On May 17, 1993, Princeton astrophysicist Richard Gott compiled a list of all the current Broadway and off-Broadway shows, noting when each had first opened in New York’s famous theatre district. Using this data, Gott predicted the future run of each show based solely on its current age. Remarkably, his predictions were 95% accurate, illustrating his theory that everything observed at "random" is likely in the middle of its lifetime.

The idea suggests that long-established companies might have a higher probability of continued success compared to newer entities. The robustness seen in non-perishable items could similarly indicate stability and longevity in financial markets. Could the Lindy Effect apply to stocks or other investments?

What is the Lindy Effect?

Lindy's Law was popularized by Nassim Nicholas Taleb, an influential mathematician known for his work in risk management and statistical analysis, and a famous author of books such as Black Swan, Antifragile, Skin in the Game and many others. Lindy effect is an observable phenomenon that provides insights into the survivorship of non-perishable, intangible items such as ideas, technologies, companies and cultural works.

"The Lindy effect is a concept that the future life expectancy of some non-perishable things like a technology or an idea is proportional to their current age, so that every additional period of survival implies a longer remaining life expectancy. Where the Lindy effect applies, mortality rate decreases with time." — Nassim Taleb

According to this concept, the future life expectancy of such items is proportional to their current age. Simply put, if an item has already survived for a certain period, it is likely to survive for an equally long period going forward. To illustrate, if a technology has been around for 100 years, it is expected to remain relevant for another 100 years. He highlighted that the longer something has been in existence, the higher the probability that it will continue to exist. This effect partially explains why certain cultural artifacts, like the works of Shakespeare or the teachings of Socrates, remain influential while more recent bestsellers fade into obscurity. Similarly, sacred religious texts like the Ramayana, Gita, Bible, Quaran which are thousands of years old and are likely to survive for a long time.

Marathon Runners: Companies that Thrive Over the Long Term

Many businesses operate well beyond the lives of their founders and initial executives. This survival can be seen as a Darwinian process: the longer a company operates, the greater its chances of continuing to thrive.

Statistics show that half of all companies fail within 5 years, and 80% within the first 20 years. However, some companies defy these odds and survive for much longer, becoming outliers. These companies, which have endured through various economic cycles and challenges, can be viewed through the lens of the Lindy Effect. Several modern examples illustrate how Lindy's Law applies to successful companies:

• Kongo-Gumi: For 14 centuries, Kongo-Gumi specialized in building Buddhist temples, demonstrating exceptional longevity until its acquisition.

• Tata Group of Companies: Over 156 years of dominance across IT, FMCG, Steel, Car & many other businesses. It has survived independence, 2 world wars, wars with neighboring countries, and many other events - all the while increasing its market share and dominance domestically and internationally.

• Coca Cola: Founded in 1892, it has weathered significant events such as the Great Depression, two World Wars, and the Cola Wars of the 1980s. It has increased its dividends for 61 consecutive years.

Traditional valuation techniques often assume a company will survive indefinitely, which can be problematic, especially for younger companies in their growth stage.

However, these companies, which we refer to as "marathon runners," grow consistently over very long periods. This counterintuitive perspective challenges the common assumption that longevity reduces future lifespan. They age "backwards," in line with Lindy's Law, continuing to thrive and adapt to changing market conditions. For value investors, considering the Lindy Effect can provide valuable insights into a company's longevity and potential future performance.

Warren Buffett’s Value Investing Strategy Uses Lindy Effect

Warren Buffett exemplifies the practical application of the Lindy Effect in investing. Buffett has historically avoided investing in companies that have not been around for at least 15-20 years. His investment philosophy aligns with the idea that longevity can indicate future stability and success. If a company has been around for a couple of decades, it is more likely to continue thriving for another few decades, which fits Buffett's long-term investment horizon.

Consider the case of Coca-Cola and Cadbury's Dairy Milk. Despite changes in consumer behavior and market trends, these products have remained popular. Coca-Cola, for instance, is based on the timeless idea of providing a refreshing beverage. Its brand has become so entrenched in consumer culture that it remains a staple despite various market shifts. Similarly, Dairy Milk has sustained its popularity as a beloved chocolate brand.

Buffett invests in such companies not just because they have been around for a long time, but because they offer something unique that competitors find hard to replicate. The combination of timeless principles and strong, irreplaceable products is what makes these companies appealing investments.

Once a company has matured, it becomes easier to assign a fair value due to its established brand, loyal customer base, and strong market position. Warren Buffett's investment strategy exemplifies this principle. He focuses on established companies with proven track records. The average age of the top 10 holdings, which constitute 92% of the portfolio, in Berkshire Hathaway's portfolio is 108 years, with 7 of these companies being older than 100 years.

When we look at the next 10 holdings of Berkshire Hathaway, which constitute approximately 6-7% of the total portfolio, the average age is 52 years, with 2 companies above 100 years and a total of 4 companies above 50 years of age. Buffett intuitively understands that mature companies with a long history of success are more likely to continue thriving. This is why he prioritizes investing in businesses that have stood the test of time and demonstrated their ability to generate consistent cash flow.

Analysis of Lindy Effect as an Investment Factor

Performance of Stocks Picked on the Basis of Lindy Effect

An analysis conducted by Market Sentiment looked at S&P 500 companies that were over 100 years old. They narrowed this list down to 73 target companies applying filters on companies that had a minimum market cap of $1Bn & had fundamental data available as of 2000. Here’s the results of their analysis:

• A $100 investment in Lindy stocks would have grown to $776 (a 676% return) compared to $486 (a 386% return) for the S&P 500. This outperformance was achieved with comparable portfolio volatility (12.3%) and maximum drawdown (55%) to that of the S&P 500.

• As with any portfolio, power laws are applicable. A few winners contributed significantly to portfolio gains. Notable companies like Moody's, Equifax, and Hershey delivered returns exceeding 1,000%.

• However, being a legacy company does not guarantee success. General Electric, once the biggest company in the world in 1999, fell by 25% over the last 20 years. Citigroup struggled to recover from the Global Financial Crisis.

• When applying a market-cap-weighted portfolio, the results were less impressive, with the portfolio slightly underperforming the market. This underperformance was primarily due to the poor performance of the largest companies in the list over the past two decades.

Lindy’s Law at Odds with Financial Theories

Competitive advantage period (CAP) and mean reversion theories state that a company's ability to generate returns that exceed its cost of capital is limited and that stocks tend to revert to their mean value over time. Despite the validity of CAP and mean reversion in many cases, there are notable exceptions. L'Oréal, for example, has seen its earnings per share grow by 11% annually and its dividends by 14% over the past 40 years. This sustained growth defies the typical patterns predicted by financial theory.

Marathon runners like L'Oréal, Tata Group etc. exemplify how financial theories and popular investment beliefs can fail to predict a company's growth trajectory. According to Lindy's Law, L'Oréal's 115 years of history suggest it may continue to thrive for many more decades. This perspective aligns with long-term quality value & growth investing, where the focus is on identifying companies with enduring value and potential for consistent growth.

Limitations of the Lindy Effect in Stock Markets

Survivorship Bias

Relying on the Lindy Effect can lead to survivorship bias. While many companies have survived for decades, countless others have failed. This bias can give a misleading sense of security regarding the longevity of existing companies.

While survivorship bias might be a concern—many companies that started 50-100 years ago no longer exist—the point of the Lindy Effect is the increased probability of survival for those that have already lasted a long time. Companies that survive through various business cycles and outlast competitors tend to be robust and less likely to fail. This resilience is an important factor for investors to consider, emphasizing the significance of a company's operational history and its performance over time.

Technological Change

Investors must be cautious of technological disruptions that can render even long-standing companies obsolete. Companies like Kodak and Nokia failed to adapt to technological changes, leading to their decline. In India, MTNL and HMT suffered from similar fates. For a company to continue thriving, it must evolve and adapt, even if it is built around simple products and services. Successful examples include Britannia and Dabur, which have evolved significantly from their earlier iterations.

Implications for Long-Term Quality Growth Investing

For most investors, considering a company's long track record is crucial. Even smaller companies in niche markets with a 50-year history suggest resilience and potential longevity. Here are some essential checkpoints:

1. Evaluate Longevity: Focus on companies with a long operational history.

2. Assess Management: Look for stable, experienced management teams.

3. Industry Stability: Consider the industry's stability and the company's role within it.

The Lindy Effect can help filter out overhyped management strategies and trading techniques that often don't last. Instead, focus on time-tested principles and avoid getting too excited about the latest revolutionary strategy. Things that have lasted a long time tend to continue lasting.

Find Companies that Continuously Innovate & Adapt

While Lindy's Law offers valuable insights, it is essential to avoid overly simplistic interpretations. Not every long-standing company will be successful in the future solely due to its history, nor will every young company fail due to a lack of a track record. Richard Gott's forecast accuracy of 95% underscores the importance of recognizing exceptions and outliers. A company's survival and success depend on its ability to sell products and services, which are often perishable. Even if a company is founded on timeless ideas, it must continually innovate and adapt to remain competitive.

For instance, Microsoft, founded in 1974, rose to prominence as IBM, founded in 1911, began to decline. IBM struggled to adapt to the personal computer revolution, while Microsoft capitalized on this shift with its Windows operating system and office software.

New companies can emerge with better products or services based on the same timeless principles. As an investor, it is crucial to use judgement and not rely solely on a company's age. This is where Warren Buffett's genius comes into play. He excels at identifying companies that not only have a solid foundation of timeless ideas but also offer products or services that are indispensable and not easily replaced. For example, in the top 10 holdings, we find the top holding is in Apple - where Berkshire holds 40.81% is 47 years old, while the remaining 9 constitute ~50% of the invested portfolio. Apple's success stands in contrast to older companies that have struggled to adapt to technological changes. Buffett's high allocation towards Apple, shows his recognition of Apple's exceptional qualities that go beyond its age.

What will not Change in the Next 10 Years?

Here’s an excerpt from an interview of Jeff Bezos -

I very frequently get the question: "What's going to change in the next 10 years?" And that is a very interesting question; it's a very common one. I almost never get the question: "What's not going to change in the next 10 years?" And I submit to you that that second question is actually the more important of the two -- because you can build a business strategy around the things that are stable in time. ... [I]n our retail business, we know that customers want low prices, and I know that's going to be true 10 years from now. They want fast delivery; they want vast selection.It's impossible to imagine a future 10 years from now where a customer comes up and says, "Jeff, I love Amazon; I just wish the prices were a little higher." "I love Amazon; I just wish you'd deliver a little more slowly." Impossible.And so the effort we put into those things, spinning those things up, we know the energy we put into it today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it.

And in his 1997 shareholder letter Jeff Bezos wrote:

We believe that a fundamental measure of our success will be the shareholder value we create over the long term ... Because of our emphasis on the long term, we may make decisions and weigh tradeoffs differently than some companies.

Wright Titan: Long Term Growth Strategy

The natural process of aging ingrained in our mindsets leads us to believe that everything ages as we do. In contrast, Lindy's Law shows that some companies "age backwards," gaining strength and life expectancy as they grow older. This law effectively describes the lifecycle of the marathon runners in which we invest. These companies form the foundation for the compounding benefits captured in all our quality growth portfolios.

The Wright Titan portfolio is a core investment portfolio that looks at steady growth over a long term horizon. Our focus is on identifying "marathon runners," companies with proven longevity and growth potential. These "marathon runners" are high quality, low volatility & trending large cap stocks that have proven their ability to navigate various market cycles, offering a reliable foundation for long-term growth. The strategy also includes mid-cap stocks for additional growth potential, combining stability with opportunity.

To learn more about large caps and Wright Titan, read our article on All About Large Cap Stocks With Wright Titan and India's Stock Market Shifts: Are Large Cap Stocks the New Safe Haven for Investors?