What makes something a forever investment?

The other day I was reading a letter written by Bill Ackman to the board of Howard Hughes Holdings. In the letter, Ackman is asking the board to accept the takeover bid made for Howard Hughes by Ackman's investment firm Pershing Square.

At the very end of the letter, Ackman refers to Howard Hughes as a “forever company”. This got me thinking: what actually makes a company suitable to own forever? What might be some of the criteria you’d look for?

I came up with four things that I think would make something a stronger than average candidate.

1. A business you know and understand

This is a simple one, but it will rule out the vast majority of companies. Can you explain how the company in question makes money? Can you explain the competitive dynamics in its field? Do you know what to keep an eye on to stay abreast of how things are going?

This is important because if your goal is to potentially hold a company’s stock forever, there are almost certainly going to be periods of time where the business and/or its stock are going to be performing either extremely well or extremely poorly.

When it comes to making a long-term decision on what to do in this kind of situation, you will almost certainly be better served by your knowledge of the underlying business than on whatever the market prices are making you feel in the moment.

Exor, the publicly traded investment vehicle of the Agnelli family that founded Fiat, offers a good example of owning what you know.

Most of Exor’s portfolio continues to be in three auto and industrial companies that trace their lineage to the Fiat empire: Ferrari, CNH Industrial and Stellantis (the result of Fiat Chrysler’s merger with Peugeot and Citroen’s parent company).

That level of concentration might be a little off-putting to outsiders, especially when you consider the cyclical nature of Stellantis and CNH. But through the lens of owning what you know, it makes perfect sense. These are all companies and industries that Exor’s management know better than anyone else.

It is also worth noting that Exor have a size of shareholding (and board representation) that gives them a far bigger say on how their portfolio companies are run than normal investors would have. This is also the case with Ackman and HHH. Pershing owns over 37% and Ackman used to chair the board.

2. A market that will still have demand

I was going to say “products and services that will still have demand” but I think it is both easier and more valuable to pin down more general wants and needs that will still require satisfaction. The exact nature of products that consumers will favour in the future is harder to pin down.

Healthcare provides a screaming example for me here. I can’t be sure which technologies will be used to diagnose medical problems in 2065, but I am pretty sure that people will still want to know what is wrong with them. I cannot predict what the biggest selling drugs will be in 2065, but I know people will still want to get better.

In many cases you will also be able to back up your thinking with data. The World Health Organisation, for example, predicts that “between 2015 and 2050, the proportion of the world’s population that is over 60 years old will double from 12% to 22%”. To me, the long-term outlook for healthcare demand in general seems strong.

3. A strong position in its niche

In a future where the type of products and services that this company provides are still in demand, how likely are your company to still be the ones providing them profitably?

This is obviously a harder question to answer. I’d start by looking for structural advantages that stop other firms from stealing the company’s customers or competing away their profitability today. In other words, I am looking for a moat due to factors like switching costs, network effects or intangible assets.

Given that we are supposed to be thinking about forever, this doesn’t really account for game changing advances that could, in theory, render today’s moat irrelevant. Imagine a rancher with a monopoly on cart horses in the USA, only to one day find out that everybody was driving Model-T cars instead.

With that in mind, hunting in industries where innovations move slowly or major upheavals seem unlikely (like an improvement on cold drinks as a method of human refreshment) might boost your confidence somewhat. Failing that, the next quality is almost essential.

4. A proven ability to innovate and adapt

This one comes from the playbook of Phil Fisher, a man that Warren Buffett often credits for shaping his investing philosophy. As I alluded to earlier, competitive advantages today and for the next ten or twenty years are fine but industries, technology and humanity do not stand still.

For that reason, a culture of innovation is vital to increase your chances that 1) the business will still be relevant far into the future and 2) will still be growing its sales and profits. Of course, a moat today can also leave a business better placed to fight off emerging threats and adapt to changing trends.

The example of big pharmaceuticals comes to mind here. Existing patent-protected cash cows provide the money to fund research, development and trial expenditures that will hopefully find new blockbuster treatments of their own. Meanwhile, their resources and entrenched sales forces make them the perfect suitor to acquire smaller firms with promising new drugs in the pipeline.

In another example, the switching costs and network effects embedded in Microsoft’s business software products have left them well-placed to jump on new trends (like cloud computing) and bought them time to replicate innovations from elsewhere. Like when they effectively copied Slack with Teams.

There are many examples throughout history of dominant companies in the existing “way of doing things” not being fast enough to adapt and paying the price. I looked into one reason for this in a recent edition of my Bookworm column.

The dream situation

If you can find a company that you understand, has attractive and growing end markets, has a strong competitive position in those markets, and has shown an ability to adapt to a changing world, you might have just found yourself a 'forever candidate'.

Why? Because several of those qualities could result in a company being able to generate excess cash and keep reinvesting those profits back into its business at attractive rates of return. Not just for a year or two, but for many years from now.

This is the potential that Ackman appears to see in Howard Hughes.

Ackman thinks that HHH’s land holdings and master planned communities, where it controls all of the land and buildings, still have decades of growth potential and robust cash generation ahead.

As for the reinvestment part of the puzzle, he wants to provide it by investing this cash into other companies. While Ackman’s goal of turning Howard Hughes into a “modern-day Berkshire Hathaway” is an ambitious one, it will certainly be interesting to watch him try.

Disclosure: I own shares in Howard Hughes Holdings.