2024-01-17 11:10:48 ET
Summary
- Choosing companies with a solid competitive advantage and high ROIC increases the chances of long-term investment success.
- Alphabet (Google) is a good long-term investment due to its dominant position in search, YouTube's growth potential, and the growth of its cloud segment.
- Visa is positioned for long-term growth as digital payments become more prevalent; its competitive advantage and financial performance make it a strong investment choice.
- Meta is expected to continue its growth as social media and digital advertising trends continue; its financial performance and competitive advantage support its long-term potential.
Predicting the unpredictable
The year 2064 is not random; it is the year I will have my 66th birthday. At that age I expect to be a retiree and have a nice nest egg set aside from investments made when I was young. Or at least I hope that will be the case.
Immobilizing a $10,000 stock portfolio today for 40 years is enough to take full advantage of compound interest and accumulate considerable wealth by the time I am retired, but there is one big problem: no one guarantees me that I will invest in the right companies. Indeed, 40 years is a long time, and we human beings are not even able to know for sure what we will have for lunch tomorrow.
When we talk about such a large time frame, all the normal techniques for evaluating an investment are lacking. What would be the point of discounting 40 years of expected future cash flows? Doing it accurately for 10 years is already virtually impossible. The same is true for a simple dividend discount model as well as for technical analysis. It is just a waste of time to try to figure out the fair value of a company based on the next 40 years.
So, having established that we cannot know our potential return over such a time frame, this article will take a less quantitative approach than usual. After all, it would already be a success for an investor to have identified a company that is still operating after 40 years. Think about how much the world has changed from 1984 to the present.
However, there are two conditions that increase our chances of success:
- Choose a company with a solid competitive advantage, as this is the only way it can increase its revenues over time. A business with no competitive advantage is bound to deteriorate sooner or later.
- Choose a company with a high ROIC, possibly much higher than WACC. This allows it to exploit the potential of compound interest over time.
Empirically, it has been shown that companies with a high ROIC are more likely to outperform the market in the long run.
With the same reinvestment rate (40%) and same initial capital ($1000), Company A with a 10% ROIC will always underperform Company B with a 30% ROIC. This is because Company B, taking advantage of compound interest, will end up with more free cash than Company A at the end of the period analyzed .
So, a high ROIC and an excellent competitive advantage are essential for a successful investment with such a long time horizon. Also supporting my thesis is a famous speech by Charlie Munger at the University of Southern California:
Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return -- even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you'll end up with one hell of a result.
In other words, over 40 years of investment it matters very little what price the stock was bought at, but it matters much more whether the business has deteriorated or not. Therefore, on this occasion, the companies in my hypothetical portfolio will not be selected on the basis of their fair value. The only three aspects I will take into consideration are the following:
- Very long-term growth drivers
- ROIC and reinvestment rate
- Competitive advantage and margins- Typically, when there is a strong competitive advantage it is reflected in the financial results.
Finally, before we begin with portfolio construction, I would like to make several important premises. First of all, the purpose of this article is not to entice you to create such a portfolio to surely be rich in 2064: don't take the title too seriously. The main purpose is to create food for thought as to whether or not the companies I will discuss exist in 40 years. Of course, I would appreciate it if you would also create a hypothetical $10,000 very long-term portfolio in the comments so that we can discuss it together. That said, let's get started.
First company: Alphabet; 20% of portfolio
The first company I would include in my very long-term portfolio is Alphabet ( GOOG ) and it would have a weight of 20%.
We all know what this company does since we use its apps on a daily basis. Although it has become a real behemoth in the last 10 years, in my opinion there are still growth drivers for the very long term.
57% of its revenues come from Google Search, the most widely used search engine in the world. Currently, its market share remains overwhelming: 91.62%.
Microsoft in recent years has tried to enter this market with Bing, even implementing some ChatGPT functions, but the results have been disappointing. People simply cannot deviate from Google and are unwilling to change their habits. Even if there are new developments regarding this market in the future, in my opinion Google will never be caught off guard, which is why I believe this competitive advantage will last for a long time to come. After all, we observed this phenomenon early last year when many believed that ChatGPT would replace Google: after a few months the hype faded and Alphabet released Bard.
In addition to Google Search, I consider YouTube another operating segment that is destined to last a long time. With the introduction of shorts and a more interactive homepage, YouTube is increasingly taking on the hallmarks of an Instagram-style social media. As of today it has 2.70 billion active users, second only to Facebook.
Anyway, although there are many traits in common with Meta's apps, my opinion is that YouTube is not a direct competitor, rather it is a complementary app. Same goes for Twitch, which is totally geared toward live broadcasts and cannot offer top-notch content like YouTube. The only real competitor is probably cable TV but its numbers are gradually declining :
- 39% of US Baby Boomers watch cable TV more than 10 hours a week.
- Only 17% of Gen Z and 26% of Millennials watch TV more than 10 hours a week.
This means that as generations pass, fewer and fewer people will watch cable TV and opt for other choices such as YouTube. After all, it is inevitable given the convenience of watching what you want when you want. Moreover, the quality of some Youtubers' videos is in my opinion comparable to the best TV programs, which was unthinkable 5-6 years ago.
Currently, most of the revenue from YouTube comes from advertising but I expect that over the decades the business model may gradually shift to subscription-based. With introduction of YouTube TV, more and more users tired of advertising prefer to pay a monthly subscription: today there are 6.50 million ; 600,000 more in the last quarter alone. Obviously, it will take a long time but it will be worth it since it will make Alphabet's revenues much more stable and less volatile even during recessionary times. Usually, companies with such a business model tend to trade at high multiples given their strength, and this could positively affect Alphabet's future valuation.
Last but not least, Alphabet's cloud segment is growing fast and has become profitable over the past few quarters. This market is not yet mature and the gradual shift of companies to cloud computing seems inevitable. The latter, offers to organizations of all shapes and sizes the ability to move faster, be more agile and innovate their business. In 2022 this market had a value of $569.31 billion, in 2030 it could reach $2.43 trillion, registering a 20% CAGR . So, there is still ample room for growth. In terms of market share, Google Cloud Computing still lags behind Amazon Web Services and Microsoft Azure, currently the main competitors.
Overall, I envision the Alphabet of 2064 as a mature company that can generate predictable revenues from YouTube TV and Google Cloud subscriptions. Revenues from advertising will continue to have a large share of total revenues, albeit smaller than today. My main doubts concern the search engine, probably replaced by some kind of artificial intelligence. In any case, it would change little since I expect that Alphabet might get there first on this kind of technology.
ROIC and margins
Alphabet's strong competitive advantage is also reflected in its financial results, which are consistently improving in terms of both free cash flow and profitability.
Finally, both ROIC and reinvestment rate reflect the conditions for this company to be a compounder in the long term.
As it should be, after years of strong growth the reinvestment rate has declined compared to the past but remains sound. This decline has been accompanied by an improvement in ROIC (never so high since 2015), which means that the company is only willing to make investments with high potential. After all, compared to a decade ago, Alphabet has matured and needs stricter rules to allocate its capital.
Second company: Visa; 20% of the portfolio
Visa ( V ) would also have a 20% weight in this hypothetical portfolio, but the investment thesis is much simpler than that of Alphabet. In this case, the main growth driver is only one: the gradual adoption of digital payments over cash.
The global transition to a cashless society is almost inevitable to finally combat tax evasion and make payments safer and more convenient. Moreover, the pandemic has accentuated this trend since online purchases were the only ones allowed during lockdowns.
My view is that today's society is focused toward whatever can be had immediately or in the shortest possible time with the least possible effort. People are losing the habit of going to a physical store and buying what they want if there is the possibility of doing so from their comfortable couch. Companies like Amazon have cut off the legs of thousands and thousands of entrepreneurs with physical stores, and this has accentuated online sales. This talk can be generalized to almost anything, and Visa will benefit enormously since it will be involved in a good chunk of these transactions. The global digital payments market has been valued at $81.03 billion in 2022 and could register a CAGR of 20.80% through 2030.
Competition from Mastercard is definitely a factor to consider, but I don't think it will change the current market structure that much. Visa and Mastercard operate as a duopoly in a market with enormous potential, so I think it is in the interest of both to continue on this plan: it is not worth risking anything more. If I prefer Visa it is because it has higher profit margins.
American Express targets a rather specific customer base, so I don't think it can be a long-term threat in terms of market share. As for a future dominated by cryptocurrency transactions, it simply seems to me to be nonsense: I don't think anyone would rather get paid in a currency with the volatility of a penny stock. Should their value stabilize decades from now it might be possible, but at the moment there is no reason to think so given that those who buy them do so with the intention of driving around in Lamborghinis in a few years. I am generalizing but I think I have explained myself.
The main problem is if the central bank issues a digital currency that would bypass the function of Visa and Mastercard. The ECB is already working on such a project and it could be tested in early 2028. Personally, I don't find it feasible, but we will see in the next few years how the situation develops.
Overall, with the rise of digital payments, Visa's growth could continue for decades to come thanks to its business model based on fees and commissions per transaction made. Its competitive advantage is enormous, and it is virtually impossible for a new company that wants to enter this market to oust Visa. It would have to invest billions of dollars to set up the infrastructure and obtain thousands of business agreements with banks and financial operators around the world. By the way, Visa enjoys the network effect: the more people who have a Visa card, the more merchants are willing to accept a Visa card as a payment method. Today there are 4.20 billion Visa cards in the world: no new company would be better off entering this market.
ROIC and margins
With such a competitive advantage in such a market, Visa is in my opinion one of the best companies in the world based on its financial performance.
Free cash flow, albeit with ups and downs, shows excellent long-term growth. The free cash flow margin is what most distinguishes this company: more than 60% from 2021 to date. Basically, out of $100 in revenues, $60 is free cash flow: hard to find better.
Its cost structure, skewed toward fixed rather than variable costs, allows profitability to improve steadily as transaction volume increases. Thanks to operating leverage, from FCF margin of 30.40% in 2010, it has now reached 60.30%. Further improvement in the coming years cannot be ruled out.
ROIC averages above 20%, which is great; in the last two years it averaged around 30%. The only downside is the reinvestment rate, averaging 12.67% and not high enough to take full advantage of the high ROIC. Despite the growth prospects, Visa is a mature company and it is not easy to find new investment opportunities in its market. In any case, the high free cash flow margin can compensate for the low reinvestment rate. With the cash generated, Visa tends to buy back its shares each year and allows EPS to have an additional growth driver. In 2010 there were 2.77 billion shares outstanding; today there are 2.08 billion.
Third company: Meta; 20% of the portfolio
The third and final company with a weight of 20% is Meta ( META ).
For better or worse, social networks have revolutionized the world, and Meta is obviously the most important company in this market. People often think that its apps (especially Facebook) are now dead and that it is impossible to increase users further: this is simply a mistaken belief.
Of the 2.08 billion daily active users, 75% are not from Europe, US or Canada. In these countries, user growth has been stagnant for years already; it is the Rest of the World and India that are the markets where Meta's presence is largest and on the rise.
So, in more developed countries Meta is growing only in terms of ARPUs, while in less developed countries it is growing both in terms of users and ARPUs.
Digital advertising is gradually replacing traditional advertising methods, and the trend is still growing strongly: $616 billion was spent worldwide in 2022, and in 2027 it could exceed one trillion . Due to its dominant position in social networks, Meta will continue to benefit from this growing trend. After all, it is inevitable that methods such as door-to-door advertising or television advertising will be sidelined since most of the population spends many hours a day in front of their mobile phones/PCs.
Instagram and Facebook generate most of Meta's revenue and I expect that in a few decades they will still have a major influence on our lives. However, I believe the most important growth driver available to Meta is WhatsApp. Its potential is often underestimated, especially in the United States where people still prefer SMS.
Mark Zuckerberg is working to make this app as profitable as possible, which is why he has implemented new features currently available only in India and Brazil. The goal is to make WhatsApp similar to WeChat's business model, thus making it 'an app for everything'. This aspect is of crucial importance in understanding what Meta's future will be, but in order not to make this article too long, I suggest you click this link to learn more about it.
Finally, I am not considering the prospects of the Metaverse. Since we are still in the embryonic stage, I will refrain from making any reckless predictions: it is really too complicated to understand what the Metaverse will be in a few decades. I will just say that I have faith in Mark Zuckerberg's long-term vision since he is a CEO who does not worry about the short-term needs of shareholders. If he makes a choice, it is for the good of the company, not to see a momentary price hike in the stock market.
ROIC and margins
Meta's free cash flow is growing steadily over the long term, and the current margin is close to 30%, which is excellent. Profitability was better in the past, but that does not mean that Meta has deteriorated. Over the past few years it has significantly increased CapEx in order to generate new long-term growth drivers. The advertising efficiency of the family of apps is higher than ever and more and more companies are taking advantage of it.
Meta's high investments can also be seen from the ultra-high reinvestment rate; all with a ROIC of more than 20%. In short, Meta is a compounder that has sacrificed short-term profitability for greater benefits in the future. Of all the companies featured in this article, I expect Meta to be the one with the best growth prospects.
Fourth company: LVMH; 10% of the portfolio
In my opinion, one of the best sectors to invest in is high fashion, which is why I allocate 10% of this portfolio to LVMH (LVMHF).
My thesis for investing in this company is very simple: in today's society, appearance matters a lot, and dressing in branded clothes is one of the ways to feel more appreciated. I certainly do not doubt that products from certain brands have above-average quality, but in my opinion this is not the main factor that leads consumers to buy a $2,000 Louis Vuitton bag. Putting hypocrisy aside for a second, many of the people loyal to these brands buy them to look a certain way and feel part of a certain social status. I personally disagree with their view but understand it, which is why I consider LVMH to be a company with an insurmountable competitive advantage. Probably, its customers would buy its expensive products regardless of their quality given the fame of its brands.
The most interesting aspect about high fashion is that while in the past adults were mainly the ones who bought these products, today teenagers weigh in. Gen Zs started much earlier than Millennials to buy such products, in fact they start on average as early as age 15. But there is more.
According to this report by Bain & Company , the younger generations (generations Y, Z and Alpha) will become by far the largest buyers of luxury, accounting for 80% of global purchases. In short, the further we go, the more normal it will be to spend $500 on a belt. Driving this growth will not only be wealthy households, but especially those with average wages. After all, the psychological aspect discussed above concerns the latter more.
LVMH's main competitors are Kering, Burberry, Richemont and Capri Holdings. All very good companies, but none of them compares to the amount of successful brands belonging to the LVMH group. By the way, they are not only concerned with clothing, but with the luxury market in general.
Some brands such as Louis Vuitton, FENDI, Dior and Givenchy have decades of success stories behind them, and it is really difficult for a new competitor to take over and oust them. People would never spend $500 on a T-shirt from an unknown brand, even if it is of very good quality. This kind of competitive advantage is built over time, which is why I believe LVMH will still be at the top in 40 years. Assuming there is a new brand in vogue, LVMH would probably buy it. All in all, the major players in the haute couture industry have already defined themselves decades ago; the partnerships may change but the dominant companies I believe will be the same in the future and LVMH will still be at the head. All the major French haute couture companies have mainly family ownership and dominate unchallenged.
ROIC and margins
Free cash flow has increased over the long term, albeit recording ups and downs. Demand for luxury products has declined in the past two years after the Covid-19 boom, but this is not a permanent deterioration. The perception toward LVMH's major brands has not changed. The free cash flow margin has always been in double digits in recent years, peaking at 24.90%. From a very long-term perspective, I would say an average target could be between 15-20%.
ROIC here is also stably in double digits, a marked improvement over the past. However, the reinvestment rate is quite low given the already wide spread of LVMH's brands. Offsetting this downside is in my view the strong competitive advantage from the decades-long (centuries-long in some cases) success of its brands. Personally, I expect that the LVMH of 2064 will not be so different from what it is today since its business model does not require any particular innovation and that is exactly its strength.
Fifth company: Hermès, 10% of the portfolio
From the Arnault family we turn to the Hermès family, 66% owners of the haute couture company taking the same name. Although their stake is huge, this has not prevented the stock from achieving a CAGR of 22.90% over the past 10 years.
Previously, when I included LVMH's main competitors I deliberately excluded Hermès, and the reason is that in my opinion this company is not comparable to any other. Born in 1837, the Hermès (HESAY) brand has become synonymous with quality and above all exclusivity.
As much as LVMH and Kering have quality pieces, the latter are not comparable to Hermès products in terms of brand perception. Saving for a while, everyone can afford to buy a Louis Vuitton bag; in fact, they have become quite popular even among those with average incomes. In contrast, few people can buy a leather Birkin: they start at $9,000 and can exceed $100,000. Making a comparison known to everyone, it is like comparing a Ferrari to a BMW. Of course, there are also less expensive alternatives, such as the Picotins and Evelynes bags, but the most renowned are the Birkins and the Kellys.
To achieve such a reputation, Hermès has taken decades to create this aura around its brand. Its strategies to increase profits are counterintuitive; in fact, just think that stores are decreasing year after year: in 2011 there were 328, in 2022 only 300. Moreover, it is not enough to be rich to buy their bags, you have to be a loyal customer, which makes it even more difficult to get certain bags/dresses.
To sum up, if major haute couture companies have tried to get closer to the middle class to increase revenues, Hermès has never made any compromises. To best express the competitive advantage of this company I think nothing could be better than the words of former CEO Patrick Thomas:
The luxury industry is built on a paradox: the more desirable the brand becomes, the more it sells but the more it sells, the less desirable it becomes. I believe Hermès' vision provides a solution to the dilemma.
ROIC and margins
As we can see from this image, Hermès' free cash flow is growing strongly over the long term. In particular, the last two years have been positive unlike LVMH, a further sign that the target customers are not quite the same. The free cash flow margin has improved greatly and is now firmly above 30%, an impressive result that is probably unmatched in the fashion world.
Finally, the ROIC is quite high while the reinvestment rate is a bit low. After all, it was inevitable given the company's policy on exclusivity. If Hermès were to start expanding too much and selling its top products to anyone, it would lose its competitive advantage gained laboriously over the decades.
So what does the company do with all the cash produced? It is set aside, and this is the aspect I dislike most about Hermès. 51% of its assets are cash and short-term investments, in fact the net debt is - €7.36 billion. Such an amount of cash could be invested in risk-free bonds and benefit from the current high rates, but it does not seem to be the priority. In addition, dividends of €1.37 billion were issued in the last year; I would have preferred a buyback.
Overall, beyond cash management, I consider Hermès an impressive company and one that can still be at the top in 40 years. Given its history, I find it really hard to think that it will not.
Sixth company: Intel, 10% of the portfolio
Semiconductors are the gold of the future, so I expect that this sector may still be in vogue several decades from now. In a way, my choice of Intel ( INTC ) was forced since there are no real alternatives to be exposed to this market without risking too much.
Companies like Nvidia and AMD are fantastic, but their competitive advantage is limited to chip design. As fabless companies, they rely on TSMC for manufacturing, which exposes them to high risk in the event of a China-Taiwan conflict. This has been a recurring theme in recent months, and it is impossible to predict how the situation will evolve in the next few years; let alone 40 years from now.
Intel is the only company in the West involved in all steps of chip fabrication, so it is the only real competitor to the eastern alternatives Samsung and TSMC. Western governments have every interest in helping Intel grow because semiconductors are synonymous with power. Whoever gets the best ones has access to the best technologies and the best weapons, which is one reason why China is so obsessed with Taiwan.
In addition, the semiconductor industry is capital intensive, so investments in the order of billions of dollars are needed to enter it. So, it is unlikely that there will be any new Western company willing to oust Intel in the coming decades. Suffice it to say that just to buy ASML's new High-NA EUV lithography machine requires between $300-$400 million. Intel bought one, but since it is three stories high once assembled, it had to build a new extension to the factory just to house it. Basically, it is an industry in which few can operate.
Overall, Intel's competitive advantage is considerable and should not be affected if the China-Taiwan tension escalates into war. Since this is a very long-term portfolio, I prefer to avoid other semiconductor companies whose geopolitical risk would have a devastating impact.
ROIC and reinvestment rate
Intel's free cash flow has had a rather bizarre trend: growing until 2020 and then declining to a disastrous -$10.40 billion. However, analyzing the situation more deeply, Intel is far from dead since the reduction in free cash flow is mainly due to a huge increase in CapEx. In recent years management realized that it was falling behind the competition and decided to steer for a total turnaround.
The huge amount of investment made is evidenced by a high reinvestment rate especially in recent years. Obviously, such a high CapEx is not permanent, so free cash flow will rebound in the coming years.
Overall, Intel represents to date the only hope for the West to compete with Samsung and TSMC: this market is too important and I expect it will be huge in 40 years. It will probably be as early as 2032 .
By purchasing ASML's machinery, the gap with the East could narrow, plus it will be able to benefit from government aid through the CHIPS Act.
Seventh and eighth companies: Alibaba and Tencent; 5% each
So far 90% of the portfolio consists only of Western companies, so in the remaining 10% I decided to include something new. The world's major economic powers 40 years from now might be different from what they are now: China might overtake the US as the largest economy. So, I thought it was appropriate to include the top two Chinese companies: Alibaba (BABA) and Tencent (TCEHY).
Despite the sanctions and restrictions imposed by the Chinese government, their dominance in China remains unchanged as do their growth prospects. Moreover, their gradual integration into the Western economy should not be underestimated.
I recently covered both Alibaba's and Tencent's business models in detail, so to avoid going on too long and repeating things already discussed, I am attaching links to these articles:
ROIC and reinvestment rate
For both Tencent and Alibaba, free cash flow is increasing in the long run, however Tencent's FCF margin is significantly better. This does not mean that Alibaba's is low, they simply operate in different businesses and Alibaba is disinvesting in some unprofitable projects to improve it: the results are already evident with respect to 2022.
Both companies are well structured to achieve very long-term growth in one of the countries with the fastest growing middle class. The stock market is momentarily punishing them, but this decline shouldn't last forever. After all, they both issue a dividend and generate huge amounts of cash. In my opinion, it is inevitable that sooner or later the market will realize that it has undervalued them.
Tencent's ROIC is almost double that of Alibaba, but Alibaba's reinvestment rate is twice that of Tencent. In practice, Tencent is able to allocate its capital better through more profitable investments, but it is not easy to find them. Alibaba has a lower ROIC (13% is still good) but is more willing to invest for its long-term growth.
As entrenched as they are in Chinese society, I think it is likely that Alibaba and Tencent can dominate in the coming decades as well. Even if the government is getting in their way, they have no interest in destroying the country's two best companies.
Conclusion
Summing up all the weights of the companies covered, my portfolio for the very long term would look like this:
So, a very concentrated portfolio consisting only of individual companies rather than ETFs. This approach implies exposure to a relatively high risk, but after all, this is unavoidable if the goal is ambitious and the capital invested is modest. I did not include so many companies on purpose, otherwise I might as well invest in a simple ETF that replicates the performance of the S&P 500.
As mentioned above, the goal of this article is to expose a portfolio composed of companies that when I retire I believe will still be dominant. If that is the case, then there would be no doubt that the $10,000 investment was worth it. Of course, there would be many other companies that could potentially do well over the very long term, but I have dealt only with those in which I have a firm belief. For this reason, I would be curious to know what your choices would be if you were to immobilize $10,000 for 40 years in only a few companies: in 2064 we will talk again to see who was right.
For further details see:
How To Invest $10,000 To Get Rich In 2064