The Future of Investing (Part I)

From a Forbes article by Steve Denning we learn that a study by Deloitte’s Center for the Edge shows the rates of return on assets and on invested capital for 20,000 US firms from 1965 to 2011.
Economy-wide Return on Invested Capital
The graphic shows that something has gone so terribly wrong with the type of businesses supported by Wall Street—the supposed engine of economic growth and the supposed creators of jobs. When these firms have rates of return on assets or on invested capital of, on average, just over one percent, we have a catastrophe on our hands. An ROA of just over one percent means that firms are dying faster and faster: the life expectancy of firms in the Fortune 500 is now less than fifteen years and declining rapidly.
Now, let’s look at the market’s 10 best stocks over the past 10 years, according to The Motley Fool:
Company [year founded] Return, 2005-2015 Market Cap in 2005
Regeneron Pharmaceuticals [1988] (NASDAQ:REGN) 8,113% $513 million
Keurig Green Mountain [1981] (NASDAQ: GMCR) 6,065% $179 million
Medivation [2004] (NASDAQ: MDVN) 5,516% $41 million
Priceline Group [1997] (NASDAQ:PCLN) 4,781% $917 million
Netflix [1997] (NASDAQ: NFLX) 4,718% $646 million
Monster Beverage [1935] (NASDAQ: MNST) 3,770% $397 million
Opko Health [1991] (NYSE: OPK) 3,722% $5.7 million
Illumina [1998] (NASDAQ: ILMN) 3,653% $361 million
NewMarket [1887] (NYSE: NEU) 3,648% $338 million
Pharmacyclics [1991] (NASDAQ: PCYC) 3,468% $142 million
One thing that really stands out among these 10 companies is that every single one of these stocks had a market capitalization of less than $1 billion a decade ago. You have to go down to No. 12 on this list to find behemoth Apple (NASDAQ: AAPL)  as an exception to this general rule. What investors can learn from that is that if you expect to get truly life-changing returns from stocks, you can’t expect to find them in the biggest, most prominent and well-known companies in the market. Instead, you have to dig deeper and take a look at parts of the market that many Wall Street analysts leave untouched — small companies that often take some digging just to find out what they actually do, let alone what their potential is for future growth.

Another factor to understand is that Wall Street-types do not how to grow businesses. Regeneron was the best performing public company in the last ten years but from Forbes, we learn that Wall Street’s advice to Regeneron’s CEO and founder Leonard Schleifer was just bad:
[Wall Street] investors like to simplify their investments because it is easier for them to do their analyses. So they come up with this distortion of suggesting that you should focus on one thing. But the truth of matter is that it’s very bad advice…. If you are a company and focus on one thing, you’re pretty well cooked if that one thing doesn’t make it.
Another Steve Denning’s Forbes article, “Roger Martin: How ‘The Talent’ Turned Into Vampires” begins to shed light on why the ways of Wall Street no longer work:

How did America—a country dedicated to the proposition that all men are created equal—become one of the most unequal countries on the planet? Why do the nation’s leaders now spend so much of their time feeding at the trough and getting ever more for themselves? Why has public-mindedness in our leaders given way in so many instances to limitless greed?

These questions are being raised, not in some anti-capitalist rag from the extreme Left, but in the staid pro-business pages of the Harvard Business Review, in a seminal article by Roger Martin, the former dean of the Rotman School of Business and the academic director of the Martin Prosperity Institute: “The Rise and (Likely) Fall of the Talent Economy.

One key factor, argues Martin, is a fundamental shift in nature of the economy. Fifty years ago, “72% of the top 50 U.S. companies by market capitalization still owed their positions to the control and exploitation of natural resources.” But in the latter part of the 20th century, a new kind of organization began to emerge: an organization that prospered not by natural resources but through “the control and exploitation of human talent.”

“By 2013 more than half of the top 50 companies were talent-based, including three of the four biggest: Apple, Microsoft, and Google. (The other one was ExxonMobil.) Only 10 owed their position on the list to the ownership of resources. Over the past 50 years the U.S. economy has shifted from financing the exploitation of natural resources to making the most of human talent.”

In the past 50 years, our economy has dramatically changed but the Wall Street mentality has changed very little. What worked on Wall Street over 50 years ago when most of the economy was driven by the control and exploitation of natural resources is no longer working now that our economy is based on making the most of human talent.
It is easier to enhance creativity by changing conditions in the environment than by trying to make people think more creatively. And a genuinely creative accomplishment is almost never the result of a sudden insight, a lightbulb flashing on in the dark, but comes after years of hard work…. If you do anything well, it becomes enjoyable…. To keep enjoying something, you need to increase it’s complexity.
~ Creativity by Mihaly Csikszentmihalyi
A genuinely creative accomplishment is almost never the result of a sudden insight, but comes after years of hard work.
Schleifer and Yancoppulos

Leonard Schleifer, left, and George Yancoppulos in a lab at Regeneron headquarters in Tarrytown. / Photos by Matthew Brown / The Journal News

For two decades, Leonard Schleifer, CEO and founder of Regeneron, has protected his Cheif Science Officer, George Yancopoulos from investor demands for results as failures piled up. “George was too talented,” says Schleifer. “The people around him were too talented. It wasn’t a matter of whether we can do this. It was a matter of when we can do this. Would we survive long enough to have a hit?”

“Everything that we’ve been doing for 25 years, it interconnects,” says Yancopoulos. “It’s not like we changed direction in the middle, or we did a new trick. It’s all building on the foundation of those early ideas, and we’re just taking them to the next level.”

Schleifer likes to say that companies can “rot from the inside” if they get their priorities mixed up.
“I always say that you can tell whether a company is rotten by the following little scenario,” he says. “George and I are in the office and we’re arguing about something, which we do all time, and two people show up and knock on the office door. One of them is waving last month’s sales of Eylea in the latest country that we’ve launched in, and the other one is way waving an experimental result that doesn’t have a chance in the world of leading to a product for at least a dozen years. If we’re not equally excited about both of those – or perhaps even more excited about the long-term – then the company’s rotten.”
The future of successful investing is predicated on understanding the new dynamics of business. This includes understanding that most of the companies on the Fortune 500 companies are “rotten” and too many depend on government protections to remain profitable.
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