I'm a big fan of using other fields of sciences in the investment process - history, psychology, anthropology and many other sciences can give you new ideas and test your old beliefs. In the book “Why most things fail”, Paul Ormerod links his economic models with models of biological evolution, Ormerod's book is hugely interesting and entertaining, and there is one statistic that got my full attention; of the 6 million American companies in the American Office for advocacy, on average 600.000 companies a year disappear, and its not only the small and medium sized companies that are affected. From the 100 biggest companies in the world in 1912 only 19 remained in the top 100 by 1995 (29 of the original 100 went bankrupt).

The extinction pattern is not steady. In one year only a small percentage of companies disappear, while in times of economic turmoil whole groups of companies disappear, for instance the dot.com companies from early 2000 and several financial giants in the ongoing banking crisis.

Extinction has many causes; new technologies make old technologies obsolete, a financial crisis forces the less financially robust to go bankrupt or simple bad management can all lead to the downfall of a company. The problem for the investor is that it is difficult to predict factors that might lead to extinction.

New technologies are introduced on a daily basis, some might be ground breaking while others have little to no effect. The recent discovery of Bisin, a naturally occuring lantibiotic, which prevents the forming of bacteria and therefore decay of fresh food might lead to a fundamental change of the economy.

I used the example of Bisin to illustrate that, not only high tech companies might be affected by technological breakthroughs. Investors might argue that food retailers are safe investments because people always have to eat. In most cases this is true, but what if your vegetables, meat or milk can be kept fresh for 2 years? What would happen then? On one hand we have the food retailers with supermarket on every corner, on the other hand we have a company like Amazon specialised in the delivery of non-perishable goods. A simple article in the scientific section of a newspaper can be the foreteller of the disappearance of a complete sector.

In reality things wouldn't go that fast. Bisin might have serious side effects and even if it is completely safe it would take a long time before the general public is convinced it is safe. Other exciton factors are a lot more instant, in my article “Don't get burned by the Sun King” I describe the effects of fraudulent behaviour by the senior management. The prudent investor should be aware that bad management is more likely in a sector that is booming. The less scrupulous CEO might be tempted to massage his or her accounts if all his competitors are making huge profits and his/her companies profit is lacking.

The only thing that can protect an investor is diversification. Never assume that a certain company is immune to extinction. Many investors are tempted to concentrate their money in fast growing companies in hot sectors. This sector might however be part of the next wave of extinction. The prudent investor should therefore diversify his money by investing in different sectors. If the size of his portfolio is sufficient, diversify within the sectors as well. Have a look at the geographical spread of the turnover and try to invest in companies that are active in different regions. Be aware that extinction can be more or less instant and unpredictable. Keep your eye on hot sectors and/or sectors with imminent technological breakthroughs. It might be a good idea to take some profit and use this to diversify your portfolio further.