Saturday, July 18, 2009

A Little History

One of the things I like and have done pretty well is history. So this post is sort of a short information, or rather history, on the evolution of the business world. The top businesses in the early 1900s and now are as different as chalk and cheese. Only a handful survive, and even a lesser number of them prosper. Indeed, GE is the only company survivor remaining from the original 12 companies listed in the Dow Jones Industrial Average (formed in 1896), although GE may not have been continuously been in the DJIA index.

Here're the other 11 companies on the original Dow index: 1) American Cotton Oil Company (a distant ancestor of Bestfoods, now part of Unilever); 2) American Sugar Company, now Domino Foods; 3) American Tobacco Company, broken up in 1911 due to antitrust law, remnants now include Reynolds, Lorrillard Tobacco (part of Loews Corp.) and Liggett Vector Brands; 4) Chicago Gas Company, now part of Integrys Energy Group; 5) Distilling & Cattle Feeding Company, a division of LyondellBasell (filed for Chapter 11 early this year); 6) Laclede Gas Light Company which is still in operation as Laclede Group; 7) National Lead Company, now NL Industries; 8) North American Company, broken up in 1940s, some of which are remaining; 9) Tennessee Coal, Iron and Railroad Company, now part of U.S. Steel; 10) U.S. Leather Company, liquidated in 1952; 11) United States Rubber Company, changed its name to Uniroyal, and bought by Michelin in 1990.

This teaches me something: Business, like natural selection, evolves as the stronger replaces the weaker and the weaker gets eliminated. 99.99% of businesses are not built to last for century. Businesses are mostly built to do good in one area, seldom in a few. The moment that area is not one that consumers need, they are called to the sideline. Some of them deteriorates gradually while others, steeply and rapidly. All the time, there're many eyes wanting a share of the economy pie. Competitors aim to destroy competitors or take away existing business from others. Some manage to create a new market but a new market may impair the moat of the others though they may not seem quite to be in direct competition with the new market. Internet, cars, airplanes, computers. Look who they destroyed. Newspapers, horses, ships, writing equipments were in less demand. Computers are clearly invented for a new market but it destroyed many businesses that are not longer demanded by consumers - people do not need to write as much when you can do your documents on the computer.

Newspapers used to be one heck of a business, advertisers hate them but need them to penetrate the market. The industry started its decline in the early 1990s with the advent of information technology, in particular the Internet. The decline was gradual until picking up speed in the 2000s, and exacerbated by the recent financial crisis. Pricing power for print advertisements is lost once advertisers switch to advertising on Google, Yahoo, and now Tweetering, to reach their targeted audience. When economics of a business is permanently impaired, no amount of funding can save the business. In fact, if Internet is discovered before the print business, newspapers will not be part of history.

American Online had a rapid decline economically and financially. The narrowband (dial-up) internet service provider business is a died trade as soon as broadband is commercialized. No one will opt for slower access while wasting precious time and being frustrated at the same time. AOL saw clearly the degeneration of the narrowband service. AOL merged with Time Warner using its lofty share price as buying currency. Time Warner's stockholders were clearly short changed - more so with AOL ended with 55% of the merged entity - while AOL shareholders averted, quite clearly, a wipeout of its share price had AOL been independent. The main job of the management is to position the business for survival and prosperity which is clearly lacking from both AOL and Time Warner.

Changes can also caused rapid advances. Had fridge not been invented, sales of Coca Cola would not have run up so quickly. Coke tastes better when chilled - no one I can think of drink room-temperature Coke. That is not to say it is the single biggest factor to Coke's success. Coke operates in a highly competitive environment. Why would you chose Coke over so many other brands and flavors of aerated drinks? Coke has a winning marketing, distribution and psychology strategy. They simply won over consumers' share of mind.

History tells us that once a fundamental better product or service is developed into something commercially and economically viable, it can push business to its downfall or bring it to stratospheric level. Horses were replaced by cars when Ford had a commercially and economically viable car. People used to travel by ships but ship travels were a thing of the past once the Wright brothers' idea evolves into airliner.

But that doesn't means that new technology eliminate totally the whole of the old-world technology. Like species, that thrive in niches, will have a share of the economy pie deservingly. Value Line, the investing publishing firm with its own periodical, has a niche of their own. Its successful, Value Line Investing Survey, is an almost must-have for many investors. They are in the print business, their products are desired and wanted by investors because of the share of mind that they had created in the minds of its users, even faced with bigger competitors thrown around its castle and the tons of free information on the internet.

Who knows what will be the fate of oil companies when and if battery technology can power our needs viably?

So all these partly explain why none except one of the companies in the original DJIA's list survive as an independent and successful entity till today, although a few are now be part of a bigger entity. Then there are a few which may still be independent but are unsuccessful - consider NL Industries, Integrys Energy and Laclede Group, the biggest of them is Laclede with a market capitalization of $2.4 billion, the others are less than $800 million.

Now a little maths. When the Dow was first published, it stood at 40.94. Now it is 8500. For the Dow to go from 40.94 to 8500, it takes about every 15 years to double up. At this rate, the yearly return is compounded at 4.85% (excluding dividend).

Even if you take another period, from 1969 to 2009, Dow was about 900 in 1969. To go from 900 to 8500, it takes roughly every 13 years to double the index. The compounded rate of return is 5.7% roughly.

Of course, the measurement is taken at a time where the ending index is not normal. But even if we take a normal index, for example last year, it wouldn't affects too much, maybe add a percentage or so, and the years needed to double up is reduce by a year or so.

When GE was traded for the first time on June 23, 1892, there was only 1 trade (opposed to millions of trades today) of 50 shares at $108 per share. Since then, GE went through nine stock splits. When you do all the maths, each share in split-adjusted terms is worth 2.34 cents. So when you compare the price then and now, the stock has returned a whopping 51,200%.

Another period taken is from 1969 to now. In split-adjusted terms, the stock was 75 cents in 1969. The stock still gave a 1,600% gain. No less than a feat.

Wow! 51,200% or 1,600%, that's one hell on a deal. Impressive it may sound, but the truth is:
  • From 1892 to 2009, in a span of 117 years, it takes about every 13 years to double up, at a compounded rate of return of 5.54%.
  • From 1969 to 2009, it takes every 10 years to double up, at a compounded rate of 7,2%.
Nevertheless, it is still impressive stuff, and it doesn't take away the credit that GE is still a Hall-of-Framer of the business world. Firstly, GE is the sole survivor of the original Dow's list. And more importantly, they perform better than the Dow average of return.

Just some maths.


Daniel M. Ryan said...

Quite a trip down the past. Unfortunately, GE's recent performance has been panned by Barron's.

Penny Stock Blog said...

Great Blog