An (Old) Way To Pick (New) Stocks

| About: The Coca-Cola (KO)
This article is now exclusive for PRO subscribers.


For humans, or anything with an organic expiration date, the probability of dying rises with age.

For companies, it’s the exact opposite – a company’s probability of dying actually decreases with age.

This reverse aging process (called the “Lindy Effect”) implies that the oldest companies will last the longest, and vice versa.

Long-term investors can use the Lindy Effect to narrow down the stock universe to the most durable companies.

Companies are a lot like living organisms. They follow a cycle of birth, growth, decay, and death. Very few reach maturity or live long lives. Most perish within the first several years of their existence. But this isn't always the case. Some companies can last for decades, centuries, even millennia. Unlike living organisms, these long-lasting companies age in reverse. Their life expectancy actually increases as they get older. This phenomenon is called the "Lindy Effect." It says that the longer a company has been around, the longer it's likely to stay around. And the statistics back this up. The table below indeed shows that the probability of survival (red line) increases with a company's age, which makes sense. Companies that manage to survive the longest are the most robust and, hence, least likely to die. Or, as the legendary John D. Rockefeller put it, "The growth of a large business is merely the survival of the fittest."

A Company's Survival Potential is Proportional to its Life

Note: Of the nearly 570,000 companies started in 1994, half failed within five years, 65% failed within 10 years, and 80% failed within 20 years. The longer a company survived, the less likely it was to fail. (The risk of failing is obviously never zero, but it approaches zero.)

Source: A North Investments, Bureau of Labor Statistics

The Lindy Effect doesn't just apply to companies, however. It can actually predict the life expectancy of anything that doesn't have an organic expiration date. Take, for example, the Great Pyramid of Giza. It's safe to say that this 4,600-year-old engineering marvel will outlast most, if not all, modern buildings. Likewise, that old watch you inherited from your great-grandfather will probably be working long after your fancy new smartwatch breaks down. This often fools people into thinking that old things were made better than they are today. The real truth is that only the well-made things survived. We don't see the 99% of old things that weren't made to last. And this also goes for books, movies, music, etc. - only the best survive the passage of time to become classics. That's why a book that's been popular for centuries will most likely be popular for centuries longer. Such a prediction can't be made about a newly published book that hasn't stood the test of time.

Now, to be clear, the Lindy Effect is a probabilistic estimate of life expectancy. It works on average, not in every case. With that said, it can be a valuable addition to the investment toolbox. We can use it to filter through the massive universe of stocks to find the most durable companies. Super-investor Warren Buffett has made a lot of money using a Lindy Effect-style filter. Buffett intuitively understands that a company's true durability is a quality only revealed with time. This is why his portfolio is filled with 100-plus year-old companies that have passed the test of time. Like one of his largest holdings, Coca-Cola (NYSE:KO), for example. Coca-Cola's 130-year old soft drink business has survived world wars, depressions, recessions, and numerous setbacks and still managed to post consistent growth. This is an indicator of robustness, which makes Coca-Cola's future profits more predictable than, say, the profits of a younger company that hasn't faced any major stressors yet.

This also applies to dividends. Companies that have paid them (and grown them) through numerous economic cycles will likely continue to do so in the future. Indeed, it's highly unlikely that Coca-Cola's dividend, which has been paid since 1893, is going to get cut any time soon. The same can't be said about a young dividend payer, no matter how profitable and financially strong it might appear. As a case in point, the percentage of companies forced to eliminate their dividends more than quadrupled between 2006 and 2009 due to the recession. Most of these were young dividend payers that were earning record profits prior to the crisis. Over-relying on financial statements to determine dividend sustainability would have fooled you in this case. Successful dividend investors largely get this point, which is why they focus on companies with long dividend track records. Below is a list of 15 such companies that have been paying dividends for over 100 years, and will likely continue to pay them for decades to come.

Dividend Centenarians: Stocks Paying Dividends for 100 Years or More

Note: This list excludes utility and financial companies. David Fish's Champions, Contenders, and Challengers (or CCC) list is another good source for dividend investors.

Source: A North Investments

To conclude, the whole idea behind the Lindy Effect is that time is the best tester of fragility. It lets you know how vulnerable a company is to stressors. The longer a company has survived, the more difficulties, setbacks, and obstacles it's had to face - hence, the more robust it is. In simple terms, it means that a company's survival potential is proportional to its age. As such, we can use the Lindy Effect to filter out fragile companies and home in on the most durable ones. Unfortunately, this isn't as easy as it sounds. No publicly-available screeners (that I'm aware of) allow you to filter companies by age. So, I've compiled a list of all publicly-traded U.S. companies 100 years old or older. This list, which can be viewed here, is a great starting point for building a portfolio of stocks that you can hold for a lifetime.

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.