“I have no doubt that in reality the future will be vastly more surprising than anything I can imagine.”
– J. B. S. Haldane
In the 1967 movie, The Graduate, the young, newly minted college graduate is advised by a family friend that the future is about one word: “plastics.” The advice was a deliberately absurd laugh line, but in today’s era of unprecedented technical and societal change, we hear a great deal of similar advice delivered with perfect seriousness. Self-driving cars will change the world! We are on the cusp of revolutions in biotech, renewal energy, robotics, genetics, artificial intelligence, etc. Heck, we might even get flying cars and jet packs one day soon.
Any and all of these great changes might and probably even will happen and could very well revolutionize society, but things rarely work out quite as predicted — and even when they happen exactly as planned, trying to invest in the future is still a very, very risky thing to do.
Some investors believe they will make a fortune if they can only identify the companies that will create the revolutionary products and services of tomorrow. Others believe that established industry leaders such as Apple, Facebook, Google or Amazon will continue to grow, innovate and dominate their competitors and thereby reward investors with strong returns.
If only investing were so easy.
To demonstrate some of the perils in investing in the future, let’s consider a groundbreaking and prescient Time Magazine article published in April of 1965 on “The Computer in Society,” which detailed all the ways computers were changing the world.
According to the article, “As the most sophisticated and powerful of the tools devised by man, the computer has already affected whole areas of society, opening up vast new possibilities by its extraordinary feats of memory and calculation….It has given new horizons to the fields of science and medicine, changed the techniques of education and improved the efficiency of government. It has affected military strategy, increased human productivity, made many products less expensive and greatly lowered the barriers to knowledge.”
Time noted that IBM was then the leading global computer company, with 74% of the U.S. computer market, “a dominance that leads some to refer to the industry as ‘IBM and the Seven Dwarfs.’ The dwarfs, small only by comparison with giant IBM: Sperry Rand, RCA, Control Data, General Electric, NCR, Burroughs, Honeywell.”
But Time’s reporting was already behind the times, neglecting to mention a computer firm which would transform technology and computing and become one of the 20 largest companies in America as well as the grandfather of Silicon Valley. Founded in a garage in Menlo Park, CA, in 1947, Hewlett Packard (HP) would enter the computer market in 1966 with the HP 2116A minicomputer — one of the first portable and “plug and play” computers.
As a thought experiment, let’s say that you were convinced by the Time article that computers would change the world and called your stockbroker and invested $100 in IBM as well as in each of the Seven Dwarfs at the beginning of 1966. After all, you wouldn’t want to put all your money in just one stock. You’ve also heard something about HP, so you invest $100 in their stock, as well as $100 in the S&P 500 for a little more diversification. If you’d stayed invested for the next 50+ years through 2016, here’s how your investment in the future would have done…
Some winners, some losers, but overall not too bad. Looks like investing in the future was a pretty good idea, until you consider the top-performing stock of that same period — a company that makes a heavily regulated, low-tech product. If you had invested $100 in Phillip Morris/Altria, it would have grown to $549,087 by 2016. Who would have thought in 1966 (and certainly in 2017) that tobacco, not computers would win the future (at least in terms of returns).
Even if you had known in 1966 everything that would happen in the world (except stock prices) over the next five decades, do you think you would have invested in tobacco stocks not tech? Like many of the realities of the stock market, it makes no intuitive sense.
Some of the other top-performing stocks over this period were also surprisingly non-innovative and low tech. For example, Coca Cola returned $34,403 and its cola rival Pepsico returned $21,084, better than any of the tech companies that would change the future.
Or in the shorter-term, let’s look at the summer of 2004 when two firms went public, Google and Domino’s Pizza. One of these is a leading tech firm that revolutionized internet search, mapping, email and possibly, driverless cars. The other makes less than gourmet pizza. Most rational investors given the choice between the two firms would naturally assume that Google was the better investment. And they certainly did well over this period, returning 1,555% through January 14 2017. But Domino’s delivered a cumulative 2,401% return.
Or consider the top performing stocks of the Obama administration. While some, such as Netflix and Priceline were indeed innovators, the best performer was a chain of salons/beauty stores best known for their discounts, ULTA Salon, which returned 4,350%.
Why should this be the case? What are some of the risks in investing in innovation?
Many times, innovative companies fall victim to second mover advantage as other firms build on and enhance the original technology. Think of how social media platforms like My Space were superseded by Facebook or smartphone makers like Blackberry were outmoded by Apple’s iPhone. It is hard to know whether a company will be a failed leader or a successful follower.
Also, the initial results of innovation can be hard to maintain. Think of once great firms such as Wang Computers or Nokia or Kodak (the inventor of the digital camera) that could not keep up and fell by the wayside. By market capitalization, Apple is the largest company in the world. Millions of people use — and love — their products. But will they still be a tech leader 10 years from now? 20?
Newer industries often deliver disappointing returns when investors turn out to be too optimistic about the potential for future growth. As Professor Jeremy Siegel, an authority on long-term investing, notes: “Investors have a propensity to overpay for the ‘new’ while ignoring the ‘old’ … growth is so avidly sought after that it lures investors into overpriced stocks in changing and competitive industries, where the few big winners cannot compensate for the myriad of losers.”2
In comparison to growth stocks, which are very often innovative, forward-looking companies with strong earnings growth (or potential growth), value stocks are usually associated with generally less-innovative corporations that have experienced slower earnings growth or sales, or have recently experienced business difficulties, causing their stock prices to fall. Academic research has shown however that value company stocks have greater expected returns — and greater risk — than growth company stocks. Since 1927, U.S. Large Value stocks have returned 10.51% vs 9.43%3 for U.S. Large Growth stocks. This makes sense, since riskier companies must offer a higher potential return to attract investors.
In addition, old industries often continue to be surprisingly profitable. Consider the U.S. transportation index. From 1900 – 2015, railroads were the top performers, beating airlines, road transport (which joined the index in 1926) and the U.S. market, while airlines (which joined the index in 1934) trailed the market substantially.4 As Warren Buffet said about the Wright Brothers, “If a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”
The future may be uncertain, and the great companies of tomorrow may not always be the best investments. But the future, taken as a whole, may be the best investment many of us make.
If we are prepared to take a patient, long-term perspective and buy and hold securities from thousands of great companies around the world, we may benefit from two powerful forces:
1. Compounding, which allows your money to grow exponentially over time. If your portfolio grows an average of 6%, for example, it will double every twelve years. In 48 years, $100,000 growing at this rate becomes $1.6 million.
2. The dynamic potential of stock markets, fueled by human innovation, to create enduring wealth over time.
We don’t know which firms will be the next Domino’s or Google. We don’t know which firms will soar and which will fail, which will invent amazing new products and which will make money by doing what they have always done. But if we own many of them and invest for the future, chances are we will be rewarded over the long term.
By J. William G. Chettle April 6, 2017