What is a Lindy Stock?
Warren Buffett's lesson that few understand.
Hi Everyone,
The Lindy effect asserts that the longer a narrative, idea, or brand has lasted, the more likely it is to survive in the future. Ideas that have been around a long time are more likely to be around in the future than new ideas. Old ideas are tried and true. New ideas are unproven. What if we apply this principle to investing and stock picking? Will it help us find superior companies that have a low risk of losing money?
The Lindy Effect estimates life expectancy. It does not apply to every single firm. A company with a 100-year lifespan can be expected to live another 100 years. Of course, other circumstances come into play in the real world, and some 100-year-old enterprises will die within the next year. Some will survive for hundreds of years. But as Buffett says: "It is better to be approximately right than precisely wrong.” In this context, it means that you’re better off looking to invest in established businesses/sectors than in IPOs. Be approximately right by fishing in the right pond from the start.
Buffett and Munger have always emphasized long-term investing and bemoaned the fact that most investors think and act in the short term. Most people learn notions like an economic moat, excellent capital allocators, a circle of competence, and so on from these two investing legends. These are important lessons, but they are not the most important. Most importantly, think Lindy, something I believe most Buffett fans have completely overlooked.
The longer a company has been around, the greater the 'probability' that it will continue to exist. This is because organizations that endure the longest - by surviving multiple business cycles and competitors - are the most durable and, as a result, the least likely to die. And this is a key factor to consider as you go through your investing checklist: How long a company has been in operation and how successfully or poorly it has performed throughout the years. A company may stay small even after 50 years of operations, due to the niche industry/market it services, such as tractor parts, specialty chemicals, local area banks, and so on, yet such companies may also live and grow for another 50 years. So you should check for a long track record of the company and its management.
All else being equal, we would anticipate older enterprises to earn greater valuation multiples if the Lindy Effect remains true. This appears not to be the case. Young enterprises tend to trade at higher market prices (Take tech IPOs and the hype around them for example). When tried and true firms trade for less than younger enterprises, long-term investors can purchase into established businesses and profit from them in the long run. An excellent opportunity for the savvy investor.
What does Warren Buffett look for in a business?
“We select investments on a long-term basis, weighing the same factors as would be involved in the purchase of 100% of an operating business:
(1) favorable long-term economic characteristics;
(2) competent and honest management;
(3) purchase price attractive when measured against the yardstick of value to a private owner; and
(4) an industry with which we are familiar and whose long-term business characteristics we feel competent to judge." Warren Buffett
Numbers 1 and 4 are important in this context. An established business in an established industry will likely compound your wealth over the long run. The probability of success is higher. And, as my readers know, successful investing is about bringing the odds on your side. When you have a high probability that a company will survive another few decades, your risk of losing money decreases. The longevity of companies brings us to another important benefit: Dividends.
Companies that have paid them (and grown them) through multiple economic cycles are likely to do so again in the future. Here is an overview of some companies that paid uninterrupted dividends for more than 100 years. You will notice that none of them is in an “exciting” sector:
Chubb CB 0.00%↑ (Insurance/ Consecutive dividends since 1902)
PPG Industries PPG 0.00%↑ (Industrials/ Consecutive dividends since 1899)
General Mills GIS 0.00%↑ (Consumer Staples/ Consecutive dividends since 1898)
Colgate-Palmolive CL 0.00%↑ (Consumer Staples/ Consecutive dividends since 1895)
Consolidated Edison ED 0.00%↑ (Utilities/ Consecutive dividends since 1885)
York Water YORW 0.00%↑ (Utilities/ Consecutive dividends since 1815)
Bank of Montreal BMO 0.00%↑ (Banks/ Consecutive dividends since 1829)
Bank of Nova Scotia BNS 0.00%↑ (Banks/ Consecutive dividends since 1832)
Of course, one could argue that technology in today’s form didn’t exist 100 years ago (that’s why it’s not included) and the stocks above are part of survivorship bias. This is correct but doesn’t change the point that companies that have operated successfully for such a long time have a high probability to continue so in the future.
Final Thoughts
Industries that have been around for 100+ years (banking, insurance, disposable consumer goods, food and beverages, and others) are easier to judge than new industries (social media, search, biopharmaceuticals) because there is more history to them. Note that such companies will usually not give you big profits. Nevertheless, investors should not ignore what has historically performed well, and small profits accumulate over time. A good portfolio should be built from several sectors and factors, therefore stocks from boring but stable industries form a good basis. A good sports team cannot be made up exclusively of strikers who score goals, it needs some defensive players. Most importantly, investors can pre-select their stocks from the mentioned industries. Industries that have stood the test of time and have provided reliable income. The dividend challengers (5-9 consecutive years of dividend growth) of today can become the dividend contenders (10-24 consecutive years of dividend growth) of tomorrow. The dividend contenders of today can become the dividend champions (25-49 years consecutive dividend growth) of tomorrow and so on…
I hope you learned something today, until the next issue. 👋