On 8/31/20, the Dow Jones Industrial Average went through a change in composition. Out went Exxon, Pfizer and Raytheon. In came Salesforce.com, Amgen and Honeywell. This is the 8th time the Index components have changed this decade, the 13th time since 2000 and the 55th change since created in 1896. So changes are not uncommon. But, are they meaningful? Ask any academic and you’ll get a resounding “NO.” There is no stated criteria for selection, no metrics for inclusion, no breadth to the number of companies (which has changed significantly over time,) and not even a weighting for market capitalization! The DJIA has no relationship to “the market,” which could well be measured better by the S&P 500, or the Russell 3000. And it doesn’t even link to any specific industry! To academics, “the Dow” is just a random number that reflects nothing worth measuring!!
The DJIA is (currently) a group of 30 stocks selected by the editors of Dow Jones (publisher of the Wall Street Journal, owned by News Corp – which also owns Fox News – and controlled by Rupert Murdock). Despite its lack of respect by academics and money managers, because of its age – and the prestige of being selected by these editors – being on the DJIA has been considered somewhat revered. Think of it as an “editorial award of achievement” for size, profitability and perceived stability. For these reasons, over time many investors have believed the index represents a low–risk way to invest in corporations and grow their wealth.
So the daily value of the DJIA is pretty much meaningless. And being on the DJIA is also pretty much meaningless. But, investors have followed this index every trading day for 124 years. So, it is at least interesting. And that’s because it is a track on what these editors think are important very long-term economic trends.
The original Index composition looks NOTHING like 2020. American Cotton Oil Company, American Spirits Manufacturing Company, American Sugar Refining Company, American Tobacco Company, Chicago Gas Light and Coke, General Electric, Leclede Gas, National Lead, Pacific Mail Steamship Company, Tennessee Coal Iron and Railroad Company, United State Cordage Company and United States Leather Company. Familiar household names? This initial list represents the era in 1896 – an agrarian economy just on the cusp of coming into the industrial age. Not forward looking, but rather somewhat reflective of what were the biggest parts of the economy historically with a not forward.
Over 124 years lots of companies left the DJIA — were replaced – and many replacements left. Some came on, went off, and came back on again – such as AT&T, Exxon (formerly Standard Oil of New Jersey) and Chevron (formerly Standard Oil of California.) Even the vaunted GE was inducted in 1899, only to be removed in 1901 – then added back in 1907 where it stayed until CEO Jeff Immelt imploded the company and it was removed for good in 2018.
But, there has been a theme to the changes. Originally, the index was largely agricultural companies. As the economy changed, the Index rotated into commodity companies like gas, coal, copper and nickel – the materials leading to a new era of tools. This gave way to component manufacturers, dominated by the big steel companies, which created the industrial era. Which, of course, led to big manufacturing companies like 3M and IBM. And, along the way, there was recognition for growth in new parts of the economy, by adding consumer goods companies like P&G, Coca-Cola, McDonald’s, Kraft (since removed,) and Nike along with retailers like Sears (later removed,) Walmart, Home Depot and Walgreens. The massively important role of financial services to the economy was reflected by including Travelers, JPMorgan Chase, American Express, Visa and Goldman Sachs. And as health care advanced, the Index added pharmaceutical companies like Pfizer, Johnson & Johnson and Merck.
Obviously, the word “industrial” no longer has any meaning in the Dow Jones Industrial Index.
Reading across the long history of the DJIA one recognizes the editors’ willingness to try and reflect what was growing in the American economy. But in a laggard way. Not selecting companies too early, preferring instead to see that they make a big difference and remain important for many years. And a tendency to keep them on the index long after the bloom is off the rose – like retaining Kraft until 2008 and still holding onto P&G and Coke today.
The bias has always been to be careful about adding companies, lest they not be sustainable. And not judge too hastily the demise of once great companies. Disney wasn’t added until 1991, long after it was an established entertainment leader. Boeing was added in 1987, after pioneering aviation for 30 years. Microsoft added in 1999, well after it had won the PC war. Thus, the index is a “lagging index.” It reflects a big chunk of what was great, while slowly adding what has recently been great – and never moving too quickly to add companies that just might be tomorrow’s leaders.
Sears added in 1924, wasn’t removed until 1999 when its viability is questionable. Phillip Morris Tobacco (became Altria) was added in 1985, and hung around until 2008 — long after we knew cigarettes were deadly and leadership didn’t know how to do anything else. Even today we see that United Aircraft was added in 1939, which became United Technologies in 1976 and then via merger Raytheon in 2020 – before it is now removed, as all things aircraft are screeching to a pandemic halt. And Boeing is still on the Index despite the 737 fiasco and plunging sales. IBM was added in 1939, and through the 1970s it was a leader in office equipment creating the computer industry. But IBM after years of declining sales and profits isn’t really relevant any longer, yet it is still on the Index.
As for adding growing stars, GM stays on the Index until it goes bankrupt, but Tesla is yet to make consideration (largely due to lack of profit history.) Likewise, Walmart remains even though the “big gun” in retail is obviously Amazon.com (another lacking the size and longevity of profits the editors like.) McDonald’s stays on the list, despite no growth for years and even as the Board investigates its HR department for hiding abhorrent leadership behavior – while Starbucks is eschewed. And Cisco is there, while we all use Zoom for pandemic-driven virtual meetings.
So what can we take away from today’s changes? First, the Index has changed dramatically over 20 years to reflect electronic technology. IBM, Microsoft and Apple are now joined by Salesforce. Pharma company Pfizer is being replaced by bio-pharma company Amgen in a nod to the future, although almost 40 years after Genentech went public. Exxon disappears as oil prices fall to sub-zero, demand declines globally and electric cars are on the cusp of taking market leadership. And conglomerate Honeywell is added just to show the editors still think conglomerates matter – even if GE has nearly disintegrated.
Is any of this meaningful? I don’t really think so. As an award for past performance, it’s a nice token to make the list. As business leaders, however, we need to be a LOT more concerned about developing businesses for the future, based on trends, than is indicated by the components of the DJIA. Driving revenue growth and higher margins comes from doing the next big thing, not the last big thing. And, as investors, if you want to make outsized returns you have to know that a basket of largely laggards (Apple, Microsoft and Salesforce excepted) is not the way to build your retirement nest. Instead, you have to invest in companies that are creating the future, making the trends a reality for businesses and consumers. Think FAANG.
Nonetheless, after 124 years it is still sort of interesting. I guess most of us do still care what the editors of big news companies think.
TRENDS MATTER. If you align with trends your business can do GREAT! Are you aligned with trends? What are the threats and opportunities in your strategy and markets? Do you need an outsider to assess what you don’t know you don’t know? You’ll be surprised how valuable an inexpensive assessment can be for your future business (https://adamhartung.com/assessments/)
Give us a call or send an email. Adam@sparkpartners.com
Since 2012, I’ve been a huge fan of Facebook, Apple, Amazon, Netflix and Google. And they have dramatically outperformed the market. In the last few weeks their values have fallen dramatically, and I’ve heard grumblings that these are no longer the stocks to own.
I virulently disagree. Great companies are where you should invest. If you don’t think these are great companies, you would be right to sell them (such as GE, Sears, and many others.) But despite complaints about privacy, usage rates, nefarious users, and other attacks on technology, the reality is that we love the convenience these companies gave us. We may not think things are perfect, but we are a lot happier than we used to be, and we are pretty happy with how these companies respond to product concerns.
- These companies are still global leaders in some of the biggest and most powerful trends everywhere
- The shift to e-commerce from traditional retail continues unabated
- The movement to mobile devices continues
- Using the cloud to replace device storage and network storage will not slow
- Entertainment continues to move to streaming from TV and other sources
- Ad growth remains firmly on the internet and mobile devices
- Platform usage (such as social networks) keeps growing as more uses are developed
These mega-trends are the foundation of the FAANG companies. These companies became great by understanding these trends, then developing products for these trends that have attracted billions of customers. Their revenue growth continues, just as their product development continues. And their profits keep growing as well. Nobody ever saved their way to prosperity. To increase value you must increase profitable revenues. And that capability has not left these companies.
Some of these company’s leaders have recently been called to Washington to testify. Will they be attacked, split up, further regulated? Will the government kill the golden goose? Given that the US House of Representatives has not firmly moved to the Democrats, I see almost no sign of that happening. Democrats like happy constituents, and given how happy consumers are with these companies the Democrats are very unlikely to intervene. There has long been a deep friendship, built on significant campaign financing and lobbyist involvement, between these companies and Democrats. The change in government almost insures that the actions in Washington will prove to just be a lot of short-term heat, with little change in the overall lighting.
I don’t know when these stocks will reach a short-term bottom. Just like nobody can predict market highs, it is impossible to predict lows. But the one thing I feel very strongly about is that in a year these companies will be worth more than they are valued today.
For insight into my strong favorability for these companies, take a look at the infographic I’ve provided regarding Facebook. Despite the Facebook stock ups-and-downs, this infographic explains why long-term it has been very smart to buy Facebook. Despite how people have “felt” about the company, it is a GREAT company built on powerful trends. To understand even better, buy the ebook “Facebook, The Making of a Great Company” on Amazon for 99 cents.
It was August 15, 2017 when I wrote the column “A Bitcoin Is Worth $4,000 – Why You Probably Should Not Own One.” At the time Bitcoin’s value had increased in value by 750% in just one year, and some investors were becoming very excited about Bitcoins. Journal articles were nearly all bullish, with some big Bitcoin owners projecting they would increase in value to over $250,000 each – or possibly into the millions!
But I was far more pragmatic. I pointed out that Bitcoins had no inherent value – unlike a Picasso painting, for example. There will be no more original Picasso’s, and no more signed Picasso prints. The supply is completely known, and the price is determined by what people will pay for the artistic history of them. But anybody can make a Bitcoin. And even though there was some theoretical limit of 21 million, why anybody would want to own these non-physical data bits was unclear. Were people going to say “come, look at this hard drive. It contains 400,000 Bitcoins. Isn’t it cool?” Bitcoins were a lot more like Pokemon cards. There are a LOT of them, more coming all the time, and their value was only to people who wanted to play the Bitcoin game.
And I had a very low opinion of the necessity of Bitcoins as a currency. Everyone is pretty happy to use dollars, yen, euros, etc. And if you fear inflation there is an open market to exchange any currency for any other, so you can quickly keep your savings in the currency of your choice. The only valuable use of Bitcoins was as a currency for illegal activity you don’t want traced – such as sex trafficking, drug trafficking or gun running. While the outlaws in those occupations my enjoy a non-government currency, those folks are relatively few and far between, and the need for such currency is therefore pretty weak. Not to mention illegal.
It was pretty clear that Bitcoin was a fad. Like the famous Dutch Tulip Bulb fad that drove the price of a Tulip bulb higher than a house. While a fad the value went up, but because there was no inherent value to the bulb greater than a flower, it’s value was sure to collapse. And the same would happen to Bitcoins. To a long-term trend watcher, and person skilled at understanding trends for planning, Bitcoin had all the signs of a fad.
I remember this well because when I published this column in Forbes there was a Bitcoin editor that went ballistic. This person had no background in economics, banking, currency, stock markets, or art; the editor was a journalist who had decided Bitcoin was “the next big thing.” Bitcoin was going to overtake traditional currencies, and save the world from central banks dead-set on destroying free trade and economic growth.
Honestly, I never understood the argument. Baseless, and senseless. Bitcoin was a fad, I said clearly, and no investor should be buying them – especially small investors. And it was a fools folly to spend money becoming a Bitcoin miner. Simply invest somewhere else where trends supported growth.
But the editorial staff at Forbes landed on me like a herd of elephants coming down the Himalayas. Apparently Forbes was buying into the Bitcoin craze, and they didn’t want anyone writing bad things about Bitcoin. I pointed out that in 9 years my predictions about the future of Netflix, Amazon, Tesla – and GE, Sears, and Windows 8 and 10 – had all turned out to be accurate.
I tended to be very early with my predictions, and quite contrarian, but within 2 years I was proven right. I knew the difference between a trend and a fad, and it was important to help readers understand the difference. Bitcoins had no inherent value, and they were/are not an investment vehicle.
In the end the rancor about my Bitcoin prediction, and my unwillingness to reverse my position, caused a break between myself and Forbes. Even as Bitcoins soared in value to $19,000 by December, 2017 I held firm to the position that no sound, long-term investor should touch them. If Forbes couldn’t understand my surety, then it was their problem.
This week Bitcoins traded for $4,400. Where they traded on August 20, 2017 just as my prediction went public. Bitcoins were/are a fad. Now, there are a slew of authors writing about the lack of any reason for Bitcoins to exist. Almost all are predicting the value will continue eroding, as more and more people see there was never any value in them to begin with. Many predict this will not end until Bitcoins are worth nothing, or possibly a few cents, and all the Bitcoin miners disappear.
The important lesson is that it is not impossible to know the difference between a trend and a fad. Trends are based upon behaviors that have a basis in gain. We trended away from physical stores and toward e-commerce because the latter was more convenient, and sometimes cheaper. We trended away from PC’s with hard drives and toward mobile devices connected to the cloud because they made our lives more convenient, and often cheaper. We are watching more entertainment via on-line downloads, and less on television, because it is more convenient, and often better. These are trends. They are observable, measurable and good trends generate a better outcome for people, while bad trends are due to consumer movement toward new solutions.
When you work a job all week trying to get more done better, faster, cheaper you may not have time to study trends. When you see something new it can seem hard to know whether it is a fad, or trend. Or if a trend, how fast it will “take hold” and alter behavior. That is understandable.
And that’s where people like me make a difference. I focus on trends. Demographics, regulations, technology – all kinds of trends. I watch them, measure them, and project outcomes for the trend, and those who adopt the trend. I build scenarios that stretch out the trend, and look for when more people are following a trend than doing things the “old way.” And because I do that all day, every day, for 20 years it is possible to forecast with high accuracy what the future will look like.
Almost always it takes a bit longer than I think, but likewise it almost always takes a lot less time than almost everyone else thinks. I didn’t think it would take 5 quarters for Bitcoins to peak and then fall back to $4,400. But most people were projecting the value of Bitcoins would go up for YEARS. They couldn’t visualize the peak. Even though it happened just 4 months after I said “don’t buy Bitcoins.” Only a very, very lucky trader would have bought in August, and sold in December. For true investors, this was a roller coaster ride with an unhappy ending.
I don’t meet many company executives that do future scenario planning. They are too busy running their business to do trend analysis, projections and make long-term forecasts. But that doesn’t mean these things aren’t important. It just means you need to look for outsiders, who specialize in trend analysis and long-term scenario planning, to help you guide your business in the right direction. Because you’d much rather be Microsoft, shifting from PC’s to cloud and holding onto your value, than GE or Sears. You need a partner to help you forecast – and grow.
As all readers know, I am a fan of owning Facebook’s stock. For years I have pointed out that Facebook has been incredibly innovative at bringing people together. First, it was Facebook.com, but then leadership added WhatsApp and Messenger to expand the ability to communicate, and after that, Instagram which augmented communications via pictures and video. These capabilities, largely asynchronous, have expanded how easily we can communicate with friends, colleagues and business connections. It is this capability that made Facebook a success, because it brought people to the platforms – and as the audience grew advertising dollars grew as well.
(Watch my 2 minute video on Facebook the Innovation Engine)
Now, Facebook has launched “Portal.” It’s a piece of hardware, similar to a tablet in size. It has a speaker and a microphone, like a smart speaker on steroids, or like an enhanced tablet designed for communicating. Built on Android, it supports a plethora of apps, and it integrates with Alexa so you can not only talk to up to 7 people at the same time, but you can all listen to music via Spotify or Pandora, etc., and you can use it to make purchases on Amazon.com
At first you’d probably say this doesn’t sound very exciting. After all, aren’t we awash in hardware from smart phones to tablets to laptops to smart speakers and connected home devices? Why would we want another piece of hardware, when we already have so many that do so many different things? And didn’t Amazon infamously try to launch a enhanced smartphone (Fire Phone) and enhanced tablet (Fire Tablet) targeted at shopping, only to fail miserably? You could say Portal is likely to follow Fire into the tech archives.
And, on top of this, aren’t people paranoid about Facebook and privacy? After Cambridge Analytica manipulated Facebook data in the last election, and then the recent breach which could have revealed information on 50 million users, aren’t people going to quit using Facebook products?
There really isn’t much data to indicate people care about these breaches, or possibly illegal uses of data. Almost everyone now realizes that whatever they post on any Facebook platform, the information is public. And the reality is that by putting their information out there it actually makes users’ lives easier. Users get connections they want, information they want, and products they want that much faster, and easier. These platforms make their lives more convenient, and billions of people have no problem exchanging somewhat personal information for the convenience it provides. The more Facebook knows about them, the easier their lives are, and the richer their network communications.
That is why I’m optimistic that Portal will have an audience. Facebook Messenger has 400 million users. Those users generated 17 billion messages in 2017. Now, imagine if those users could use Portal to make those messages clearer, more powerful. And, as of June, 2018 Instagram has 1 billion monthly active users. If you have Portal it makes Instagram connecting much easier and more interesting.
Portal doesn’t have to replace an existing smartphone or tablet. It merely has to help the people who use Facebook platforms have a deeper, more powerful connection with those in their network. If it does that, there is an enormous installed base of users who could find Portal helpful, in many ways. More helpful than a stand-alone, limited use Echo (or Dot) speaker, for example, which have sold over 47 million units so far.
Facebook is good at understanding its value proposition which is connecting people in powerful ways. Facebook has shelved products that didn’t augment this value proposition – like a generalized smart phone. But Portal has the ability to further enhance user experiences, and that gives it a decent chance of being successful. And when Facebook adds its Oculus technology to Portal, allowing for 3D communications, Portal could become a one-of-a-kind product for communicating with your network.
For a look back at Facebook’s history, and my forecasts for the company, read my new ebook, “Facebook – The Making of a Great Company.” (At Amazon.com for just 99 cents!) It will help you take a longer look at Facebook’s leadership, and give you a different view on Facebook’s future than the current negative press is providing. With the stock $70 off its high, and trading at the same price it was a year ago, you just might think this is a buying opportunity.
In the recently published, “Facebook- The Making of a Great Company”, Adam Hartung analyzes the rise of Facebook and its impact on the financial community, business marketing and innovation.
Adam’s posts over the years have predicted key milestones in Facebook’s growth and its transformation into a driver of social trends. He tells the story of this company that has overcome negativity and skepticism in the financial community and has adapted to its users.
“So last week, when Facebook reported that its user base hadn’t grown like the
past, investors fled. Facebook recorded the largest one day drop in valuation in
history; about $120B of market value disappeared. Just under 20%.
No other statistic mattered. The storyline was that people didn’t trust Facebook
any longer, so people were leaving the platform. Without the record growth numbers
of the past, many felt that it was time to sell. That Facebook was going to be
the next MySpace.”
“That was a serious over-reaction.”
Adam Hartung, “Facebook-The Making of a Great Company”
On July 26, 2018 Facebook set a record for the most value lost in one day by a single company. An astonishing $119B of market value was destroyed as the shares sank more than $40. For many investors, it was the sky falling.
As most of you know, I’ve followed Facebook closely since it went public in 2012. And, I’ve long been an admirer. I said buy it at the IPO, and I’m saying buy it now. Click on the title of any of the posts to read the full content.
To summarize, Facebook may be under attack, but it is barely wounded. And it is not in the throes of demise. The long-term trends all favor the social media’s ongoing growth, and higher values in the future. Below I’ll offer some of my previous blogs that are well worth revisiting amidst the current Facebook angst.
FANG (Facebook, Amazon, Netflix and Google) investing is still the best bet in the market. They have outperformed for years, and will continue to do so. Why? Because they are growing revenues and profits faster than any other major companies in the market. And “Growth is Good” (paraphrasing Gordon Gekko.) If you have any doubts about the importance of growth, go talk to Immelt of GE or Lampert of Sears.
Don’t forget, for years now Facebook is more than Facebook.com. It’s smart acquisition programs have dramatically increased the platform’s reach with video, messaging, texting and eventually peer-to-peer video. Facebook’s leadership has built a very adaptable company, able to change the product to meet growing user (and customer) needs.
Facebook is on a path toward significant communication domination. Facebook today is sort of the New York Times, Washington Post, Los Angeles Times and about 90% of the rest of the nation’s newspapers all in one. Nobody is close to challenging Facebook’s leadership in news distribution, and all news is increasingly going on-line.
For all these reasons, you really do want to own Facebook. Especially at this valuation. It’s getting a chance to buy Facebook at its value when the year started, and Facebook is that much bigger, stronger, and adapted to changing privacy regulations that were still a mystery back then.
Oh, one last thing (paraphrasing Steve Jobs.) Facebook actually isn’t the biggest one day drop in stock valuation, despite what you’ve read.
Stocks are priced in dollars, and dollars are subject to inflation. So we should look at historical drops in inflation adjusted dollars. Even though inflation has been mostly below 3% since the 1990s, from 2000 to today the dollar has inflated by 46%. So inflation-adjusted, the biggest one day value destruction actually belongs to Intel, which lost $131B in September, 2000. And Microsoft is only slightly in third place, having lost $117B in April, 2000. So keep this in mind when you think about the long-term opportunity for Facebook.
Now Published! “Facebook- The Making of a Great Company” ebook by Adam Hartung.
The last few quarters sales growth has not been as good for Apple as it once was. The iPhone X didn’t sell as fast as they hoped, and while the Apple Watch outsells the entire Swiss watch industry it does not generate the volumes of an iPhone. And other new products like Apple Pay and iBeacon just have not taken off.
Amidst this slowness, the big winner has been “Apple Services” revenue. This is largely sales of music, videos and apps from iTunes and the App store. In Q2, 2018 revenues reached $9.2B, 15% of total revenues and second only to iPhone sales. Although Apple does not have a majority of smartphone users, the user base it has spends a lot of money on things for Apple devices. A lot of money.
In a bit of “get them the razor so they will buy the razor blades” CEO Tim Cook’s Apple is increasingly relying upon farming the “installed base” of users to drive additional revenues. Leveraging the “installed base” of users is now THE primary theme for growing Apple sales. And even old-tech guys like Warren Buffett at Berkshire Hathaway love it, as they gobble up Apple shares. As do many analysts, and investors. Apple has paid out over $100B to developers for its services, and generated over $40B in revenues for itself – and with such a large base willing to buy things developers are likely to keep providing more products and working to grow sales.
But the risks here should not be taken lightly. At one time Apple’s Macintosh was the #1 selling PC. But it was “closed” and required users buy their applications from Apple. Microsoft offered its “open architecture” and suddenly lots of new applications were available for PCs, which were also cheaper than Macs. Over a few years that “installed base” strategy backfired for Apple as PC sales exploded and Mac sales shrank until it became a niche product with under 10% market share.
Today, Android phones are the #1 smartphone market share platform, and Android devices (like the PC) are much cheaper. Even cheaper are Chinese made products. Although there are problems, the risk exists that someday apps, etc for Android and/or other platforms could become more standard and the larger Android base could “flip” the market.
The history of companies relying on an installed base to grow their company has not gone well. Going back 30 years, AM Multigraphics an ABDick sold small printing presses to schools, government agencies and businesses. After the equipment sale these companies made most of their growth on the printing supplies these presses used. But competitors whacked away at those sales, and eventually new technologies displaced the small presses. The installed base shrank, and both companies disappeared.
Xerox would literally give companies a copier if they would just pay a “per click” charge for service on the machine, and use Xerox toner. Xerox grew like the proverbial weed. Their service and toner revenue built the company. But then people started using much cheaper copiers they could buy, and supply with cheaper consumables. And desktop publishing solutions caused copier use to decline. So much for Xerox growth – and the company rapidly lost relevance. Now Xerox is on the verge of disappearing into Fuji.
HP loved to sell customers cheap ink-jet printer so they bought the ink. But now images are mostly transferred as .jpg, .png or .pdf files and not printed at all. The installed base of HP printers drove growth, until the need for any printing started disappearing.
The point? It is very risky to rely on your installed platform base for your growth. Why? Because competitors with cheaper platforms can come along and offer cheaper consumables, making your expensive platform hard to keep forefront in the market. That’s the classic “innovator’s dilemma” – someone comes along with a less-good solution but it’s cheaper and people say “that’s good enough” thus switching to the cheaper platform. This leaves the innovator stuck trying to defend their expensive platform and aftermarket sales as the market switches to ever better, cheaper solutions.
It’s great that Apple is milking its installed base. That’s smart. But it is not a viable long-term strategy. That base will, someday, be overtaken by a competitor or a new technology. Like, maybe, smart speakers. They are becoming ubiquitous. Yes, today Siri is the #1 voice assistant. But as Echo and Google speaker sales proliferate, can they do to smartphones what smartphones did to PCs? What if one of these companies cooperates with Microsoft to incorporate Cortana, and link everything on the network into the Windows infrastructure? If these scenarios prevail, Apple could/will be in big trouble.
I pointed out in October, 2016 that Apple hit a Growth Stall. When that happens, maintaining 2% growth long-term happens only 7% of the time. I warned investors to be wary of Apple. Why? Because a Growth Stall is an early indicator of an innovation gap developing between the company’s products and emerging products. In this case, it could be a gap between ever enhanced (beyond user needs) mobile devices and really cheap voice activated assistant devices in homes, cars, offices, everywhere. Apple can milk that installed base for a goodly while, but eventually it needs “the next big thing” if it is going to continue being a long-term winner.
On Monday, Harley Davidson, America’s leading manufacturer of motorcycles, announced it was going to open a plant in Europe.
Ostensibly this is to counter tariffs the EU will be imposing on its products if imported from the USA. President Trump reacted vociferously on Tuesday, threatening much bigger taxes on Harley if it brings to the USA any parts or motorcycles from its offshore plants in Brazil, Australia, India or Thailand. He also intimated that Harley Davidson was likely to collapse.
Lots of heat, not much light. The issues for Harley Davidson are far worse than an EU tariff.
Harley Davidson has about 1/3 of the US motorcycle market. But in “heavy motorcycles,” those big bikes that are heavier and generally considered for longer riding, Harley has half the market. Which sounds great, until you realize that until the 1970s, Harley had 100% of that market. Ever since then, Harley has been losing share – to imports and to its domestic competitor Polaris.
It was 2006 when I first wrote about Harley Davidson’s big demographic problem. Basically, its customers were all aging. Younger people were buying other motorcycles, so the “core” Harley customer was getting older every year. From mid-30s in the 1980s, by the year 2000 the average buyer was well into their mid-40s. In 2007, I pointed out that Harley had made a stab at changing this dynamic by introducing a new motorcycle with an engine made by Porsche, and a far more modern design (the V-Rod.) But Harley wasn’t committed to building a new customer base, so when dealers complained that the V-Rod “wasn’t really a Harley” the company backed off the marketing and went back to all its old ways of doing business.
Simultaneously, Harley Davidson motorcycle prices were rising faster than inflation, while Japanese manufacturers were not. Thus, as I also pointed out in 2007, it was struggling to maintain market share. Slower sales caused a lay-off that year, and despite the brand driving huge sales of after-market products like jackets and T-shirts, which had grown as big as bike sales, it was unclear how Harley would slow the aging of its customer base and find new, younger buyers. Harley simply eschewed the trend toward selling smaller, lighter, cheaper bikes that had more appeal to more people – and in more markets.
Globally, the situation is far more bleak than the USA. America has one of the lowest motorcycle ridership percentages on the globe. Americans love cars. But in more congested countries like across Europe or Japan and China, and in much poorer countries like India, Korea, and across South America motorcycles are more popular than automobiles. And in those countries Harley has done poorly. Because Harley doesn’t even have the smaller 100cc,200cc, 400cc and 600cc bikes that dominate the market. For example, in 2006 (I know, old, but best data I could find) Harley Davidson sold 349,200 bikes globally. Honda sold 10.3 million. Yamaha sold 4.4 million. Even Suzuki sold 3.1 million – or 10 times Harley’s production.
But, being as fair as possible, let’s focus on Europe – where the new Harley plant is to be built. And let’s look exclusively at “heavy motorcycles” (thus excluding the huge market in which Harley has no products.) In 2006, Harley was 6th in market share. BMW 16%, Honda 15%, Yamaha 15%, Suzuki 15%, Kawasaki 11% and Harley Davidson 9%. Wow, that is simply terrible.
Clearly, Harley has already become marginalized globally. Outside the USA, Harley isn’t even relevant. The Japanese and Germans have been much more successful everywhere outside the USA, and every one of those other markets is bigger than the USA. Harley was simply relying on its core product (big bikes) in its core market (USA) and seriously failing everywhere else.
Oh, but even that story isn’t as good as it sounds. Because in the USA sales of Harley motorcycles has been declining for a decade! Experts estimate that every year which passes, Harley’s customer base ages by 6 months. The average rider age is now well into their 50s. Since Q3, 2014 Harley’s sales growth has been negative! In Q2 and Q3 2017 sales declines were almost 10%/quarter!
As its customer demographic keeps working against it, new customers for big bikes are buying BMWs from Germany – and Victory and Indian motorcycles made by Polaris, out of Minnesota (Polaris discontinued the Victory brand end of 2017.) BMW sales have increased for 7 straight quarters, and their European sales are growing stronger than ever – directly in opposition to Harley’s sales problems. Every quarter Indian is growing at 16-20%, taking all of its sales out of Harley Davidson USA share.
Going back to my 2016 column, when I predicted Harley was in for a hard time. Shares hit an all-time high in 2006 of $75. They have never regained that valuation. They plummeted during the Great Recession, but bailout funds from Berkshire Hathaway and the US government saved Harley from bankruptcy. Shares made it back to $70 by 2014, but fell back to $40 by 2016. Now they are trading around $40. Simply put, as much as people love to talk about the Harley brand, the company is rapidly becoming irrelevant. It is losing share in all markets, and struggling to find new customers for a product that is out-of-date, and sells almost exclusively in one market. Its move to manufacture in Europe is primarily a Hail-Mary pass to find new sales, paid for by corporate tax cuts in the USA and tariff tax avoidance in Europe.
But it won’t likely matter. Like I said in 2006, Harley Davidson is a no-growth story, and that’s not a story where anyone should invest.
An American epoch has ended. General Electric was part of the first ever Dow Jones Index in 1896. When the Dow Jones Industrial Average was formed in 1907 GE was a participant. GE has been the only company to remain on the index. All other original companies long ago completely disappeared.
GE did so well because its leadership had been able to constantly change the company to keep it relevant, and growing. During the century prior to hiring Jeff Immelt as CEO GE went from light bulbs to generating electricity and making all kinds of electrical infrastructure equipment, electric locomotives, mainframe computers, medical equipment, computer services, financial services, entertainment…. The list is very long.
Although not all GE CEOs were great, the Board was able to place CEOs in office who could sense market shifts and make good decisions. GE leadership thoughtfully analyzed markets, and made investment decisions to sell businesses that were not growing. And they made investment decisions to invest in trends which created growth. One of the best of these was Jack Welch, who developed the nickname “Neutron Jack” for his willingness to jettison businesses that were not growing and leading their industry, while willingly investing in entirely new growth markets where trends showed high rates of return like financial services and entertainment – wildly “non-industrial” markets.
But CEO Immelt was completely tone-deaf to the outside world. He was wholly unable to understand how to lead a team that could make good investments. Instead under Immelt’s leadership GE over-invested in historical products where they were losing advantage but trying to “keep up.” Selling businesses that were growing but faced stiff competition, rather than investing in growth. And refusing to invest in new external growth opportunities that could keep revenues increasing – and drive a higher GE market capitalization.
All the way back in 2009 I pointed out that GE was in a Growth Stall, and had only a 7% chance of consistently growing at 2%. I warned investors. At the time I said GE had to go all-out on a growth strategy, or things would turn ugly. But a lot of investors, employees – and apparently the Board of Directors – were ready to blame the Growth Stall on the economy. And blame it on Welch, who had been gone for 8 years. And say GE was lucky Immelt saved the company from bankruptcy with a loan from Warren Buffett’s Berkshire Hathaway.
Say what? Saved the company? Why did Immelt, and the Board, let GE get into such terrible shape? It was time to replace the CEO, not double down on his failed strategy.
Six years ago, May, 2012, I published in Forbes “5 CEOs that Should Have Already Been Fired.” At the time I said Immelt was the 4th worst CEO in America. I cited the 2009 column, and pointed out things really weren’t any better in 2012 than in 2009. That column had well over 1million reads. There was no way GE’s board was not aware of the column, and the realization that Immelt was a horrible CEO.
The Board of #3 (Walmart) fired Mike Duke. And the Board of #1 (Microsoft) fired Steve Ballmer. There is no real board at #2 Sears (which will file bankruptcy soon enough) because the CEO is also the largest shareholder (via his hedge fund) and he controls all board decisions. He should have fired himself, but had too much ego. But the board of GE – well it did nothing. Even though GE almost went bankrupt under Immelt, and its value was being destroyed quarter after quarter it left him in place.
I revisited the performance of these five CEOs and their companies in August, 2014 and reminded hundreds of thousands of readers – which I’m sure included GE’s Board of Directors – that company revenues had declined every year since 2009. And this string of failures had caused the company’s value to decline by 2/3. Yet, the board did nothing to replace this horrific CEO.
By March, 2017 I was so exasperated I finally titled my column “GE Needs a New Strategy and a New CEO.” Again, I detailed all the things that went wrong. It took 7 more months before the Board pushed Immelt out. But the new CEO failed to offer a better strategy, continuing to promote the notion of selling businesses to raise cash to “fix” the broken businesses – without identifying any growth strategy at all.
The only thing that can “fix” GE – save it from being dismembered and sold off – is a growth strategy. I offered how the new CEO could undertake this effort in October, 2017. But the Board, still wholly incompetent, still isn’t listening. Nobody should be surprised that GE is now removed from the Dow, and the new CEO is clearly without a clue how to find a path back to relevancy.
Too bad for investors, employees, suppliers, customers and the communities where the GE businesses reside. This didn’t have to happen. But due to an incompetent Board of Directors, which did nothing to properly govern an incompetent CEO, it did. And there’s little doubt it won’t be long before GE meets the same end as DuPont.
The US e-commerce market is just under 10% the size of entire retail market. On the face of it this would indicate that the game is far from over for big traditional retail. After all, how could such a small segment kill profits for such a huge industry based on enormous traditional players?
Yet, Sears – once a Dow Jones component and the world’s most powerful retailer – has announced it will close 100 more stores. The Kmart/Sears chain is now only 894 stores – down from thousands at its peak and 1,275 just last year. Revenue dropped 30% versus a year ago, and quarterly losses of $424M were almost 15% of revenues.
But, that ignores marginal economics. It often doesn’t take a monster change in one factor to have a huge impact on the business model. Let’s say Sales are $100. Less Cost of Goods sold of $75. That leaves a Gross Margin of $25. Selling, General and Administrative costs are 20%, so Operating Income is only $5. The Net Margin before Interest and Taxes is 5%. (BTW, these are the actual percentages of Walmart from 1/31/18.)
Now, in comes a new competitor – like Amazon.com. They have no stores, no store clerks, and minimal inventory due to “e-storefront” selling. So, they are able to lower prices by 5%. That seems pretty small – just a 5% discount compared to typical sales of 20%, 30% even 50% (BOGO) in retail stores. Amazon’s 5% price reduction seems like no big deal to established firms.
But, Walmart has to lower prices by 5% in response, which lowers revenues to $95. But the stores, clerks, inventory, distribution centers and trucks all largely remain. With Cost of Goods Sold still $75, Gross Margin falls to $20. Fixed headquarters costs, general and administrative costs don’t change, so they remain at $20. This leaves Operating Income of …$0.
(For more detailed analysis see “Bigger is Not Always Better – Why Amazon is Worth More than Walmart” from July, 2015.)
How can Walmart survive with no profits? It can’t. To get some margin back, Walmart has to start shutting stores, selling assets, cutting pay, using automation to cut headcount, beating on vendors to offer them better prices. This earns praise as “a low cost operation.” When in fact, this makes Walmart a less competitive company, because it’s footprint and service levels decline, which encourages people to do more shopping on-line. A vicious circle begins of trying to recapture lost profitability, while sales are declining rather than growing.
Walmart was (and is) huge. Even Sears was much bigger than Amazon.com at the beginning. But to compete with Amazon.com both had to lower prices on ALL of their products in ALL of their stores. So the hit to Walmart’s, and Sears’, revenue is a huge number. Though Amazon.com was a much, much smaller company, its impact explodes on the larger competitor P&L’s.
This disruption is felt across the entire industry: ALL traditional retailers are forced to match Amazon and other e-commerce companies, even though there is no way they can cut costs enough to compete. Thus, Toys-R-Us, Radio Shack, Claire’s and Bon-Ton have declared bankruptcy in 2018, and the once great, dominant Sears is on the precipice of extinction.
All of which is good news for Amazon.com investors. Amazon.com has 40% market share of the entire e-commerce business. The fact that e-commerce is only 10% of all retail is great news for Amazon investors. That means there is still an enormously large market of traditional retail available to convert to on-line sales.
The shift to e-commerce will not be stopping, or even slowing. Since January, 2010 the future has been easily predictable for traditional retail’s decline. The next few years will see a transition of an additional $2.5 trillion on-line, which is 5X the size of the existing e-commerce market!
As stores close new competitors will emerge in the e-commerce market. But undoubtedly the big winner will be the company with 40% market share today – Amazon.com. So what will Amazon’s stock be worth when sales are 5x larger (or more) and Amazon can increase profits by making leveraging its infrastructure and slow future investments?
Twenty years ago, Amazon was a retail ant. And retail elephants ignored it. But that was foolish, because Amazon had a different business model with an entirely different cost of operations. And now the elephants are falling fast, due to their inability to adapt to new market conditions and maintain their growth.
Author’s Note: In June, 2007 I was asked to predict WalMart’s future. Here are the predictions I made 11 years ago:
- “In 5 years (2012) Walmart would not have succeeded internationally” [True: Mexico, China, Germany all failed]
- “In 5 years (2012) Walmart would no new businesses, and its revenue will be stalled” [True]
- In 5 years (2012) Walmart would be spending more on stock repurchases then investing in its own stores or distribution” [True – and the Walton’s were moving money out of Walmart to other investments]
- “In 10 years (2017) Walmart would take a dramatic act, and make an acquisition” [True: Jet.com]
- “In 10 years (2017 Walmart’s value would not keep up with the stock market” [from 6/2007 to 6/2017 WMT went from $48 to $75 up 56.25%, DIA went from $134 to $180 up 34.3%, AMZN went from $70 to $1,000 up 1,330% or 13.3x]
- “In 30 years (2037) Walmart will only be known as “a once great company, like General Motors”