We at Stallion Asset strongly believe that there are 3 Ways to Learn Investing
1) Study of history of last 50 years (Experience of Market Cycles)
2) Study of what Stocks have created wealth (Factors that make money)
3) Study of People who have created Wealth and How (Qualitative factors that make money)”
This blog is about the Second factor i.e. Stocks that have created wealth in the Long term. The biggest problem in being a long term Investor is that most business’ get worse with size & growth rates fall down hence its really difficult to hold stocks for the long term. Smart investors use this opportunity to shift out from low growth stocks to higher growth stocks to get their expected returns.
The Idea of long term Investments is buy business’ that get better with size not worse.
Jeremy Siegel in his book “Stocks for the long run” did a study of the 20 biggest winners from 1957 to 2012 (55 Years) and the results were surprising. Out of 20 Biggest winners, 12 were consumer companies, 4 were Healthcare companies.
In the Same book, the weights of Consumer, Financials, Health Care & Information Technology was 10% in 1957 of total S&P 500 Market Cap, whereas by end of 2012 the weight of these four sectors rose to 57% of Total S&P market cap. Of course this can happen as more business’ of this sector got included in S&P 500 but remember S&P 500 includes the most successful 500 Companies in America.
Surprisingly the World’s most Popular Long Term investor Warren Buffet in December 2018 disclosure had 45% Weight in Financial, 23% in Technology, 18% in Consumer Staples i.e. 86% of Portfolio in these 3 sectors.
We Went back 10 years in 2008 end (This is when Financial crisis was at Peak) and we found the story to be similar. Buffet had 45% in Consumer Staples,22% weight in Financials(even after a massive fall of 50-70% in financial stocks) & 6% in Healthcare.
Why are smart long term Investors backing Financial Services, Consumer, HealthCare & Information technology Companies, History also tells the same thing these kind of companies do well but why?
The Reason is Simple, they get better with Size. A construction company doesn’t get better with size infact a small economic slowdown can trigger massive volatility in Earnings, A steel company has no correlation with size as the price is going to be exactly the same weather you produce 10 Million tonnes or 1 million tones, Similarily an Airline companies as it gets bigger will have to get into less profitable routes as that’s the only way to grow.
Long term Investments need to get better with Size not worse!
Financial Services – Given an option to Open an Account with HDFC Bank or a New bank with 100 Branches where would you open your account? The answer is simple a bigger bank who has more ATM’s, more Branches & More products. If you are a Shark in a Ocean like HDFC Bank you simply sell more to the same customer. HDFC bank Serves 8000 Customer per branch & in a company like India where credit + Saving + Protection will be growing at 15% YOY for next 10-15 years. HDFC Bank just keeps getting better with size as it introduces new products & Scale them in no times like insurance & wealth products.
Consumer companies – You may produce a better product than Fair & Lovely for fairness but how would you distribute it to lakhs of Retailers? The game of Consumer Staples is distribution, the bigger you get you can keep selling old products as well as keep introducing new products to the same channel. Lately i have started learning start up Investing and have spend sometime with both start up companies as well as old consumer legends. The game the Big Consumer companies play is simple – The second a Consumer company like Marico see’s one product of a smaller competitor reaching 25-30 Crore of sales which typically means that the product is solving a problem & is loved by the consumer, they come out with similar product & use distribution network to sell it to millions via their distribution network. Here again being Large works in your favour & not against you. You just have to see which products are doing good, replicate it & Distribute it.
Pharmaceutical – Most IT & Pharmaceutical companies in India are B2B outsourcing kind of business model whereas typically companies with large R&D Expense and massive marketing network have done fabulous compounding in the past like Abbott has done a 14% CAGR from 1957 to 2012 as it became bigger it could invest more into R&D which other smaller players couldn’t. Even if the Smaller players got a patent they had to partner with a larger player for distribution. The Business model of Larger companies kept getting better with size.
Consumer Technology companies like Google, Facebook, You tube, Amazon are all winners take all game. The bigger you get, its next to impossible for a smaller player to solve the same problem. You go to instagram, because your friends are on instagram. The Moat here is a large network effect. Content marketers use youtube because the audience is on youtube & the audience is on youtube because majority of content is on youtube. The Bigger these business model’s get the better is it for me. They become better with size.
Conclusion – Are you holding business’ that are getting better with Size or Worse?
Disclosure – Stallion Asset is a Equity Research company & this blog is for educational purpose only.