The South Dakota Investment Council’s Tenacious Investment

In 1985, the South Dakota Investment Council, which is responsible for the investment of financial assets owned by the State of (you guessed it) South Dakota, made an unremarkable decision. It bought $5 million in shares approximately 1,400,000 shares of Eastman Kodak (on a split-adjusted basis), the blue-chip film manufacturer that had a fifty-year track record of delivering 12.1% annual returns. 

As we all know, despite the fact that Eastman Kodak was once one of the most dominant business entities in the entire history of the United States, it lost nearly all of its market share as the world embraced digital photography and sales of photographic film shriveled to nothing. The company’s failure to establish a meaningful position in the world of digital photography (or any alternative) ultimately resulted in Kodak filing Chapter 11 bankruptcy in a New York federal court on January 19, 2012. 

The South Dakota Investment Council never sold its stock. At first blush, you might think, “That stinks for them, $5 million down the drain.” But that conclusion would omit an important detail. On January 4, 1994, Eastman Kodak spun off its chemical, fiber, and industrial materials division Eastman Chemical Company (EMN). Since Eastman Chemical was about one-fifth the size of the overall Eastman Kodak empire pre-split, each shareholder in Eastman Kodak received one share of Eastman Chemical for every four shares of Eastman Kodak that they held entering 1994.

This meant that the South Dakota Investment Council received 350,000 shares of Eastman Chemical in 1994, an ownership position that it holds to this day. Along with a few additional purchases along the way, the South Dakota Investment Council currently sits on 412,947 shares of Eastman Chemical that is worth $78.57 per share, or $32.4 billion. The original 350,000 shares are worth $27.5 million, and have paid out $8.4 million in cumulative dividends during its twenty-five years as a publicly traded company that have been redeployed to the benefit of South Dakota.

On a compounding basis, the original $5 million stake in Eastman Kodak grew into $35.9 million worth of Eastman Chemical shares and cash dividends generated from them. On one hand, that is only 6% compounding during a time period when the Dow Jones index compounded at a rate of almost 9%. But you should also recall that Eastman Kodak paid out decades of dividends between 1985 and 2011, and that would have added an additional $6.3 million in total cash disbursements that would bring the total to $42.2 million and an annual compounding rate of 6.5%. 

The State of South Dakota invested in an entity where 80% of the parent entity collapsed to effectively $0 and the long-term production from the initial investment allocation is still positive returns that were double the return of the inflation rate (i.e. South Dakotans doubled their purchasing power each year on average over the course of a thirty-four year holding period in the original Eastman Kodak). 

This is an important reminder of the oft-overlooked fact that nearly every publicly traded stock in the world is legally set up as a “perpetual entity.” When you buy a share of something and refuse to sell it, you get to collect the fruits of the cash it generates and capture the growth of the value of the business (in the form of capital gains) into infinity as long as the company does not go bankrupt. That is the only terminal event.And even in those rare instances, there are often spinoffs along the way as well as many years of cash dividends (that can be diversified into other operations) to offset the effects of the disappointments. 

Time and the receipt of cash dividends can be a very interesting tool for hedging one’s exposure to the business risks of your investment holdings. Even for declining businesses, a whole lot of cash can be extracted (and sometimes, even entire subsidiaries can be extracted) over the course of a multi-decade period that can put you in a position where you can even absorb a bankruptcy and simultaneously build wealth when viewed holistically. 

If a magic genie visited the South Dakota Investment Council’s managers in 1985 and said, “If you buy that Kodak stock, it will go bankrupt in 27 years. Now write down what you think you will leave the State in 2019.” Most of them might have written down 0%, or maybe 20% or 30% of the investment amount if they were thinking prospectively about the pooled dividends. I doubt many of them would have written down that the investment would be looking at nearly 600% cumulative returns in the aggregate. The 10.1% compounding from the $1 million in Eastman Chemical shares more than offset the nearly 100% loss from the $4 million in Eastman Kodak shares. 

The positive compounding of 6% to 6.5% is all the more outstanding when you fully internalize the fact that the Eastman Chemical shares were only a fifth of the original Eastman Kodak investment. That is why Jesse Livermore, after a lifetime of reflection upon Wall Street, said that the real wealth is made not in the selling, but the sitting. The South Dakota Investment Council understands this principle, as even its “mistake” investment selections have built wealth for the state. 

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