Law of Diminishing Returns: Warren Buffett Experiment
Warren Buffet had given the following example as a law of diminishing returns and future revenue growth and I decided to take him up on it. "A growth rate of that magnitude can only be maintained by a very small percentage of large businesses. Here's a test: Examine the record of, say, the 200 highest earning companies from 1970 or 1980 and tabulate how many have increased per-share earnings by 15% annually since those dates. You will find that only a handful have. I would wager you a very significant sum that fewer than 10 of the 200 most profitable companies in 2000 will attain 15% annual growth in earnings-per-share over the next 20 years." – Warren Buffett
I used the year 1990 Fortune 500 and the year 2013 Fortune 500 for my criteria. (Yes, I used 23 years instead of 20 but don't think much difference is made)
Based on a capitalization rate of 15% and 23 years as a time interval, I arrived at a future value factor of 24.891 (1.15^23) and multiplied that by the 200th ranking company's revenue in 1990, using it as a base for 2013 qualification.
2.172 x 24.891 = 54.063 Billion 2013 Annual Revenue as base for criteria.
I did not have much of a list so I decided to add in companies that had 23-year sales growth over 13%
(36.113 Billion 2013 Sales as the base)
Still only 86 companies made the cut in total.
I manually sorted through the list for companies that were both in the top 200 in 1990 as well as the top 86 in 2013. I found 28 that had over 13% revenue growth for the last twenty-three years or 14% of the 1990 Fortune 200.
| Company | 2013 Rank | 1990 Rank | |
| 1 | Exxon Mobile | 2 | 3 |
| 2 | Chevron | 3 | 11 |
| 3 | Phillips 66 (SpinOff) | 4 | 30 |
| 4 | Berkshire Hathaway | 5 | 179 |
| 5 | Apple | 6 | 96 |
| 6 | General Motors | 7 | 1 |
| 7 | General Electric | 8 | 5 |
| 8 | Ford | 10 | 2 |
| 9 | Hewlett-Packard | 15 | 33 |
| 10 | IBM | 20 | 4 |
| 11 | Archer Daniels Midland | 27 | 57 |
| 12 | Procter & Gamble | 28 | 14 |
| 13 | Caterpillar | 42 | 38 |
| 14 | Pepsi | 43 | 23 |
| 15 | ConocoPhillips | 45 | 30 |
| 16 | Johnston & Johnston | 41 | 47 |
| 17 | Pfizer | 48 | 80 |
| 18 | United Technologies | 50 | 17 |
| 19 | Dow Chemical | 52 | 20 |
| 20 | Intel | 54 | 137 |
| 21 | Coca-Cola | 57 | 121 |
| 22 | Merck | 58 | 70 |
| 23 | Lockheed Martin | 59 | 45 |
| 24 | Johnson Controls | 67 | 126 |
| 25 | Abbott Labortories | 70 | 90 |
| 26 | Dupont | 72 | 9 |
| 27 | Honeywell | 78 | 65 |
| 28 | Deere | 85 | 66 |
How many of the 28 companies had over 15% annual E.P.S growth for the last twenty years? Buffett's wager was that fewer than 10 had done so. I used net income as a proxy for E.P.S.
Lockheed Martin (LMT) had the largest CAGR of the bunch, making the earnings cut with 2 Million 1990 earnings compared to 2.745 Billion in 2013 or 36.29% CAGR over the last 23 years.
Coca-Cola! (KO) als! o makes the cut from 1990 earnings of 71.7 Million to 9.019 Billion or a 23.39% CAGR for the last 23 years.
Intel (INTC) was another company with over 15% growth for the last 23 years, growing from 391 Million net income in 1990 to 11 Billion in 2013. Intel managed a 15.614% CAGR for the last 23 years.
ConocoPhillips (COP) went from 1990 net income of 219 Million to 8.428 Billion in 2013 or good for a 17.2% CAGR.
Apple (AAPL) was one of four in the 20%+ club, growing from 454 Million 1990 net income to a phenomenal 41.733 Billion in 2013 or a 21.72% CAGR.
Berkshire Hathaway (BRK.A) (BRK.B) is really no surprise here considering the CEO and team who are running the place. Berkshire had 1990 net income of 447.5 Million and 2013 net income of 14.824 Billion or a 23-year CAGR of 16.44%.
Chevron (CVX) also had phenomenal growth numbers over the 23-year span, growing from 251 Million to 26.179 Billion or a whopping 22.39% CAGR.
Looks like Buffett's bet would have paid off with only 7 companies from the 1990 Fortune 500 growing both revenue at 13%+ and net income at 15%+. It is crazy to think that if one took the Fortune 500 in 1990 (or possible now), with the goal of at least a 15% CAGR from investment, the chances of doing so would only be about 3.5%.
Score one for the small caps? About the author:I am working towards the CPA & CFA designations, and would love to manage an investment partnership in the future. I am a self taught investor through Warren Buffett, Charlie Munger, Ben Graham, Peter Lynch, Joel Greenblatt, David Einhorn, Seth Klarman, Howard Marks, Phillip Fisher and Thornton O'Glove. My focus is a bottoms up Value-GARP strategy with a mix of top down contrarianism.
"When you find yourself on the side of the majority, it is time to pause and reflect." - Mark Twain
Visit Tannor Pilatzke's Website
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Seanickson - 16 hours ago I appreciate the article, but I think net income is a fairly poor proxy for EPS, the two can differ fairly significantly for a lot of companies.
BEL-AIR - 11 hours ago Thats why most of your gains should come from the appreciation from under valuation to full valuation, and not from the growth of the company, buy for 50 cents to 25 cents and sell for 95 cents, might take you a few years to happen, but you get the valuation growth plus the business growth with dividends if any on top, then you look for another 50 cent bargain... You only buy and hold for 35 years if you are to big, other wise returns will be alot smaller. Take buffet's returns as an example, his returns are significantly less today compared to the days he bought and sold every few years, so instead of buying a dollar bill for 50 cents or less and selling once it goes to full value, then wash, rinse, and repeat. Now he is so big he is forced to buy and hold forever, and as your example above shows, odds of getting high returns are slim indeed even for the oracle. Please leave your comment:
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