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It’s often the case that investors buy into a company that has a terrific economic franchise, one that allows it can charge a premium price and achieve high ROCE, and then, a few years down the line profits start to decline. The world has moved on.
Whether through technological change making competing ways of delivering a service or producing a good, or whether through social change reducing demand your favourite firm can no longer attract customers and still achieve the old profit margins.
This is the way capitalism works: creative destruction over and over again. Just drive around a town built in the Victorian era. Here in Leicestershire we have old textile factories, in Stoke you see the remnants of famous potteries, and on the Tyne, shipbuilding yards.
In our own time we’ve seen the decline of the high street as a portion of shopping moves online; and the numbers of high street travel agents and insurance brokers have fallen. Newspapers have had a hard time of it, as have producers of paper car manuals.
Now we are seeing the combustion-engine based industry and fossil fuel power producers under threat, as well as the landline phones and linear TV.
We need to keep up to date. We need to continually challenge our assumptions regarding the durability of a business model – some sectors are much less vulnerable to change than others, but all must be watched for signs of attack.
Charlie Munger was recently asked about his experiences in helping Berkshire Hathaway to grow over the last 60 years. What had surprised him, and how he used some of those surprises in his quest to become a “better learning machine”?
He replied:
“Some of the things that surprised me the most was how much dies. The business world is very much like the physical world where all the animals die in the course of improving all the species, so they can live in niches and so forth. All the animals die and, eventually, all the species die. That’s the system.
“When I was young, I didn’t realize that that same system applied to what happens in capitalism to all the businesses. They’re all on their way to dying, is the answer, so other things can replace them and live. It causes some remarkable death.
“Imagine having Kodak die. It was one of the great trademarks of the world. There was nobody who didn’t use film. They dominated film. They knew more about the chemistry of film than anybody else on Earth. And, of course, the whole damn business went to zero.
“Look at Xerox, which once owned the world. It’s nothing compared to what it once was. Practically everything dies on a big enough timescale. When I was young, it was just as obvious then, [but] I didn’t see it for a while.
“Things that looked eternal and had been around for a long time, I thought would likely be that way when I was old. But a lot of them have disappeared. Practically everything dies in business. None of the eminents last forever.
“Think of all the great department stores. Think how long they were the most important thing in their little community. They were way ahead of everybody in furnishing credit, convenience in all seasons, convenience back and forth using the same banks of elevators and so forth [over] multiple floors. It looked like they were eternal — and they’re basically all dying or dead. Once I understood that better, it made me a better investor.”
“To have IBM have the huge position it once had in terms of utter dominance and, now, it’s just one of the also-rans. It’s still an admirable place. I’m sure they still have a lot of talent left in IBM, but it doesn’t help. You die even though you’re talented and hard-working.”
Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk)
