The global economy is an ecosystem where thousands of companies appear and disappear each year, with the typical half-life of a listed company being around 10 years. Long-term investors would be well advised to look at this ecosystem through a Darwinian lens.
‘Survival of the fittest’ is often misunderstood to mean ‘survival of the strongest’. Darwin’s theory highlights adaptation to change in the environment as key to survival and development. The dark form of peppered moth is the classic example. During the Industrial Revolution, pollution killed lichen on tree bark, which became darkened by soot, favouring the emergence and rapid development of a darker-winged form of moth in the UK.
Beyond the random short-term fluctuations, the economic environment is an ecosystem subject to slow, but very powerful changes. Global warming, and reactions to it by institutions and consumers, is an example of such slow, high-impact change.
Too focused on the short term, most market participants can – and often do – ignore slow changes to this environment. Until a point at which they finally, and very rapidly, incorporate these changes into their view of the world. To paraphrase Hemingway, investors adjust the share price of companies which no longer fit a changed environment in two ways: “gradually, then suddenly.”
In the long run, companies which can adapt to these changes – the ‘fittest’ – will survive and thrive. Those companies who don’t, or simply can’t, will fail. Regardless of how strong their balance sheet or their dominance of an industry are.
Sustainability is just another word for adaptability. Understanding a company’s ability and willingness to adapt is crucial for long-term, growth and income seeking investors.
But assessing the ‘fitness’ of companies is not straightforward. It requires thoughtful analysis which goes well beyond box ticking ESG ratings and glossy reports. Hence the development of our proprietary and forward-looking Impact, Ambition and Trust framework. This helps us assess a company’s ability to grow both its share price and its shareholder payouts.
Take Nestlé as an example, which has a high Impact on a wide range of stakeholders: its agricultural supply chain, its customers’ nutrition, and society at large through its carbon footprint.
Nestlé’s Ambition to mitigate this impact across the group is evident in its sustainability goals, which have been published and regularly updated for at least a decade. For instance, its commitment to halve its absolute greenhouse gas emissions between 2018 and 2030 is much more ambitious than its peers.
The third plank of our analysis is around Trust: are we confident in the company’s management ability and willingness to deliver on ambitious goals? For Nestlé, measurable and meaningful progress achieved on targets set in the past gives us confidence that they can be trusted for the future.
In summary, Nestlé has a high impact, and the trust we have in the company delivering on ambitious goals gives us confidence that they will be able to adapt.
If we accept that companies which adapt will thrive, what about the providers of the adaptation tools used in the process? We invest in French company Schneider Electric for precisely that reason: their power management solutions help companies become “fitter” by reducing energy consumption. We foresee a large and growing market opportunity, a management seizing that opportunity and a dependable income for years to come. We also predict a large positive impact, and an ambitious management team which we trust to execute on their strategy to adapt their own business.
As long-term shareholders anticipating a changing environment, we are convinced that selecting companies which can adapt is the best way to preserve future income and capital for our clients. We look for a resilient dividend, which we expect to grow over the long term. Not necessarily the ‘strongest’ today, but one which is ‘fit’ for today and the decades to come.
The good news is that, in contrast to what happens in nature, companies do not have to wait for random mutations to adapt: some can make the necessary changes themselves. These are the companies we invest in for the long term.