A cornerstone of Jeremy Siegel’s research in “Stocks for the Long Run” is that high-tech investments have a strong tendency to fizzle out over time. If you look at the best performing businesses over the past sixty years, they tend to sell products that are similar to what was being sold in the 1960s.
Colgate-Palmolive has been one of the best performers since 1956, and it is still selling toothpaste and soap. 3M is on the list, and its famous Post-It notes are still around. Pepsi is still on the list, and America continues to eat potato chips. A bunch of oil companies–Exxon, Shell, and Chevron–are on the list, and they’re still selling and transporting oil, chemicals and natural gas.
Selling the same goods or services over and over again becomes a competitive advantage for three reasons. First, when a company keeps selling the same thing, it tends to gain a reputation that leads to the creation of a brand (opening the door to charging premium prices). Secondly, as customers seek out a product and more items get sold, the bulk volume orders support economies of scale (opening the door to cutting costs of materials). And third, as a product line becomes increasingly entrenched, it is constantly improved upon. After all, today’s iteration of Hershey chocolate is a byproduct of five generations of businessmen trying to perfect the candy business.
Once a product is established for two generations, it is able to leverage the above elements and reach that blue-chip status that leads to reliable investment returns.
Investments in industries with rapid technological change almost never get to tap into the forces above because competitive survival often precludes tinkering with the maximizing profits. Perhaps the closest success stories that we have seen are Microsoft Office and the iPhone, which have lasted for a generation and half a generation respectively.
That is why, when you look at 20th century tech sector returns, IBM is the company you can point to that succeeded in creating multi-generational wealth.
It naturally makes you wonder: Is past prologue? Will only one firm out of Microsoft, Google/Alphabet, Amazon, Oracle, Cisco, and Apple prove to be the IBM investment of the next two generations?
I don’t think so. My expectation is that the future will be different for tech sector investors (a dangerous phrase, I know!) because they are sitting on so much cash that they can effectively insulate themselves from technological obsolescence when their now-successful product lines fade away.
It is more than theoretically possible that iPhones could cease to exist in twenty years and Apple stock could still deliver 8-10% annual returns for shareholders because the $200+ billion cash position could cobble together not-yet existence business lines that will provide the cash gushers of the future.
IBM was in the opposite position in the 1960s. Not only did it not have the equivalent of a $200 billion cash position, but it had incurred tens of billions of dollars in pension obligations as it compensated IBM engineers and hardware salesmen for their services during the mid-20th century. Employment contracts from the 1970s still linger in the form of IBM’s current $100 billion pension obligation (about $85 billion of which is currently funded.)
If you analyze tech stocks like Zillow or Trulia, the historical rule to avoid tech stocks as long-term investments still holds true. The competition is too brutal to support reliable returns. But the tech stocks with tens of billions of dollars in cash aren’t going anywhere because failure would require the collapse of their current business lines and also business line X, Y, and Z that get acquired in the meantime due to the cash pile.
I don’t know what Alphabet, Apple, and Microsoft are going to look like in 2040, but they’re still going to be around and pumping out cash. Their cash reserves are so high, and provide so many opportunities for business line diversification, that I cannot presume otherwise.
Originally posted 2018-01-15 10:20:56.