Let's play a little game based on one of Buffett's principles. Let's posit that they close the market for 20 years, but that the market closing has nothing to do with basic business conditions. The economy unfolds as it otherwise would have. Let's then take the five largest American companies by market cap and ask how an investment in them might fare if the next opportunity to sell shares were 20 years in the future. What would we stand to learn by conducting this thought experiment? How would it affect our overall view of the five companies? How would we evaluate their long term business risks? Their opportunities? Their hardihood and ability to persist, resist, withstand, and innovate?
But first, just for the fun of it, let's take a quick look at the past. Let's start with 1955, the first year in which Fortune published a ranking list for the largest 500 American companies.( Fortune 500: 1955 Archive Full List 1-100 CNN Money) It was also, coincidentally, the first year in which (age 11) I began reading the business section of the daily newspaper and following stocks. The five largest American companies by sales in 1955 were, in order, General Motors (NYSE:GM), Exxon (NYSE:XOM), U.S. Steel (NYSE:X), General Electric (NYSE:GE), and Esmark. What might we have said at the time about risks, opportunities, and persistence of these five companies? Think a moment before going on to the next paragraph.
I know the problem. What we think now is contaminated utterly by hindsight. We would embrace Exxon, then called Standard Oil of New Jersey (with the famous ticker symbol J). Oil is, after all, essential and "permanent." We would embrace GE (advertising tag line: "Progress is our most important product"). We would raise our eyebrows at General Motors. Sure, they just had a knockout year, but aren't the Germans cooking up a little export car that looks like a beetle, and what if oil prices start to go up? Won't the Japanese follow the Germans? As for U.S. Steel, the world will always need steel, a lot of it. But can they make that in Japan? In Korea? Can you imagine a world where steel is a smaller part of things?
You want to know the only thing I had even a hint of? I grew up in South Carolina. My dad was a textile executive and hated unions. Unions, he thought, were destroying America. Unions were the reason cars were terribly expensive for people where we lived, while the folks that made cars could buy our cotton cloth dirt cheap. The auto makers were paying those damned unionized workers in Detroit and northern steel mills. But they would get theirs eventually, my dad thought. They would eventually price themselves out of the market and maybe the whole U.S. industry with them. Over a long period of time his highly ideological view may have been sort of correct. If nothing else it would have been a good trigger for caution about General Motors and U.S. Steel.
And Esmark? What the heck was Esmark? Eventually it was a conglomerate, but in 1955 it was Swift and Company, a meat packer. This probably seems absurd, but Armour, another meat packer, was also in the top 10 and Cudahy, Morrell, and Hormel were all in the top 100. A fan of Spam (the old-fashioned kind), I might have tried to tell you in 1955 that meat-packing had a solid future. This is a good moment to note two things. Fortune compiles its rankings by sales, not market cap, and good data on market cap is not readily available that far back. Companies with more sales and lower margins, and probably lower valuations, are ranked a bit too high now that our major focus is market cap. Among those with weak profit margins were meat-packers, a measure I wouldn't have picked up on at the time (sticking to the Peter Lynch principle that I liked to have fried Spam and eggs for breakfast).
Profits might have been a better measure. By that measure the top four were about right. Esmark sinks, however (and would sink in a particularly interesting way in later years). A good replacement would be DuPont, which was higher on the profits list, ranking third in fact (better margins in chemicals). Note also that all of the companies have morphed to some degree, not just Esmark but notably Exxon (Standard Oil of New Jersey) which was the survivor in a merger with Mobil in 1999.
You can have your own fun by looking through the whole time series of Fortune 500 companies in rank order. After 1955 U.S. Steel began a steady fall. GM held on a little better. By 1980 Philip Morris appeared at number 4. Remember the golden years of smoking and cigarette companies whose incremental cost of production was virtually zero? The year 1999 is really fun. By then the rankings were available by market cap. The big four were Microsoft, GE, Cisco, and Wal-Mart. (Wal-Mart, a low-margin retailer, ranks far higher by sales in all years.) Remember when GE and Microsoft ran neck and neck for largest market cap, changing places on a day-to-day basis? And Cisco. Even I caught that one. I did some squirrelly arithmetic back then that I could use to explain to friends that Cisco would have to sell product stacked end to end from here to Jupiter to justify its market price. That was just sour grapes, of course, for not having bought it around 1995.
But what about the current big five?
The Big Five in 2013
Apple (NASDAQ:AAPL), Exxon Mobil, Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT), and Berkshire Hathaway (BRK.A, BRK.B) are currently the five largest American companies by market cap. (Large Caps - Top 20 by Market Capitalization - The Online Investor) They did not get there by accident. They got there by a history of doing things right. But what is their future? Let's now assume that the market is going to be closed for twenty years and ask how that makes us feel about each company.
I won't keep you in suspense. Apple is the one I would have the least confidence owning for twenty years with no opportunity to exit. In the short run the doubts about Apple have to do with the absence of Steve Jobs. Jobs was Apple and Apple was Jobs. He left some great things, including a huge pot of cash which could be used to pay a special dividend or engage in financial engineering. Lots of outsiders have ideas for ways that this cash could serve them, but nobody seems to have a real idea about how to use it to grow the company. Financial engineering and dividends don't keep you number one in market cap for long. And of course being number one to start with comes with another obvious problem: the size problem. Flanker products and little tweaks don't move the needle. But wait, there is a more generalized problem, having to do with what Apple has been at its core: the "genius" problem.
Becoming Apple wasn't easy, and going forward as Apple will be even harder. As a business Apple resembles writers, painters, musicians. Apple is the artist of businesses. Nothing is harder than being an artist. Artists wake up every morning knowing that they have to come up with something brilliant that day or the day is lost. That's the essence of the "genius problem." Lawyers, accountants, and engineers don't have that problem. They just have to put in a day of competent work, which is plenty hard enough but very doable with effort. Artists are different. I know from being one in my youth (a fiction writer) and being married to one (a visual artist) that inventing wonderful things for your place in the world creates anxiety like nothing else. I feel for Apple. It has to reinvent itself, if not every day, every year or so, and at a market cap of around 500 billion the odds are stacked against it. I'll pass.
(2) Exxon Mobil
Exxon is the stalwart of stalwarts. It was the second largest American company in 1955 (by sales) and it is the second largest (by market cap) today. That's 58 years, at least, and it was right up there before the S&P started measuring. What does consistency of this sort mean? It means institutional coherence and persistence, for one thing. They have learned how to do things right, and they have learned how to pass that knowledge along to the next generation. It also may mean that what they do isn't that hard to do. Given the difficulty of the engineering processes in finding and refining oil, along with the capital discipline to do it profitably, that may seem a dubious statement, but I think it applies. Exxon's business has been reasonably stable over its long life even as technologies have improved. Exxon has generally been at the forefront of these improvements. Exxon requires highly intelligent, highly competent, and highly motivated managers, scientists, and engineers. What it does not require is transformational artistic master strokes. It doesn't require genius. No iPods or iPads have to be invented every few years. Two bright kids in a garage aren't going to topple Exxon. For long life, the big winners are competence, persistence, and discipline.
Exxon has these qualities in spades. Even Exxon's "mistakes" have had a way of working out. Quite a few people doubted the Mobil merger and thought Exxon overpaid, but few doubt it now. The current "dumb move" is the $41 billion for XTO, a fracking pioneer with lots of nat gas reserves. Maybe they overpaid, but the more you think about future carbon taxes and environmental legislation the more logic begins to emerge from it.
Exxon probably isn't vulnerable to anything two kids in a garage can come up with, but they do have their vulnerabilities. Oil is getting harder and harder to find on the scale that Exxon requires. National oil companies are providing stiffer competition. Its costs are going up. There is also the outlier threat. One of the alternative sources of energy may break out swiftly into meaningful scale. Some event may force the world into recognition of the full environmental cost of energy (the Al Gore thesis) putting Exxon on the defensive in a life-threatening way. I wouldn't bet that way, however, maybe just take it into account when it comes to position size. The probabilities are on your side. I own Exxon and I'm keeping it. I think of it as a 20-year holding.
For a more detailed examination of Exxon as well as the last name on this list, see my recent article titled "It's Not So Much Why Buffett Bought Exxon Mobil, It's Why He Bought It Now."
Google also partakes of the "genius problem" although to a lesser degree than Apple. It was certainly thought up as a stroke of genius, but to a greater degree than Apple the moment of genius gave rise to an architecture which may sustain itself for some time, even grow with flankers and modifications, without another stroke of genius. That seems to be the case at the moment, anyway. There is wild talk in a number of areas such as Google taking over the enterprise of outer space exploration for humanity or fixing the environment or engaging one of the other major problems/opportunities of the world. This is natural thinking for a company which totally changed the way the whole human race deals with information. Do I think Google can then coast into leading another futuristic scenario? Not really. They might, but the odds are against it. There was an organic growth of Google from the original idea which won't be there in tackling those other tasks. They will stem from a list of tasks to address, not from a brainstorm. That's not how Google itself came into existence.
And there's the other side of the "genius problem." Google lives in a business sector populated by geniuses and you never know what they will come up with. Google looks pretty solid right now, but there may be a couple of kids out there with a half-formed notion that will jell and ultimately end up unseating Google. Maybe. Maybe not. I just can't estimate. I'm not sure anybody really can. Given twenty years quite a lot can happen in Google's domain. Perhaps over 20 years it will morph into something like a utility, albeit with an unusual revenue model. This would be an amusing outcome for a company created and to some degree managed by flower children who apparently time-traveled from the 1960s. The role of semi-regulated communications utility could mean moderately high returns over a long period. All in all I like Google better than Apple but not enough to lay down cash without any chance to exit. I just don't have enough visibility on long term risks and opportunities. Reluctantly, I have to pass.
Don't get me started on Microsoft. Just let me say that I went one for two on the two major calls you could have made on it. The good one first: I knew it was priced for absurdity in 2000 and never gave a thought to owning it. Now the bad call: I didn't buy it when it came out, either, or at any time in the next dozen or so years when it would have been brilliant to have done so. Microsoft was the stock that taught me that 35 times earnings is cheap for a company that is compounding earnings at a high rate. I learned this just by watching. I have made no use of this knowledge because when I prepare to hit the buy button on a stock like that I get a terrible scaly itch in the middle of my back where you can't scratch.
Where I got to like Microsoft, a little, was the last three or four years after it became a value stock. It has all that cash. It has smart people working there and associated with it (Gates, for heaven's sake, even at a distance). It could financial engineer itself until it looked like an acrobat walking on top of twenty foot stilts. It could figure out the cloud. It could sweep the board in games. It could buy startups. It could create startups. Heck, it could buy a railroad, a utility, a food stock, all of the above. One of the two times I bought it I was mentioning these reasons in the locker room to a good friend and U of C MBA. He looked at me, allowed a pregnant pause, and said three words: "imperiled business model." That tipped the scale and I backed out of the position, whereupon Mr. Softy promptly rallied 15%. I bought and held another time for about two months. Net net I made approximately three dollars and seventy-three cents ($3.73) in Microsoft, lifetime. That's about the same amount I am up lifetime playing a slot machine ($3.75 on a cross country bus trip in 1962 after which I decided to quit while I was ahead).
Would I hold Microsoft for 20 years? Just three words: imperiled business model. I'll quit while I'm ahead.
(5) Berkshire Hathaway
This is the hard one, in a way. Berkshire has enormous persistent advantages. Unlike the other four companies, it started from a small base (in 1965, the year of the Buffett takeover) and has gained steadily on the rest of the world ever since. If the trend persisted for twenty more years it would probably be number one on the market cap list. Is this likely to happen? I think it is actually fairly likely. Berkshire is a conglomerate made up of many relatively unassailable businesses (famous last words) including an enormous well-placed railroad, utilities, insurance companies, consumer brands, and niche companies in areas like machine tools. Instead of one huge atherosclerotic giant it is a collection of smaller and more manageable businesses run within a corporate framework that emphasizes quality, integrity, initiative, and capital discipline. It has a diversification of product that Exxon lacks, and in an odd way it is less a mega-cap than a collection of businesses of varying cap sizes. Quite a few people see it as an index substitute. This would seem the best of all worlds. What are the risks?
The big one, of course, is Warren Buffett's big deficiency: he lacks immortality. He's just like the rest of us, and the actuarial tables aren't on his side going out 20 years. Can Berkshire be anything like what it has been without Warren? I am willing to give it a tentative yes, and here's why. Insurance, railroads, and utilities are very persevering companies, and Buffett put together the best of breeds. The same is generally true of the smaller businesses that fill out his direct ownership portfolio. Good people are in place throughout Berkshire, including his new stock portfolio managers. No one will be quite like Buffett when it comes to making deals and opportunistic moves in bad market times, but these may not be the ultimate measures of success for Berkshire.
Consider Berkshire and Apple, Buffett and Jobs. There is one major difference between Buffett and Steve Jobs. Jobs was a genius and an artist. He did something that could be done only a few times, and only by him. He was not an institution builder. Buffett has always been adamant that he is not a genius, that genius is not required for what he does. Don't high jump, he says, find a low hurdle and step over it. Getting over low hurdles means being competent, smart, honest, and persistent in little things every day - in effect running dozens of smaller Exxons, with diversification. I believe that Buffett has managed to impart this way of coming at things not only to the next level of management but throughout Berkshire. I own Berkshire in size, and I'm keeping it.
Finally, this thought. Forcing oneself to look out 20 years isn't as much of a mind game as it might appear. A substantial part of the projected value of a business comes from cash flows and residual value estimates which are that far out and farther. If you are any kind of long term investor you very much want to have a good estimate of a company's health 20 years into the future.
All five or the largest U.S. companies possess many virtues - not least a low level of debt and high level of cash, giving them flexibility to invest in good opportunities or their own stock. Of the five largest U.S. companies by market cap the two I would be reasonably comfortable holding if the market were closed for 20 years are Berkshire and Exxon, in that order. That says a great deal about what I think of their industries, their managements, their moats, and their overall corporate architecture right now. I would be much less confident about the three innovative giants. Of the three I prefer Google but not enough to lay out cash for it as a long term holding.