How quality companies evolve in changing environments
The Greek philosopher Heraclitus would have felt very at home in financial markets. Fluctuation has always been a defining feature of both the stock market and the politico-economic environment: from the austerity of the 1950s, to the terrible inflationary years of the mid-1970s, to the roaring exuberance of the 1980s and late 1990s.
As a result, investment themes come and go. In 2015, for instance, anything with exposure to energy and emerging markets is down in the dumps, while investors cling dearly to the shares of companies with cyclical exposure to the UK economy. How different to 2011 when all talk was of the commodity super cycle and the UK economy was threatening a double-dip recession. Or 1973 for that matter when oil was the place to be and the UK economy certainly was not.
One of the nice things about owning good quality shares operating in mature, rational industries is that they tend to be successful at incrementally adapting to changing conditions in the economy, the political environment and in their own sectors. Indeed, they must avoid being rendered obsolete. International expansion is also something we like – it helps to mitigate political and economic risk at the national level.
Unilever, for instance, would not have been able to grow its dividend by more than 10% per annum since the 1960s by just sticking to selling palm oil and margarine. It has moved on, developed new brands (it launched Dove, for instance, in 1957, a €1bn brand today) and expanded into new areas. Unilever continues to evolve, building out its presence in the fast-growing categories of personal care and beauty for instance, over the last few years. The company was recently reclassified from a food manufacturer to a personal care company in various stock market groupings, reflecting this shift. Nor does Johnson & Johnson still have the same product portfolio it did in 1962 when it began its track record of 53 consecutive dividend increases.
So even when, as an investor, you ‘do nothing’ to a portfolio, under the surface there are thousands of people (employees of the companies held within a portfolio) getting up every morning and reacting to a changing world. This is not something that the short-term investor cares much about, but it matters for the long-term investor.
I think, for instance, of Diageo’s issues with inventory over the last two years and the changes the company has now made to sales incentive structures to address the issues; the steady progress Astrazeneca has made to rebuild its pipeline over the last few years; the progress Sage, Microsoft, Informa and Relx are making in accelerating innovation for their digital products; the shift that Pearson is making away from physical textbook publishing and towards a digital and services model in the global education market; the expansion by geography and product that Compass, IG Group and Jardine Lloyd Thomson are quietly making; the new services Paypoint is rolling out with its next generation terminal, and the investment Spectris is making in innovative new test and measurement products despite the currently tough backdrop for global industrial production.
In my view, all these developments, and the degree to which they succeed matter far more to the long-term investor than what happens to US interest rates or Chinese GDP growth in the next few weeks.