Even Leading Companies Can Disappear Into the Sunset

Monday, January 9, 2012

Buy-and-hold investing carries a wonderful vision:

  1. Find a successful company
  2. Buy the company’s stock
  3. Sit back, relax, and watch the money grow

The problem is that most successful companies peter out, either meandering around some plateau, producing no return — or, worse, falling back with mounting losses.

Many events and conditions can cause firms to succeed or fail. A common risk occurs when a technological development occurs. How the company responds can determine whether its future will be filled with success, mediocrity or failure.

Pennsylvania Railroad: Example of a diminishing former leader

The PRR was one of the great American companies. From Wikipedia:

The PRR was the largest railroad by traffic and revenue in the U.S. for the first half of the twentieth century and was at one time the largest publicly traded corporation in the world. At its peak it controlled about 10,000 miles (16,000 km) of rail line; in the 1920s it carried about three times the traffic (measured by ton-miles of freight) as other railroads of comparable length….

During its history the PRR merged with or had an interest in at least 800 other rail lines and companies. The corporation still holds the record for the longest continuous dividend history: it paid out annual dividends to shareholders for more than 100 years in a row. At one point the budget for the PRR was larger than that of the U.S. government; at its peak it employed about 250,000 workers.

For PRR, that decision point occurred in the late 1930s when diesel engines were beginning to replace steam locomotives. In need of replacing its aging passenger locomotives, management decided to stick with steam, modernizing by designing a radically different steam locomotive. The result was Robert Loewy’s famous “S1,” the largest express passenger engine ever built to replace the aging K4s, as pictured below with Loewy.

Management was thrilled, producing visions of a crack 100 MPH express train rushing thrilled passengers swiftly and smoothly to their destinations.

The engine was featured at the 1939 New York City World’s Fair, being placed on a platform with rollers that allowed the engine to operate.

However, in driving their creation to Manhattan, they discovered a fatal flaw: The engine was so long that it couldn’t negotiate most of the PRR’s curves! The locomotive became the first and last S1 produced and was relegated to a relatively straight route in the Midwest.

Back to the drawing board

Loewy was put to work again on a new, improved (AKA properly functioning) locomotive. Voila, the “T1” was born. Management was re-thrilled, with dazzling advertisements created to announce its creation.

To relate to companies we see today (e.g., Microsoft), it helps to study the PR’s exciting verbiage:

Here’s the drama that comes of a drawing board . . . first of a series of new engines now in service on the East-West route of the Pennsylvania Railroad! Capable of speed up to 120 miles an hour . . . different in design . . .  the long streamlined giant not only marks another forward stride in the science of railroading – it is indicative of the spirit of progress in an industry vital to the welfare of America, now and in the future.

About 50 T1s were built and operated, but the engines failed to live up to the hype. While they could handle curves, they suffered from slipping wheels at high speeds (thereby failing to live up to speed expectations) and they required abnormally high maintenance.

Management awakens to the real problem

Worse than the engine creation problems above was management’s decision to stick with steam locomotives. Even before the S1 and T1 were designed and built, the industry had begun its technological shift to diesel engines. Here are Union Pacific’s and Burlington’s, shown at the 1934 Century of Progress Fair in Chicago.

Technological developments and train design (exterior and interior) made diesel trains such as the Santa Fe Super Chief the well-recognized, desirable and modern mode of rail travel.

The bottom line

No leading company, regardless of size or previous successes, gets a free ride into the future. Without wise management, innovation and underlying industry growth, a leader can easily slip into the also-ran category — or into oblivion. Therefore, don’t own a stock simply because of the company’s past successes. Own it because it has the potential for future successes.


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