The Investment Lesson Behind the Kodak Bankruptcy

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The recent bankruptcy of Eastman Kodak reminds investors they don't make companies like they used to.

Founded in 1892, Kodak shows that very few of these 19th century giants exist anymore.

Companies, like washing machines, just don't have the staying power they used to. Even the largest companies these days are unlikely to outlast a 40-year investing career.

The evidence for this increased corporate mortality rate is both substantial and startling.

According to John Hagel III, Co-Chairman of Deloitte LLP Center for the Edge and author of "The Power of Pull" (Basic Books, 2010), the lifespan of such companies is now about 15 years. That's a stunning change from 1937 when the average life expectancy of the companies in the Standard and Poor's 500 Index was 75 years.

A similar 1983 study of the 1970 Fortune 500 found the life expectancy of its companies to be around 40 years, with a third of them vanishing in the intervening 13 years.

Thus the progression from 75-year corporate lifespans to 40 and now to 15 since 1937 has been clear and more or less smooth.

The Kodak Bankruptcy is One of Many

Of course, not all these corporate deaths are due to bankruptcies – some of them are takeovers, which are much more common since the 1970s.

Even so, bankruptcy is not even enough to kill some companies. Think of the airlines, which have survived multiple Chapter 11 bankruptcies, staggering on like zombies through a fog of losses until – like PanAm in 1991 – somebody mercifully puts a silver bullet in their corpse.

Other companies disappear because they cannot cope with technological change. That is Kodak's problem, even though 120 years is a pretty good run.

However, entrepreneurs' motivations are different today.

Estate duties, which reached their current punitive level in Herbert Hoover's misguided 1932 tax increase, are another cause of short corporate lifespans. After all, if your company will be broken up on your death, you'd be wise to sell it in your lifetime and turn the money into a more liquid form.

The younger generation of entrepreneurs seems to have internalized this idea. Today, they go for repeated entrepreneurship rather than old-style empire-building.

Peter Thiel, for example, made his first billion when he sold PayPal to eBay Inc. (Nasdaq: EBAY). Then, instead of building a corporate behemoth, he used his money, skills and company-building know-how to jump-start several other companies, including Facebook and Palantir Technologies.

The corporate lifespan is thus much shorter than it was, and not likely to lengthen again.

As investors, that means we need to abandon traditional techniques of value investing. That's because in a short-lived corporate world, there are no long-term values in the traditional sense.

When companies do initial public offerings (IPOs), their first few years will be devoted to allowing the founders and venture capitalists to cash out. In this period, you can expect accounting shenanigans and short-term stock-price boosting games.

Then, after the founders have sold, the company may become a zombie, with their research and innovation capabilities sucked out, existing only until its cash pile runs out. Research in Motion Ltd. (Nasdaq: RIMM) and Yahoo Inc. (Nasdaq: YHOO) may have reached this stage, for example.

Short-lived Corporations and Your Investments

That has important implications for workers, but it can affect our investment decisions even more.

In a world of short corporate lives, here are a few investment strategies to consider:

  1. Dividends: If a company pays a 10% dividend yield and lasts only 15 years, and liquidates for 20% of its current value, that would still give you an overall return of 7%, which beats fixed-income these days. Plus, if you're smart, you may be able to sell it for full value about eleven years later, before others have cottoned on to its decay. Energy Master Limited Partnerships (MLPs) like Linn Energy (Nasdaq: LINE) are excellent examples of this type of investment.
  2. Bargains: If you buy something for 50% of its net asset value, and the company is making profits, you will probably end up making out on the deal when it is sold off or wound up. In this case, the income may not be worth much, but the assets are.
  3. Fast growth: If you are really convinced the company's profits are going to explode, and you're buying on a fairly cheap price/earnings (P/E) ratio, you may be able to ride the rocket. But don't pay too much, and don't forget to jump off when the rise seems to be slowing.
  4. Family companies in family-oriented cultures: Other countries don't have the same estate taxes, are more family-oriented, and are less attracted by get-rich-quick schemes. In Germany or Japan, corporate lifespans have not shortened to the extent they have in the United States. In general, emerging markets are more long-term oriented than the U.S., although their political and economic risks may kill companies before their time.

In general, avoid companies that do not pay dividends. There will be cases of companies, especially in the tech sector, which enjoy an entire corporate lifespan of say 20 years without ever paying anything to investors who are not insiders with stock options. Don't be the sucker that buys these empty bags at high prices.

Also avoid well-established blue-chips, the equivalent of Kodak, which tend to be priced as if they will last forever, and whose dividend yields are not enough to compensate you for their now-shortened lifespan.

To take one example at random: The Procter & Gamble Co. (NYSE: PG). PG has been around since 1837. It is a perfectly good company, but its 2.1% dividend yield won't compensate you adequately unless PG makes it to 2060. History tells us it may not.

So while, shorter corporate lifespans may well speed innovation, they make being an employee or an investor much more difficult and dangerous.

Investors should recognize this and adjust their strategies accordingly.

When the times change investors need to change with them. That's the lesson behind the Kodak bankruptcy.

[Editor's Note: Today, S&P 500 companies have a record $5 trillion on their balance sheets. That's twice the total of just a year ago.

But it's how those companies use that cash that will determine whether the stock is a buy, sell or hold.

In today's Private Briefing, Martin Hutchinson shares a secret showing you how to determine which cash-rich companies will provide maximum gains. To find out more, please click here.]

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  1. Jeff Pluim | February 10, 2012

    Over all a good article, but I would like to add a couple of points. First MLP's: I am still waiting for some MLP to get sued for something like a serious oil spill. Even though MLP's are called limited partnerships, it is my understanding (please correct me if I am wrong) that they are in fact not limited with regard to liability, and that mom and pop investor could lose not just their investment, but all that they own if something happens in the MLP that triggers a huge liability to it.
    As for Kodak, they did not die because they did not keep up with the technological advances of the day. In fact, they were decades ahead of the curve but made a very poor management decision that, instead of being out front of the curve, cost them the entire business. In 1984, Kodak invented digital photography. But they were making so much money on their film sales that they thought they would be shooting themselves in the foot if they brought digital photography to market. They had the potential to move humankind ahead into the digital age and profit greatly by their position. But the dummies chose to hide the advances because they were looking at the small picture instead of the BIG PICTURE. I can see the automotive industry making the same mistake. They are so heavily invested in the oil industry that they do not want to accept the inevitable move to electric vehicles. Just try to order one of the new electric vehicles and see how long the waiting list is. That should tell you about the great demand for the new electric vehicles. But the major car manufacturers are only toying with it instead of going all-in. One industry that I can see lasting for a century or longer is the newly developing space industry. The advances made at the CERN facility outside of Geneva, where the physicists clocked a faster than light neutrino are being ignored or totally rejected by mainline physicists even though CERN re-did their experiment and got the same results a second time. (My paper explains why they got the results they did. For a copy email me at jeffpluim at hotmail.com) These results mean that humankind can travel faster than light. It means that we will soon be able to move into space in a way that only sci-fi has alluded to. The investment potential will last for centuries.

  2. jrj90620 | February 10, 2012

    I think great companies come from great management.No one lives forever,so the great managers that grew the great companies, eventually retire or die.Then it's hard to find someone to replace them and the company declines.Or,the great manager was great for a particular time,but not able to change.

  3. Steve | February 10, 2012

    @ Jeff: As a species we must extend ourselves into space. Avoiding that will cripple if not extinguish us. What if we are the only technological species in this galaxy, or the oldest? If the galaxy is teeming with advanced intelligence capable of interstellar travel we should have encountered that by now. If we have, then that intelligence is either indifferent and philosophically detached or loving beyond our understanding. Neither has produced empirical evidence.

    Interestingly, 10000X the speed of light would still require 10 years to cross the galaxy ignoring acceleration/deceleration and E=M(C squared). What kind of physics would allow that? We would be microscopic to intergalactic travelers.

    I cannot imagine a future confining humanity to this planet. Annihilation seems more probable than sustained confinement. Localized settlement of R < 20 light years will require adaptation and terraforming taking decades after arrival while Earth tries to support 20 billions. FTL travel in the near future is as essential as oxygen, temperate heat, water and beer.

  4. Gregory | February 27, 2012

    Can you prove that in 1984 Kodak Invented digital Photography? Why would they do such a thing when Kodak was such a big part of film photography? That would be like cutting your own throat.
    If kodak did invent digital photography then there's no room for crying . Kodachrome was discontinued after a 75 year run. Paul Simon Made a song about it. Kodachrome Was a great transparency film and you could tell the difference between kodachrome & Ektachrome.

  5. Gregory | February 27, 2012

    I'm not gonna leave a reply about my own blog but Kodak had too many programs runnig. I bought into the promise of excellance program. You used kodak film & paper and if something went wrong with the print, Kodak would remake the print at their cost. I had an edge over other photographers by being able to offer a guarantee to my custiomers, but when I called Kodak back to ask about this program, they didn't even remember that there was such a program. I also bought Kodak flyers so that I could put my name on it and send out flyers with my name on it. They were reasonably priced , so I had my own flyers with kodak's photos on them. Well times changed. people can live without gettuing their picture taken. But you can't live without eating!

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