Midway through last month I wrote about the levels of the Dow and S&P 500 and how they had basically gone nowhere for the last 9 years. 5 weeks later however and how things have changed:
11,433 - Dow Jones, 11th Sept, 2008
8,852 - Dow Jones, 17th Oct, 2008
1,249 - S&P 500, 11th Sept, 2008
940 - S&P 500, 17th Oct, 2008
A 17% and 24% fall respectively. Now we are starting to get somewhere! Hopefully this downward trend continues for a while longer.
Marketwatch headline: “Stocks to search for stability”.
“I have discovered that all human evil comes from this, man’s being unable to sit still in a room” - Blaise Pascal
Throughout the history of business, great companies have been run into the ground by management that has tried to move away from their domain of expertise. Whether it was due to their want to climb the ranks of the Fortune 500 by increasing revenue, a misguided sense that diversification makes a company better, or even to relieve boredom, they have committed this sin time and time again. Not only does it make management look like fools but it is to the detriment of the shareholders; the only people management should ever care about.
Coca-Cola in the 70s was a prime example. The company had blanketed the globe with its ubiquitous brand of cola but sales had stagnated due to the failed marketing of international bottlers. J. Paul Austin, the chief executive officer, decided to spend some of the companies surplus cash on some totally left-field ideas: wine, plastics, whey-based drinks, water purification and even shrimp farming. The result? A 1% average annual return throughout that decade. When Roberto Goizueta took over in 1981 he decided to continue diversifying by acquiring Columbia Pictures and the annual report took on the form of a magazine advertisement for the latest movies coming out of the studio!
Fortunately for the company they didn’t let the cola business completely stagnate and rolled out the highly successful Diet Coke which shifted Goizueta’s attention back to the core of the company. With his competitive spirit awakened he took the fight to Pepsi and made another stupendous error: he unveiled “New Coke”. When the American public discovered what happened they totally boycott the new cola and proceeded to demand the old formula back adversely affecting sales and the share price. However, no matter what management did they couldn’t permanently tarnish the name of Coca-Cola and the company continued making a profit until management finally awoke from their slumber, albeit 15 years later, divested of the diversified distractions and focused on the marketing of the brand. Today the success is quite apparent as they blanket the globe with colas, juices and other liquid refreshments to the great fortune of their shareholders.
Any company that passes the first 5 years of existence and continues to grow profits without undue leverage already has a good thing going. The key for management is to continue to milk the gold mine while only branching into areas that they are experts in and continuing to provide high levels of return. Software companies should remain software companies, Cola companies should remain cola companies and energy companies should remain energy companies. It is a very good thing indeed when management sit quietly in a room.