Try to imagine what the S&P 500 will look like in 20 years – not the price but its components. It’s difficult to impossible.
As long-term investors we face the challenge of investing for a future of which we can’t foresee. The tenet of long-term investing therefore isn’t to predict those transformations but to find management teams and organizations that have proven themselves the most capable of adapting to those changes.
Many publications have pointed out the disappointing returns of the S&P 500, and by proxy the SPDR S&P 500 Trust, over the past decade. But few have pointed out the radical changes in the underlying components.
Iconic American companies have been replaced by others. Eastman Kodak was replaced by F5 Networks, Inc. (NASDAQ:FFIV). The New York Times was replaced by Netflix, Inc. (NASDAQ:NFLX).
According to a study conduced by Innosight, the average time a company spent listed on the S&P 500 was 61 years in 1958. By 1980, the average time dropped to 25 years. Today, the average company sits on the index for just 18 years.
Over the last decade, nearly half of the index has been replaced and the rate of change is only expected to accelerate.
Richard Foster, author of the book Creative Destruction, argued that the lifespan of a company is determined by how effectively management can:
- Run current operations efficiently
- Create new businesses to meet evolving consumer needs and
- Shred business that no longer meet company standards for growth and returns.
The only way companies can survive over the long term is to embrace creative destruction – the constant economic turmoil created by new technologies and business models. But few companies will achieve this goal and most fade with time.
The problem is that the goals listed above are in conflict. Companies often focus on current operations. Emphasis is placed on short-term profitability rather than managing their long-term evolution to keep pace with a changing economic environment.
Markets outperform companies – they always have with only a few exceptions. As investors, we want to find those exceptions.
Two companies embrace reinvention like no other.
International Business Machines Corp. (NYSE:IBM) has managed to survive a century in the fast moving technology sector by evolving from a tabulating company into an I.T. consulting powerhouse.
During the 1980’s, International Business Machines Corp. (NYSE:IBM) dominated the PC market. The segment grew revenues from $500 million in 1981 to $5.5 billion by 1984. But within a decade, International Business Machines Corp. (NYSE:IBM) had been replaced by more nimble competitors and the company was worth more broken apart than as a whole.