will you do as well on your own?

If you have a particular talent for finding companies producing new products that should ensure massive revenue growth over the next few years, by all means cash in on the ride, just be sure to unload when 20+ years of future gangbuster growth are already priced into the stock. If you are up to the challenge, you might also be able to find great short candidates to profit from in any market considering the constant stream of companies going downhill. You might focus on income producing investments, or creative long/short hedges. The average hands off investor may do best buying an index (indexes like the S&P 500 are continuously updated, ETFs offer additional low cost diversification including foreign exposure and commodity related exposure). Although you should still expect the possibility of at least one very long period of negative returns after speculative manias. You could be underwater for a decade or longer buying the S&P 500 at historically high price to peak earnings ratios (which exist at the time of this writing). Another option would be to entrust your wealth to competent managers that are likely to survive and thrive in any type of market (I would personally focus my search on funds with the best return per unit of risk characteristics). However fund managers usually under-perform, especially after fees are taken into account. Perhaps you are better off investing directly -- building businesses, providing services, and creating jobs yourself instead of working with the middle man that is the stock market? How about investing in your own education or career or something that will actually improve your own happiness?

1 Comments:

Blogger nospams said...

It is interesting to note that the one true "star performer" from the original DOW Jones list mentioned in this article, GE, plummeted and nearly went bankrupt during the 2008 financial crisis. Some experts believe the outlook for this company is grim even today in 2011.

9:57 AM  

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