LONGEVITYMark Urquhart, Investment Manager. July 2016
If we in Baillie Gifford’s Long Term Global Growth team are trying to invest on a ten year or more time horizon, then by definition we must seek to find businesses which not only endure but also prosper. But, as I think about longevity, it runs much deeper than this – for me it encompasses how companies think about themselves and how this manifests in culture, risk-taking and capital allocation.
Firstly, it is worthwhile to start with some simple arithmetic. I hope we all appreciate the power of compound growth but it still startles me to see some of the figures written down. For example:
Or taking a more extreme example:
All of these scenarios represent very good growth outcomes but I think both help to emphasise the power of longevity in terms of being an engine of growth – this is simply the law of large numbers put another way. Intuitively, as revenues get larger, growth becomes harder to achieve but this is what makes it by definition so valuable. Google or Amazon growing at mid-teens to 20 per cent or more off bases of $75 billion or $100 billion literally adds billions of dollars which can transform long-term profits and discounted cash flows (DCF). Contrast this with Groupon, where revenue growth has gone from more than 500 per cent in 2011 to almost no growth in the current year. Of course, such observations are easy to make with the luxury – which no investor is afforded – of 20/20 hindsight.
Longevity is about much more than simple revenue growth. At times it is simply about the survival of the company and the endurance of the brand. If one thinks back to Apple’s lost decade, where revenues in 1999 were below those of 1991, it was virtually impossible to foresee the explosive growth which would follow Steve Jobs’ return in 1997. Through this period the company had some rocky moments which could have led to its demise, however, it endured. Apple has now moved into the echelons of long-lived technology companies which have previously been discussed by the Long Term Global Growth team.
At times, endurance in itself is an achievement and creates opportunities for future growth. Perhaps we should view these as the corporate equivalent of the teenage years – some companies go off the rails but those which survive may have something pretty special about them. As an aside here, I was struck while recently reading the excellent book about Pixar, Creativity Inc. by its co-founder Ed Catmull, how that business only survived through the stubborn belief and deep pockets of Steve Jobs – no venture capitalist would go near it. So, longevity, whilst extremely valuable in my opinion, is extremely hard to spot before it occurs. The odds were stacked against Pixar producing its first movie but now it will probably make a hundred.
This facet of not knowing how long-lived a business might be is amplified by the economic theoreticians. There is no place for a Hermes or Chanel in the free-market theories of perfect competition and Schumpeterian disruption but I think we all know the greater fallacy lies in the underlying concept of rational agency. Concepts such as creativity, beauty, craftsmanship and brand do not fit neatly into efficient consumption frontiers but are absolutely key to understanding the longevity of companies.
Not all destruction is creative and not all creation is destructive.
More recently, I would contend, the economic profession does a particularly poor job in understanding the concepts of first-mover advantage and network effects. For example, how has Tesla built an order book worth around $15 billion (the largest ever consumer product launch) without spending a dime on advertising, and why does Google have such commanding shares in the search market everywhere except China?
In my view, the biggest failing of investment managers pouring over companies’ figures is forgetting to value the intangible assets which do not appear on the balance sheet. This is understandable because the number is not by definition objective. It involves judgment, subjectivity and embracing uncertainty but I would contend that for truly great and long-lasting companies it is the single most important figure – it is the DNA of the company and the essence of longevity. Facebook has $21 billion of intangible assets on its balance sheet, a sum which consists of its goodwill paid in the acquisitions of Instagram, Oculus Rift and WhatsApp. But it has nothing there for its greatest assets, the 1.5 billion or more users of its eponymous site and the probable genius of Mark Zuckerberg. For me this is as, if not more important, for a Netflix or an Under Armour than it is for a Gucci or a L’Oreal. The maturity of a company does not make its future longevity more valuable.
So what endures and what fails? This is not only the hardest question to answer but also one of the most important, with lots of studies and data pointing to a continued contraction in the lifespans of companies. The graph opposite illustrates the shrinking lifespans of companies and as usual, there are numerous academic debates on whether we are currently plateauing and arguments over M&A. But note within the overarching trend to contraction those special few which endure and have done for over a century.
LTGG Portfolio Holdings by Company Age
Based on a representative portfolio, new client portfolios may not mirror the representative portfolio exactly.
As at May 2016.
This trend is entirely in keeping with our theories of an acceleration in innovation, but it also concurrently makes longevity all the more rare and therefore intuitively more valuable.
My answer to this question of what endures and what fails would be that the odds of survival and, more positively, being long-lived increase dramatically with special cultures and management teams. We know from experience how some companies cannot lift their horizon away from the next quarterly data point (often because their own remuneration is tied to short-term performance) but the great companies think in, plan for and take risks over decades. Of course, we cannot predict what disruption might occur in the future but we can look to companies which are willing to embrace uncertainty and disrupt themselves as signals of their desire to endure. We should embrace executives who are there to build great businesses and change the world rather than those who professionalise the task and see five years as a lengthy tenure. We should also pay ongoing attention to the make-up of boards and whether they will tolerate time horizons and experimentation which help enhance the odds of longevity.
As a word of caution, we need to guard against valuing longevity for its own sake. There are lots of companies which are long-lived but which sustain rather than prosper. We should not be interested in companies which are cash-rich, perhaps protected from takeover, but are not growing. For us, the enticing prospect of longevity combined with growth provides the heady combination which we should seek. Our portfolios should reflect businesses in which our confidence that they will not only be here but be growing in 2025 and beyond is high. Of course, we will not get these predictions all right – ABB, First Solar, Nintendo et. al. stand as our own reminders of the chimera of future growth which historical numbers can create. We should hold all our beliefs about future growth strongly but lightly in my opinion – embrace the asymmetry of returns which the market so regularly overlooks, but be willing to admit when we have made mistakes in our future prognostications.
Our 10 Question Stock Research Framework sits at the heart of our investment process
10 Question Stock Research Framework
Great companies innovate to create new areas of opportunity and by doing so help to prolong their corporate life.
To close I have a couple of suggestions for changes, which I hope will be improvements, to our process. Firstly, we should ban all talk of TAMs – the total addressable market – these are spot numbers in any other guise and useless in my view. Ten years ago, did anyone imagine the success of Amazon Web Services or YouTube? The supposed experts had no conception of how large cloud computing might become or how many smartphones would be sold. Tesla’s potential in the mass market today looks rather different than when the company produced the first Roadsters, etc. The point here is not to constrain ourselves to a point in time – great companies innovate to create new areas of opportunity and by doing so help to prolong their corporate life. Secondly, I think we should think about longevity explicitly in our stock research framework.
Within our 10 Question Stock Research Framework, Question 4 asks, Is your business culture clearly differentiated? How? I suggest we now ask How long might this culture last?
Question 9 asks Is the business attractively valued? Here I suggest we now ask What time-frame should we consider valuation over?
I look forward to debating these suggestions with the team.
I feel more and more strongly that longevity is an asset with which we can differentiate ourselves from the market. This is not in any way an attempt to say we should not own companies which are growing more slowly although it does, I hope, explicate some of my portfolio enthusiasms. Longevity is most exciting and rewarding in companies which are growing fast and should be very highly valued by us as long-term investors.
Important Information and Risk Factors
The views expressed in this article are those of Mark Urquhart and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved on the stated date and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford Life Limited is authorised by the Prudential Regulation Authority (PRA) and regulated by the FCA and the PRA. Baillie Gifford & Co Limited is a unit trust management company and the OEICs’ Authorised Corporate Director.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Persons resident or domiciled outwith the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
Important Information Hong Kong
Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 licence from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of UCITS funds to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 can be contacted at 30/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong. Telephone +852 3756 5700.
Important Information South Korea
Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.
Important Information Japan
Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.
Important Information Australia
This material is provided on the basis that you are a wholesale client as defined within s761G of the Corporations Act 2001 (Cth). Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth). It is exempt from the requirement to hold an Australian Financial Services License under the Corporations Act 2001 (Cth) in respect of these financial services provided to Australian wholesale clients. Baillie Gifford Overseas Limited is authorised and regulated by the Financial Conduct Authority under UK laws which differ from those applicable in Australia.
Important Information South Africa
Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
Important Information Canada
Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005. It is the legal entity through which Baillie Gifford Overseas Limited provides some marketing functions in Canada.
Potential for Profit and Loss
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used in this article are for illustrative purposes only.
The S&P 500 and S&P Global Small Cap (“Index”) is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”). Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.
Mark Urquhart Investment ManagerMark graduated BA in Philosophy, Politics and Economics from Oxford University in 1992. He spent a year at Harvard as a Kennedy Scholar in 1993 before completing a PhD in Politics at the University of Edinburgh in 1996. Mark joined Baillie Gifford in 1996 and was an Investment Manager in the UK and Japanese Equities Teams, until co-founding our Long Term Global Growth Team when it was established in 2003. Mark became a Partner in 2004.
YOU MAY ALSO LIKEInsights.Visit Baillie Gifford's Insights page.Mapping Veganville: journeying towards a vegan societyCan plant-based foods save the planet? Investment manager Brian Lum explores changing attitudes.Climate Change: Risk or Opportunity?Alicia Cowley, member of the Asia Client Service Team, is joined by ESG specialists Marianne Harper Gow and Michelle O’Keefe to discuss the burning question: Does climate change pose a risk to investment returns or are we able to identify investment opportunities in this area?A Passage for India.Whereas manufacturing once provided developing countries with a clear economic development path, robotics has made the route more challenging. Lawrence Burns explores the dilemma India now faces and suggests a possible route for its future development.