One of the most common fallacies in business life and in investing is that change is all around us and that everything is changing and therefore, by deduction, all of us need to hyperventilate about whether our investments are on the bleeding edge of change.
A decade ago, in his book ‘Antifragile’, Nassim Taleb popularized the Lindy Effect with the following words: “If a book has been in print for forty years, I can expect it to be in print for another forty years. But, and that is the main difference, if it survives another decade, then it will be expected to be in print another fifty years.
“This, simply, as a rule, tells you why things that have been around for a long time are not “aging” like persons, but “aging” in reverse. Every year that passes without extinction doubles the additional life expectancy. This is an indicator of some robustness. The robustness of an item is proportional to its life!
For the perishable, every additional day in its life translates into a shorter additional life expectancy. For the nonperishable, every additional day may imply a longer life expectancy.”
Since Taleb wrote these words, numerous investors have written about the Lindy Effect. This piece by Market Sentiment is amongst the most insightful we have read n the subject. Part of the reason for that is how the author teases out some really interesting non-intuitive findings. First Market Sentiment shares with you the underlying logic of how the Lindy Effect works in investing [not all of the following research & data applies to America]:
“Half of all companies fail within five years, and 80% in the first 20 years. However, some companies become outliers and survive for hundreds of years. So, in theory, the Lindy Effect applies to companies.
Take Coca-Cola, for example — The company was founded in 1892 and survived the Great Depression, two World Wars, and the 1980s Cola wars, just to name a few. Not only did the company survive all this, it has thrived and increased its dividends for the past 61 consecutive years. Based on the Lindy Effect, Coca-Cola has a better chance of making it to the next century than Google.
If you are a value investor, this is an important but often overlooked factor. Ultimately, the company valuation is based on the present value of future cash flow. The problem with the current valuation technique is that we always project that the company will survive in perpetuity.
This is why it becomes so hard to value companies in their growth stage. A classic example is that during the dot-com bubble, economist Burton Malkiel pointed out that at Cisco’s implied growth rate (Cisco was only 15 years old at that time), it would become larger than the entire U.S. economy within 20 years.
But, once a company has matured, it will have an established brand, a loyal customer base, and a strong market position, making it easier to assign a fair value to the company. Buffett understands this intuitively, and it’s one of the key reasons why he only invests in established companies — The average age of the top 10 holdings of Berkshire is 113 years, with seven companies older than 100 years!” [The underlining is ours because we believe that Marcellus’ staff and their clients need to take cognisance of this point. Note that Marcellus’ Global Compounders Portfolio has Berkshire as one of its investee companies.]
Then comes Market Sentiment’s outstanding number crunch. “We are leveraging this excellent dataset created by Boris Marhanovic, where he consolidated all public companies in the U.S. that were more than 100 years old. There were 485 companies on the list, and after some data cleaning, we are left with 73 target companies that we can consider as Lindy stocks.
To give you a flavor of the type of companies that we are investing in, below are the top 10 companies from our list of Lindy stocks: General Electric, Corning, Exxon, Pfizer, Citigroup, J&J, Berkshire, Coca-Cola, Merck, Eli Lilly.”
Then Market Sentiment runs a $100 equal-weighted Lindy portfolio consisting of these 73 companies which have been around for more than century and compares the results with the S&500 over the 2000-23 period. For the full results, we would strongly recommend that you read this entire piece of research.
Most of us would imagine that the FAANG powered, QE fuelled S&P500 would outperform the doddering 100-year old Lindy stocks and…most of us would wrong. Market Sentiment says and shows: “The results are surprisingly in favor of the Lindy stocks. $100 invested in Lindy stocks would have grown into $776 (676% return) compared to only $486 (386% return) if you had invested in the S&P 500. The cherry on top was that this outperformance was achieved with comparable portfolio volatility (12.3%) and max drawdown (55%) to that of the S&P 500…
As with all portfolios, power laws are applicable here as well. A few of the winners contributed a major chunk of our portfolio gains. Even though we filtered for a minimum of $1 billion company valuation (as of 2000), firms like Moody’s, Equifax, Hershey, etc. managed to give us a 1,000%+ return.”
For those who are stunned by this outcome, Market Sentiment offers a Buffett one-liner which helps rationalise this result: “Time is the friend of the wonderful company, the enemy of the mediocre.”
If you want to read our other published material, please visit https://marcellus.in/blog/
Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.
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