At The Money: At the Money: Learning Lifecycles of Companies. (August 21, 2024)
The Magnificent Seven, the Nifty Fifty, FAANG: Each of these were popular groups of companies investors erroneously believed they could “Set & Forget,” put them away forever, and you’re set for life. But as history informs us, the list of once-great companies that dominated their eras and then declined is long.
Full transcript below.
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About this week’s guest:
Professor Aswath Damodaran of NYU Stern School of Business is known as the Dean of Valuation. His newest book, “The Corporate Life Cycle: Business Investment and Management Implications” is out today.
For more info, see:
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TRANSCRIPT
The Magnificent Seven, the Nifty Fifty, Fang Stocks. These describe those must-own, “Set & Forget” companies that absolutely have to be in your portfolio if you want to keep up. Buy them, own them, put them away forever, and you’re set for life.
Or are you? The list of once-great companies that dominated their eras is long: Sears, Woolworth, AT&T, General Motors, Worldcom. Remember market darling General Electric? It dominated the 1990s, it’s now a fraction of its former glory.
These stocks are not one offs. They’re the normal fate of all companies. I’m Barry Ritholtz, and on today’s edition of At The Money, we’re going to explain what you need to understand: All companies go through a normal life cycle.
To help us unpack all of this and what it means for your portfolio, let’s bring in Professor Aswath Damodaran of NYU Stern School of Business. He has written numerous books on valuation and finance. His newest book is out this month, “The Corporate Life Cycle,” Business Investment and Management Implications.
So Professor, let’s start with your basic premise. Tell us about the concept of corporate life cycles and how they’re similar to human life cycles and go through specific stages of growth and decline.
Aswath Damodaran: Let’s start with the similarities. I mean, aging brings its benefits and its costs, right? The benefits of aging is I now can get the senior discount at Denny’s on the pot roast.
Now, So that’s a minor benefit, but also brings the benefit of more financial security. You’re not responding. I mean, you don’t have the responsibilities you’d had when you’re younger, but it does come with constraints. I can’t jump out of bed anymore. So aging comes with pluses and minuses. And when I think about businesses, I think about in the same way.
A very young, a startup is like a baby, needs constant care and attention and capital. A young company is like a toddler, a very young company. You age, you become a corporate teenager, which means you have lots of potential, but you put it at risk every day. And then you move through the cycle just like a human being does.
And just like human beings, companies fight aging. They want to be young again. And you know what? There’s an ecosystem out there that is designed to tell companies they can be young again. Consultants, bankers, selling them products saying you can be young again. I think more money is wasted by companies not acting their age than any other single action that companies take.
And that’s at the core of how I think about corporate life cycles. You have an age at that age.
Barry Ritholtz: That’s really fascinating. I love the, the five specific stages of that corporate life cycle. You describe startup, growth, mature growth, mature decline, and distress. Tell us a little bit about the distinct features of each of those stages.
Aswath Damodaran: The challenge you face when you’re a young company is survival. I mean, two thirds of startups don’t make it to year two. Forget about year five, year ten. So as a startup, you don’t have a business yet. You’ve got a great idea, and most of these great ideas just crash and burn. They never make it to the business stage.
So that stage, you need somebody who’s an idea person who can come up with this great idea, convince employees, convince consumers that the idea can be converted to a product. It’s all about story. You’re telling a story.
The second stage, you’re building a business. Very different skill set, right? Supply chains. You’ve got to manufacture your product. You’ve got to get it out there. Third stage, you’re now an established business model. You’re asking, can I scale this up? Remember, most companies can’t scale up. They hit a ceiling and then they stop. Some companies are special. They’re able to keep growing even as they get bigger.
You mentioned the Fangam, the Mag 7, and if you look at what they share in common is they were able to grow even as they got bigger. That’s what made them special.
And then you become middle aged, a mature company, you’re playing defense. Why? Because everybody’s coming after your market. You could argue that even among the Mag 7, Apple is playing more defense than offense. They have the smartphone. It’s at 75 percent of their value. They’ve got to protect that smartphone business.
Then you’re going to decline. And companies don’t like this. Managers don’t like it. It will bring decline. You’re just managing your business as it gets smaller. It’s not your fault. It’s not because you’re a bad manager, but because your business has started shrinking.
So at each stage, the skill sets you need, the mindset you need, the challenges you face will be different. And that’s why you often have to change management as you go through the life cycle.
Barry Ritholtz: So let’s talk about those transition points between each of those stages. They seem to be particularly dangerous for companies that don’t adapt, at least don’t adapt well to that next stage. Tell us about those transition points.
Aswath Damodaran: Transition points are painful. I mean, they’re painful for humans. They’re painful for companies. The transition point for an idea company becoming a young company is coming up with a business model. Doesn’t happen overnight. You got to try three or four or five before one works.
The transition point for a young company becoming a growth company is what I call a bar mitzvah moment. Because when you’re a young company, companies cut you slack. You know, investors cut you slack. They let you grow. You can talk about the number of users and the number of subscribers you have, and they push up your value. But there will be a point where those investors are going to turn to and say, how are you going to make money?
You know, how many young companies are not ready for that question? I mean, that’s what to me separated Facebook from Twitter. Facebook, whatever you think about Mark Zuckerberg, was ready for that question when it was asked. It had a model. It could tell you how it met. Twitter’s never quite figured out how to make money. And it’s not a young company anymore. It failed its bar mitzvah moment because it wasn’t ready for that question.
So when I think about life cycles, I think about transition moments and good managers are ready for the next transition moment. They’re not caught by surprise, but it’s not easy to do.
Barry Ritholtz: Do these life cycle stages vary across different industries, or is it pretty much the same for all companies?
Aswath Damodaran: Oh, there, there, and this is where corporate life cycles and human life cycles are different. A corporate life cycle can vary dramatically in terms of duration. The oldest, you know, company in history was a company called Kongo Gumi. I’m sure you know, I don’t know whether you’ve heard of it. It’s a Japanese business that was started in 571 AD. It lasted 1500 years. And all it did was Build Japanese shrines. That was its core business.
It stayed, stayed alive for 1500 years. Why? Because it stayed small. It was family run. There was a succession plan and it never got distracted.
If you look across publicly traded companies now, there are some companies to become an established company, you have to spend decades in the wilderness. I mean, you mentioned GE and GM. Think of how long it took those companies to go from being startups to being established companies. Because they had to build plants and factories.
In contrast, we think about, think of a company like Yahoo founded in 1992. Becomes a hundred billion dollar company in 1999. So what took Ford seven decades to do, Yahoo did in seven years.
But here’s the catch. It took Yahoo only seven years to get to the top. They stayed at the top for exactly four years. You can date their fall to when Google entered the market. And think of how quickly Yahoo disappeared.
So the capital intensity of your business matters. Your business strategy matters. And one of the things I think we’ve kind of encouraged and pushed in the 21st century, and I’m not sure if it’s a good thing or a bad thing, is we’ve designed business models that can scale up quickly with very little capital.
Think Uber, think Airbnb, intermediary businesses. But the challenge with these businesses is it’s going to be very difficult for them to stay at the top for long. And when they go into decline, it’s going to be precipitous.
I think that changes the way we think about the corporate life cycle of the 21st century company versus the 20th century company.
And I’m afraid business schools are not ready. All of what we teach in business schools is for the 20th century company. And the 21st century company might have a much shorter life cycle and it will require a very different set of business strategies and decision making processes than the 20th century companies.
Barry Ritholtz: So let’s talk about some of those decision making processes. If I’m an investor looking at companies in different life cycle stages, will that affect the type of valuation technique I should bring to analyzing that company?
Aswath Damodaran: It’s not so much evaluation technique, but the estimation processes are going to vary.
I mean, let’s take an example. Let’s suppose you’re valuing Coca Cola. You have the benefit of a hundred years of history. You know their business model. You can draw on just data and extrapolate. You could be just a pure number cruncher. It’s all about projecting the numbers out, and you’re going to be okay.
But if I came to you with Zoom or Peloton or Palantir, and I asked you to value now, there’s not a whole lot of historical data you can pull on, and that historical data is not that reliable. So the difference, I think, is you have fewer crutches when you value young companies.
You have less to draw on and that’s going to make you uncomfortable.
And you got to be willing to live with that discomfort and make your best estimates.
One of my concerns when I have students in my class is they’re so concerned about getting things right. So how do I know I’m right? And I tell them, you’re definitely going to be wrong, accept it and move on. With young companies, you have to accept the premise that the numbers you’re going to come up with are going to be estimates that are going to be wrong. And you’re going to be willing to say I was wrong and revisit those estimates.
And that’s a mindset shift that some people can make, and some people have trouble with. They’re so caught up in being right, they can never admit they’re wrong.
Barry Ritholtz: So let’s talk about different investment strategies and philosophies like growth or value investing. How do these align with different life cycle stages? I would imagine a young startup might be more attractive to a growth investor, and a mature company might be more attracted to a value investor.
Aswath Damodaran: We self select, right? We think about growth investing is including venture capital at one extreme to, you know, the Magellan’s of the world.
We buy high growth companies, and growth companies tend to be focused in on the younger stage companies. You know, value investing tends to be focused on more mature and declining companies. That’s okay, as long as you recognize that, because what it will do is create portfolios that are kind of loaded up with those kinds of companies.
Think about one of Warren Buffett’s laments is that he never invested in technology companies early in the cycle until Apple came along. If you looked at Berkshire Hathaway’s investments, they tend to be in mature companies.
But that shouldn’t be a lament. The approach that value investors, at least old time value investors took, almost self-selected those companies. It would have been impossible for you to buy a young growth company because you are so caught up in buying stocks with low PE ratios, or lots of book value, lots of cash, that you essentially missed those companies because you were designed to miss them.
So I think as long as people recognize that your investment philosophy will lead you to kind of cluster in one section of the life cycle – which will create risks and dangers for your portfolio. I think you’re okay. But I think that people who tend to be blind to that often miss the risks that come with their investment philosophy.
Barry Ritholtz: So there are some companies that seem to successfully transition between the various stages you’ve identified. How should investors think about these companies? How can they identify when a management team has figured out how to transition from, growth to mature growth?
Aswath Damodaran: I’ll give you two examples. This year (2024) both Google and Facebook initiated dividends for the first time in their history. And I was happy. I own both stocks. And the reason I was happy is let’s face Google and Facebook are not young growth companies anymore. They’re trillion dollar companies which are looking at earnings growth in the long term, probably in the high single digits.
And when people look at 8% growth, they say, well, that’s disappointing. You have to recognize you’re a trillion dollar company growing at 8%. That’s a healthy growth rate. And I think what impressed me about both Google and Facebook, and I call them by their old names, not Meta & Alphabet is the management seems to be realistic about where they’re on the life cycle. That’s what paying dividends tells you is we understand we’re no longer young growth companies. We’re more mature and we’re going to behave like more mature companies.
And I think that again reflects what I said earlier. If you act your age, it’s a much, much healthier sign for your company. It doesn’t mean you’re not going to grow, but you’re going to grow in a healthy way.
Barry Ritholtz: So it sounds like you’re talking about both adaptability and then transformation between stages.
Aswath Damodaran: And a management team that recognizes that, that what you need as a company will shift depending on where you’re in the life cycle. You’re not overreaching.
Barry Ritholtz: So to wrap up, all companies go through corporate life cycles, they’re startups, they grow, they mature, and eventually they decline. Understanding this life cycle, identifying when management is transitioning appropriately, identifying these companies at the right valuation is the key for long term investing in individual companies.
If you’re paying too much for a company in a mature decline or even distress segment, your portfolio is not going to be happy.
I’m Barry Ritholtz. You’ve been listening to Bloomberg’s At The Money.
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