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Dan Nestlerode: Creative Destruction in Corporate America

by on February 19, 2012 6:00 AM

Austrian-American economist Joseph Schumpeter (1883-1950) studied the formation and bankruptcy of companies in Europe and the United States. He concluded that economic progress in a capitalist society, indeed probably any society, must come as a result of creative destruction.

That is to say that companies are created, live a useful life and eventually disappear (become bankrupt or are merged or bought out by other companies) to allow for the creation of new companies as the markets and their competition changes. (Governments might also go through a similar cycle, but that is a subject for another day.)

For investors, Schumpeter’s theory is important because it challenges buy and hold portfolio strategies as well as the notion that if the holdings were good for my parents’ portfolio, they should be good for mine too now that I have inherited them.

The period from the 1930s through the 1980s was a period of gradual improvements in existing technologies that allowed dominant companies to thrive and survive over a 50-year period.

More recently, the dynastic companies that were part of mid-20th century America have begun to have financial problems and subsequently disappear from the American financial scene. What was good for Mom and Dad’s portfolio is no longer appropriate for the kids or grandkids.  Things have changed, and more troubling for some, the rate of this change has accelerated, thus further discrediting the buy and hold portfolio strategy.

In a study done by Innosight lead director Richard N. Foster, the average lifespan of S&P 500 Index companies was examined over the past 50 years. In the 1960s, the era in which I was raised and joined the investment business, the average life span of an S&P 500 company was more than 60 years.  That span narrowed to 25 years in 1980 and now the average company lifespan is a mere 16 years – a near 75 percent decline in average lifespan in just 50 years.

Sixteen years is a very short economically useful lifespan for businesses and creates all kinds of implications for investors and the careers of today’s graduates.  This study implies that you will have to make many more portfolio changes and job changes than your parents or grandparents experienced.  The idea of anyone being a one-company person is rapidly disappearing from the American, and probably global, scene.

Since 2002, such American icon firms as Circuit City, Quaker Oats, Sears, Compaq, Texaco, Wendy’s, Bear Stearns, Radio Shack, The New York Times, Maytag, Clear Channel, Solectron, Global Crossings, Eastman Kodak, Palm, American Airlines and others have disappeared from the S&P 500 Index listing, though some are still in business. Others, such as Family Dollar, Celgene, Smucker’s, Google, Ralph Lauren,, Comcast, Iron Mountain,, e*Trade, Ebay, Legg Mason, Estee Lauder and have grown in size and importance and have become part of the S&P 500 Stock Index.  I doubt your parents had any of these new additions to the Index in their portfolios.

A few companies have managed to overcome this company life cycle through great management practices and the ability to exit businesses that have reached their natural decline. Dealing with long-term evolution in business is difficult and requires adroit management to exit core businesses and continue innovating in the face of entrenched interests and long experience doing what used to work well.

I am, of course, pleased to acknowledge the company my father founded and its ability to thrive in the ever-changing market place, not to mention the changing regulatory environment. This year marks Nestlerode & Loy Inc.’s 75th anniversary. Though we may not have been cited in the Innosight study, it does identify other companies that have managed their lifespan issues with finesse: IBM, Proctor & Gamble and Johnson & Johnson.

The bottom line for investors, business owners and employees is that you have to pay continuous attention to developing events and make the needed changes to survive and thrive personally.  As Alan Kay said, “the best way to predict the future is to build it.”

Dan Nestlerode was previously the Director of Research and Portfolio Management at Nestlerode & Loy Investment Advisors in State College. He retired in 2015 after 50 years in the investment business. A graduate of Penn State University, Nestlerode became an investment advisor in 1965. He can be reached at [email protected]
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