Something important is happening to corporations these days – they aren’t living as long as they used to. According to researchers at Dartmouth a public company listed before 1970 had a 92% change of being around in 5 years versus just a 63% chance for companies listed in the 2000’s (the study controlled for the financial crisis). Companies are dying faster than they ever have.
This is interesting in the context of General Electric’s removal from the Dow because GE is one of the ultimate symbols of corporate sustainability. But the fact is, every company is becoming increasingly susceptible to innovation and disruption which is leading to faster rates of corporate failure.
This is important because there’s a bit of a paradox in the way newer firms are disrupting the economy – in a way they are making the entire economy more susceptible to widespread disruption and faster turnover. Existing firms (which are relatively physical asset based) are being disrupted by firms that are more digitally asset based. For instance, Amazon owns virtually no stores, Uber owns no cars, AirBnB doesn’t own their real estate, Netflix doesn’t own any cable lines, etc. Part of the reason these firms have been so successful is because they are able to scale quickly thanks in part to the fact that they don’t have the costly burden of physical assets. But therein lies the paradox – while these firms are faster to scale and able to quickly wipeout existing physical asset firms, they are susceptible to being disrupted (quickly) by other digital asset firms.
This is a hugely important trend to understand for anyone trying to start a company and for anyone who is allocating assets. As corporate turnover increases, the way we allocate assets will be increasingly impacted. We already knew that stock picking was difficult, but this trend will make it even more difficult as the turnover rates for public companies increase. And I suspect that this trend will exacerbate the shift into indexing based strategies as many indexing strategies systematically take advantage of this shift by removing shrinking firms from their indices and replacing them with growing firms.
As I’ve explained before, indexing works for very specific and empirically sound reasons. As corporate turnover increases this is just one more trend that will continue to drive the success of indexing based strategies relative to stock picking based strategies.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.