Long's Law YTD

by: Harry Long


The index has continued to crush the market.

Oligopolies are always in style.

The robber barons understood that, and so should you.

Long's Law states that long-term free cash flow margins (FCF/revenue) in any industry over a multi-decade time frame tend towards the inverse of the number of competitors in that industry.

For example, in an industry with three competitors, FCF margins will tend towards 33.33% or 1/3. However, Economic "Laws" should best be termed Economic "Tendencies." The rule roughly holds across a vast array of industries.

Previously, we examined a portfolio of oligopoly businesses. Here is the refined group, combined with a bond allocation. It continues to trounce the market YTD:

Visa (NYSE:V)

MasterCard (NYSE:MA),




Moody's (NYSE:MCO),

McGraw-Hill Financial (NYSE:MHFI)

Alphabet (NASDAQ:GOOG)

Direxion 20+ Year Treasury Bull 3X (NYSEARCA:TMF)

Here are the results:

Click to enlarge

The index does well on an absolute and a relative basis vs. the S&P 500:

This index is very interesting because it provides downside protection in a dropping or sideways market, not only because of the high quality of its holdings, but also because of the allocation to TMF, which gives exposure to 3X leveraged long duration U.S. government bonds. However, the index gives exposure to sharply rising markets as well.

The major risk of this index is that, because there are very few truly oligopolistic firms with little competition, the index is extremely non-diversified. This is focus investing on steroids, which I have publicly warned against. This index is a great way to tracking the performance of wide-moat businesses, however.

It is worth exploring these wide-moat businesses more thoroughly, especially after a crash in the equity markets. These companies rarely go on sale, but oligopolies plus leveraged long-duration government bonds can give an eye-popping result.

Network Effect Businesses are the only category of business in which market share reinforces the competitive advantage of the businesses themselves. For instance, most merchants accept Visa and MasterCard, because most customers use Visa and MasterCard. This same logic applies to major futures exchanges such as ICE, CME, and CBOE.

Major Credit Rating Agencies are firms which have historically served as the de facto regulators of bond markets. For a variety of reasons too highly complex to go into in this article, this business has historically tended towards oligopoly. Selling opinions for money, especially with few major competitors, is a fine business indeed for McGraw-Hill Financial, which owns Standard & Poor's, and for Moody's.

Internet Search is dominated by Alphabet/Google because its algorithms are so advanced that users are served up highly accurate results. I cannot predict if this business will be shaken up by abrupt and discontinuous technological advances in the future. Your risk factor here is a brilliant man or woman in the proverbial garage (a.k.a., what Google started as).

Most importantly, this collection of businesses are the modern day toll bridges of electronic payments, futures trading, bond issuance, and information. In each of the diverse industries in which each company operates, the toll that each extracts is so durable that it almost might as well be a tax.

Owning toll bridges in economically important industries is incredibly lucrative. Just keep your eye on any brewing competition.

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Remember, hope is for people who do not use data. Wise investors plan using evidence-based methods.

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.