Think Like Warren Buffett
by Glenn Curtis (Contact Author | Biography)
Back in 1999, Robert G. Hagstrom wrote a book about the legendary investor Warren Buffett, entitled "The Warren Buffett Portfolio". What's so great about the book, and what makes it different from the countless other books and articles written about the "Oracle of Omaha" is that it offers the reader valuable insight into how Buffett actually thinks about investments. In other words, the book delves into the psychological mindset that has made Buffett so fabulously wealthy.
Although investors could benefit from reading the entire book, we've selected a bite-sized sampling of the tips and suggestions regarding the investor mindset and ways that an investor can improve their stock selection that will help you get inside Buffett's head.
1. Think of Stocks as a Business
Many investors think of stocks and the stock market in general as nothing more than little pieces of paper being traded back and forth among investors, which might help prevent investors from becoming too emotional over a given position but it doesn't necessarily allow them to make the best possible investment decisions.
That's why Buffett has stated he believes stockholders should think of themselves as "part owners" of the business in which they are investing. By thinking that way, both Hagstrom and Buffett argue that investors will tend to avoid making off-the-cuff investment decisions, and become more focused on the longer term. Furthermore, longer-term "owners" also tend to analyze situations in greater detail and then put a great eal of thought into buy and sell decisions. Hagstrom says this increased thought and analysis tends to lead to improved investment returns. (To read more about Buffett's ideologies, check out Warren Buffett: How He Does It and What Is Warren Buffett's Investing Style?)
2. Increase the Size of Your Investment
While it rarely - if ever - makes sense for investors to "put all of their eggs in one basket," putting all your eggs in too many baskets may not be a good thing either. Buffett contends that over-diversification can hamper returns as much as a lack of diversification. That's why he doesn't invest in mutual funds. It's also why he prefers to make significant investments in just a handful of companies. (To learn more about diversification, read Introduction To Diversification, The Importance Of Diversification and The Dangers Of Over-Diversification.)
Buffett is a firm believer that an investor must first do his or her homework before investing in any security. But after that due diligence process is completed, an investor should feel comfortable enough to dedicate a sizable portion of assets to that stock. They should also feel comfortable in winnowing down their overall investment portfolio to a handful of good companies with excellent growth prospects.
Buffett's stance on taking time to properly allocate your funds is furthered with his comment that it's not just about the best company, but how you feel about the company. If the best business you own presents the least financial risk and has the most favorable long-term prospects, why would you put money into your 20th favorite business rather than add money to the top choices?
3. Reduce Portfolio Turnover
Rapidly trading in and out of stocks can potentially make an individual a lot of money, but according to Buffett this trader is actually hampering his or her investment returns. That's because portfolio turnover increases the amount of taxes that must be paid on capital gains and boosts the total amount of commission dollars that must be paid in a given year.
The "Oracle" contends that what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.
Investors must think long term. By having that mindset, they can avoid paying huge commission fees and lofty short-term capital gains taxes. They'll also be more apt to ride out any short-term fluctuations in the business, and to ultimately reap the rewards of increased earnings and/or dividends over time.
4. Develop Alternative Benchmarks
While stock prices may be the ultimate barometer of the success or failure of a given investment choice, Buffett does not focus on this metric. Instead, he analyzes and pores over the underlying economics of a given business or group of businesses. If a company is doing what it takes to grow itself on a profitable basis, then the share price will ultimately take care of itself.
Successful investors must look at the companies they own and study their true earnings potential. If the fundamentals are solid and the company is enhancing shareholder value by generating consistent bottom-line growth, the share price, in the long term, should reflect that. (To learn how to judge fundamentals on your own, see What Are Fundamentals?)
5. Learn to Think in Probabilities
Bridge is a card game in which the most successful players are able to judge mathematical probabilities to beat their opponents. Perhaps not surprisingly, Buffett loves and actively plays the game, and he takes the strategies beyond the game into the investing world.
Buffett suggests that investors focus on the economics of the companies they own (in other words the underlying businesses), and then try to weigh the probability that certain events will or will not transpire, much like a Bridge player checking the probabilities of his opponents' hands. He adds that by focusing on the economic aspect of the equation and not the stock price, an investor will be more accurate in his or her ability to judge probability.
Thinking in probabilities has its advantages. For example, an investor that ponders the probability that a company will report a certain rate of earnings growth over a period of five or 10 years is much more apt to ride out short-term fluctuations in the share price. By extension, this means that his investment returns are likely to be superior and that he will also realize fewer transaction and/or capital gains costs.
6. Recognize the Psychological Aspects of Investing
Very simply, this means that individuals must understand that there is a psychological mindset that the successful investor tends to have. More specifically, the successful investor will focus on probabilities and economic issues and let decisions be ruled by rational, as opposed to emotional, thinking.
More than anything, investors' own emotions can be their worst enemy. Buffett contends that the key to overcoming emotions is being able to "retain your belief in the real fundamentals of the business and to not get too concerned about the stock market."
Investors should realize that there is a certain psychological mindset that they should have if they want to be successful and try to implement that mindset. (To learn more about investor behaviors, read Understanding Investor Behavior, When Fear And Greed Take Over and Master Your Trading Mindtraps.)
7. Ignore Market Forecasts
There is an old saying that the Dow "climbs a wall of worry". In other words, in spite of the negativity in the marketplace, and those who perpetually contend that a recession is "just around the corner", the markets have fared quite well over time. Therefore, doomsayers should be ignored.
On the other side of the coin, there are just as many eternal optimists who argue that the stock market is headed perpetually higher. These should be ignored as well.
In all this confusion, Buffett suggests that investors should focus their efforts of isolating and investing in shares that are not currently being accurately valued by the market. The logic here is that as the stock market begins to realize the company's intrinsic value (through higher prices and greater demand), the investor will stand to make a lot of money.
8. Wait for the Fat Pitch
Hagstrom's book uses the model of legendary baseball player Ted Williams as an example of a wise investor. Williams would wait for a specific pitch (in an area of the plate where he knew he had a high probability of making contact with the ball) before swinging. It is said that this discipline enabled Williams to have a higher lifetime batting average than the average player.
Buffett, in the same way, suggests that all investors act as if they owned a lifetime decision card with only 20 investment choice punches in it. The logic is that this should prevent them from making mediocre investment choices and hopefully, by extension, enhance the overall returns of their respective portfolios.
Bottom Line
"The Warren Buffett Portfolio" is a timeless book that offers valuable insight into the psychological mindset of the legendary investor Warren Buffett. Of course, if learning how to invest like Warren Buffett were as easy as reading a book, everyone would be rich! But if you take that time and effort to implement some of Buffett's proven strategies, you could be on your way to better stock selection and greater returns.
by Glenn Curtis (Contact Author | Biography)
Glenn Curtis started his career as an equity analyst at Cantone Research, a New Jersey-based regional brokerage firm. He has since worked as an equity analyst and a financial writer at a number of print/web publications and brokerage firms including Registered Representative Magazine, Advanced Trading Magazine, Worldlyinvestor.com, RealMoney.com, TheStreet.com and Prudential Securities. Curtis has also held Series 6,7,24 and 63 securities licenses.
http://www.investopedia.com/articles/stocks/08/Buffett-style.asp
Saturday 29 May 2010
The Fundamental Mechanics Of Investing
The Fundamental Mechanics Of Investing
by Andrew Beattie (Contact Author | Biography)
In this article, we tell a simple story that demonstrates why stocks and bonds are created.
A Business Is Created
Jack is a farmer, and he is interested in starting up an apple stand for the tourists who pass his place. Since Jack has fairly good credit, he got a business loan to cover the costs of set up, and he now has the ideal land for apple growing. Unfortunately Jack only set aside enough money for getting his land in shape. He forgot all about buying seeds. By a stroke of luck, Jack finds a store that will sell him a magic high-growth, high-yield seed for $100, but Jack only has $50 left.
The Initial Public Offering to Raise Capital for Growth
Our clever farmer goes to five of his closest friends (you're included) and asks if they'll each give him $10 to help his business. However, Jack doesn't know if he can take it in the form of a loan because he may not be able to pay it back if the seed doesn't turn a profit. No worries: Jack promises everyone they'll receive a percentage of the tree's apples that is equal to the percentage they gave. In other words, Jack has given his friends a share in his tree. They agree and the seed is in the ground before you can sing "Johnny Appleseed".
The Distinction Between Being a Partner and Being a Shareholder
This tree, being magic and all, grows rapidly. In the first month, it is five feet tall and there are two apples. Jack keeps one apple because he owns 50% of the business's product, which he paid for with the $50 dollars he put in for the seed. He cuts the other one into five pieces, each of which goes to each of his investors, who can sell or eat it. The investors have a quick meeting and decide they'd rather have Jack sell their portion of the product and give them a percentage of the profit. So Jack makes up little papers saying, "Jack's Apple Company: you have one share guaranteeing you 10% (10/100) of the profits."
Trading Occurs in Jack's Undervalued Stock
So this tree really takes off now - the magic is coursing through the wood and it grows to 10 feet tall! There are 20 apples and Jack sells them all for $10 a piece, keeping $100 for himself and giving his friends $20 each. Jack uses his $100 to buy another seed and plants it. Pretty soon, Jack has two trees producing 40 apples and earning $400 a month.
Some of his neighbors want in on the deal Jack gave his friends, and Tim, Jack's first investor, is interested in selling his 10% of Jack's Apple Company. Judy, Jack's neighbor, wants to buy it and she offers Tim the $10 that he originally paid. However, Tim is not stupid: he realizes that this share is producing $40 a month and Jack is about to buy another seed. So Tim asks for $40 dollars and Judy snaps up the share, which pays for itself immediately.
A Bit of a Bubble Forms
The other original shareholders see how much Tim got and want to sell too, and the other neighbors notice how quickly Judy's investment paid off so they really want to buy in. The offers steadily climb until Jack's shares are being bought for over $100 a piece - more than Jack's trees are producing in a month. Only one original shareholder, Betty, is still in there and holding out on offers like $120 because she is still getting a regular payment that is pure profit for her. Suddenly, Jack's trees (four in total) are ravaged by aphids. The entire month's production is ruined and several shareholders are wondering if they can pay rent since they used their savings to buy shares.
The Bubble Bursts
The shareholders that need the money sell to Betty at a discount ($40), and then the other shareholders notice, all of a sudden, that their $100 shares are worth $40. This is very disconcerting. The remaining shareholders offer their shares to Betty, but she says she's quite content with three shares. The other shareholders are desperate now, so when the town sheriff offers them $20 a piece for the shares, they take their losses and get out.
Meanwhile, the main drive of Jack's business hasn't changed: people still want apples. Jack needs to get rid of these pesky aphids and he needs the money to buy insecticide.
Jack Issues a Bond
Jack's not too keen on issuing more stock after the fiasco with his neighbors, so he decides to go for a loan instead. Unfortunately, Jack used up his credit with the land preparation so he is once again looking for divine inspiration. He's looking at his equipment to see what he can sell and what he can't, and then it hits him: he'll try to sell his apple crates without actually selling them. The crates are useless without aphid-free product to fill them, but as soon as the aphids are gone he'll need them back.
So Jack calls up Judy (in hopes of making amends) and offers her a deal, "Judy, my good friend, I have an offer for you. I'll sell you my apple crates, which are worth $100 total, for a mere $60 and then buy them back next week for the full $100." Judy thinks about this and sees that in the worst case scenario, she can just sell the crates… sounds good. And a deal is made.
"But Judy," Jack adds, "I don't want to run my crates down there and pick them up again. Can I just write up a piece of paper? It'll save my back."
"I don't know - can we call it a promissory note?" Judy asks enthusiastically.
"Sure can, but I was thinking more of calling it a bond or a certificate," says Jack.
And lo and behold, Jack eliminates the aphids, pays Judy back, and turns a healthy profit that month and every month thereafter.
What Did We Learn?
This story will not explain everything about investing in stocks, but it does highlight one very important point: the price of Jack's stock followed investors' opinion of the stock's value rather than just the performance of Jack's company. Because the stock market is an auction, there is no set price for a certain stock, there is a concept that derails most people's trains of thought: the price paid for a stock is what it's "worth" until a lower or higher price is offered.
This fluctuation of worth is good and bad for investors because it allows for profit (when you buy an undervalued stock) but also makes losses possible (when you pay too much for a stock). If you would like to advance your understanding of stocks, please check out this Stock Basics.
For more on bonds, see the Bond Basics.
by Andrew Beattie (Contact Author | Biography)
http://www.investopedia.com/articles/basics/03/062703.asp?partner=basics5
by Andrew Beattie (Contact Author | Biography)
In this article, we tell a simple story that demonstrates why stocks and bonds are created.
A Business Is Created
Jack is a farmer, and he is interested in starting up an apple stand for the tourists who pass his place. Since Jack has fairly good credit, he got a business loan to cover the costs of set up, and he now has the ideal land for apple growing. Unfortunately Jack only set aside enough money for getting his land in shape. He forgot all about buying seeds. By a stroke of luck, Jack finds a store that will sell him a magic high-growth, high-yield seed for $100, but Jack only has $50 left.
The Initial Public Offering to Raise Capital for Growth
Our clever farmer goes to five of his closest friends (you're included) and asks if they'll each give him $10 to help his business. However, Jack doesn't know if he can take it in the form of a loan because he may not be able to pay it back if the seed doesn't turn a profit. No worries: Jack promises everyone they'll receive a percentage of the tree's apples that is equal to the percentage they gave. In other words, Jack has given his friends a share in his tree. They agree and the seed is in the ground before you can sing "Johnny Appleseed".
The Distinction Between Being a Partner and Being a Shareholder
This tree, being magic and all, grows rapidly. In the first month, it is five feet tall and there are two apples. Jack keeps one apple because he owns 50% of the business's product, which he paid for with the $50 dollars he put in for the seed. He cuts the other one into five pieces, each of which goes to each of his investors, who can sell or eat it. The investors have a quick meeting and decide they'd rather have Jack sell their portion of the product and give them a percentage of the profit. So Jack makes up little papers saying, "Jack's Apple Company: you have one share guaranteeing you 10% (10/100) of the profits."
Trading Occurs in Jack's Undervalued Stock
So this tree really takes off now - the magic is coursing through the wood and it grows to 10 feet tall! There are 20 apples and Jack sells them all for $10 a piece, keeping $100 for himself and giving his friends $20 each. Jack uses his $100 to buy another seed and plants it. Pretty soon, Jack has two trees producing 40 apples and earning $400 a month.
Some of his neighbors want in on the deal Jack gave his friends, and Tim, Jack's first investor, is interested in selling his 10% of Jack's Apple Company. Judy, Jack's neighbor, wants to buy it and she offers Tim the $10 that he originally paid. However, Tim is not stupid: he realizes that this share is producing $40 a month and Jack is about to buy another seed. So Tim asks for $40 dollars and Judy snaps up the share, which pays for itself immediately.
A Bit of a Bubble Forms
The other original shareholders see how much Tim got and want to sell too, and the other neighbors notice how quickly Judy's investment paid off so they really want to buy in. The offers steadily climb until Jack's shares are being bought for over $100 a piece - more than Jack's trees are producing in a month. Only one original shareholder, Betty, is still in there and holding out on offers like $120 because she is still getting a regular payment that is pure profit for her. Suddenly, Jack's trees (four in total) are ravaged by aphids. The entire month's production is ruined and several shareholders are wondering if they can pay rent since they used their savings to buy shares.
The Bubble Bursts
The shareholders that need the money sell to Betty at a discount ($40), and then the other shareholders notice, all of a sudden, that their $100 shares are worth $40. This is very disconcerting. The remaining shareholders offer their shares to Betty, but she says she's quite content with three shares. The other shareholders are desperate now, so when the town sheriff offers them $20 a piece for the shares, they take their losses and get out.
Meanwhile, the main drive of Jack's business hasn't changed: people still want apples. Jack needs to get rid of these pesky aphids and he needs the money to buy insecticide.
Jack Issues a Bond
Jack's not too keen on issuing more stock after the fiasco with his neighbors, so he decides to go for a loan instead. Unfortunately, Jack used up his credit with the land preparation so he is once again looking for divine inspiration. He's looking at his equipment to see what he can sell and what he can't, and then it hits him: he'll try to sell his apple crates without actually selling them. The crates are useless without aphid-free product to fill them, but as soon as the aphids are gone he'll need them back.
So Jack calls up Judy (in hopes of making amends) and offers her a deal, "Judy, my good friend, I have an offer for you. I'll sell you my apple crates, which are worth $100 total, for a mere $60 and then buy them back next week for the full $100." Judy thinks about this and sees that in the worst case scenario, she can just sell the crates… sounds good. And a deal is made.
"But Judy," Jack adds, "I don't want to run my crates down there and pick them up again. Can I just write up a piece of paper? It'll save my back."
"I don't know - can we call it a promissory note?" Judy asks enthusiastically.
"Sure can, but I was thinking more of calling it a bond or a certificate," says Jack.
And lo and behold, Jack eliminates the aphids, pays Judy back, and turns a healthy profit that month and every month thereafter.
What Did We Learn?
This story will not explain everything about investing in stocks, but it does highlight one very important point: the price of Jack's stock followed investors' opinion of the stock's value rather than just the performance of Jack's company. Because the stock market is an auction, there is no set price for a certain stock, there is a concept that derails most people's trains of thought: the price paid for a stock is what it's "worth" until a lower or higher price is offered.
This fluctuation of worth is good and bad for investors because it allows for profit (when you buy an undervalued stock) but also makes losses possible (when you pay too much for a stock). If you would like to advance your understanding of stocks, please check out this Stock Basics.
For more on bonds, see the Bond Basics.
by Andrew Beattie (Contact Author | Biography)
http://www.investopedia.com/articles/basics/03/062703.asp?partner=basics5
Friday 28 May 2010
A quick look at Genting Malaysia GENM (27.5.2010)
A quick look at Genting Malaysia GENM (27.5.2010)
http://spreadsheets.google.com/pub?key=t6p93zBmPtzub4oIFBVLGCg&output=html
Benjamin Graham's Checklist for GENM (28.5.2010)
http://spreadsheets.google.com/pub?key=tAN3tcyRLcCj8SFLWNuMeCA&output=html
Thursday 27 May 2010
A quick look at Padini (27.5.2010)
A quick look at Padini (27.5.2010)
http://spreadsheets.google.com/pub?key=tFNtOWNR4IJxYz7y76WL9NA&output=html
Benjamin Graham's Checklist for Padini (28.5.2010)
http://spreadsheets.google.com/pub?key=tKYB6E7Pp3YKh83Wnl7rc4w&output=html
A quick look at Kelington KGB (27.5.2010)
A quick look at Kelington KGB (27.5.2010)
http://spreadsheets.google.com/pub?key=tSG1Twj4DrIi5BPn29MoK5Q&output=html
AVOID
http://spreadsheets.google.com/pub?key=tSG1Twj4DrIi5BPn29MoK5Q&output=html
AVOID
Who Creates the Wealth in Society? (Part 3 of 3)
MAY 21, 2010, 6:00 AM
Who Creates the Wealth in Society?
By UWE E. REINHARDT
Uwe E. Reinhardt is an economics professor at Princeton.
This is the third post in my trilogy on the creation of a nation’s wealth.
In the first I explored what is meant by wealth. The second looked at companies as creators of wealth, with a digression on the social and economic purpose of business corporations. In this concluding post in the trilogy, I explore who are society’s main creators of wealth.
In so doing, I shall draw heavily on a lecture entitled “What Is the Wealth of a Nation?” that I delivered in 2002, at the end of a freshman economics course. Earlier posts in the trilogy drew on that lecture as well.
The lecture was inspired by the cover of a well-known business magazine that celebrated “America’s Great Wealth Creators,” with photos of dot-com heroes of the day and Jack Welch, the chief executive of General Electric until 2001. The magazine was celebrating, of course, the market capitalization of the companies led by these “wealth creators.”
This occurred toward the end of what we now call the dot.com bubble, as the price-to-earnings ratio — the market price of stocks relative to earnings — soared far above historical values, while silly books like “Dow 36,000: The New Strategy for Profiting from the Coming Rise in Stock” by James K. Glassman and Kevin A. Hassett were greeted with the utmost respect on Wall Street and in the media.
As it turned out, much of the what these “wealth creators” were said to have created was ephemeral (see the graph below and also my post “Jack Welch and the Lone Ranger Theory“), just as the subsequent fabulous wealth created by the financial sector during 2004-8 has been ephemeral.
The point of my lecture was not that businesses and their leaders do not contribute to creating the nation’s wealth. Far from it (see my paper “On the Not So Simple Steps Involved in Starting a Business Venture“). By organizing and focusing a variety of resources in a way that produces products and services designed to please someone, businesses make a significant contribution to the creation of value and wealth.
Yahoo General Electric stock performance over time, compared with major indexes. Black triangles indicate stock splits.
My point in the lecture was merely that the precise magnitude of the contribution a company makes to wealth is not easily measured, and certainly not by its market capitalization. Furthermore, I pointed out, the value and wealth contributed by companies and their leaders come only at the end of a long chain of wealth creation on which businesses capitalize, starting with the basic unit in society: the family.
It is now well recognized that the wealth of modern societies is dictated not so much by the natural resources at their disposal, but by their human capital — the knowledge and skill of human beings and their ability to learn and apply new knowledge on their own.
Anyone who has raised children to maturity appreciates the magnificent contribution conscientious parents can make to this human-capital formation, because much of the education of youngsters takes place in the home. Conscientious parents — and especially mothers — rank as the major wealth creators in modern societies, as, of course, do the offspring whose own effort is crucial in assembling that capital.
Next come educators, especially the visionary and dedicated elementary and high school teachers who succeed in getting their students interested in learning and motivated to amass human capital. The role of such teachers in the wealth-creation process is not sufficiently appreciated in our latitudes.
We at the level of higher education also contribute, of course, to the process of human-capital formation, but we have the privilege of preselecting our students and probably deserve less credit in the wealth-creation chain than do parents and high school teachers.
None of the forgoing is to say that being highly educated and skilled is either a necessary or a sufficient condition for contributing value and wealth to society. Anyone who works, be it for pay or as a volunteer, does so.
Finally, what about government? A common mantra in the United States is that “government does not create wealth, people do.” We shall hear it again and again in the Congressional campaigns this fall. What are we to make of that assertion?
In some sense, of course, the mantra is true. Government per se is just an inert set of legal contracts, as is any business. Thus one should really say: “Government and business do not create wealth. The people working in them do.”
If anyone doubts that the people working in government do not create wealth, let them imagine a society without a well-functioning government. Afghanistan immediately comes to mind.
Governments everywhere in modern societies provide the legal and much of the physical infrastructure on which private production and commerce thrive. Imagine a world in which private contracts can be adjudicated and enforced only by private thugs rather than in the civil courts.
Just as sports contests could not be fairly conducted without a strict set of rules and referees with power, so private markets could not thrive without regulations and regulators with power. A truly laissez-faire market economy would be apt to be a mess, as what Wall Street made of its own business in recent years reminds us.
In my lecture on wealth, I went to some length to provide other examples in which government contributes directly to the nation’s wealth and is, indeed, a holder of much concrete wealth on our behalf.
A nation’s wealth is truly a joint creation in which individuals, families, business and government all play crucial parts. Finding just that mix of efforts and regulations that will maximize society’s well-being is a tricky and never-ending quest.
http://economix.blogs.nytimes.com/2010/05/21/who-creates-the-wealth-in-society/
Who Creates the Wealth in Society?
By UWE E. REINHARDT
Uwe E. Reinhardt is an economics professor at Princeton.
This is the third post in my trilogy on the creation of a nation’s wealth.
In the first I explored what is meant by wealth. The second looked at companies as creators of wealth, with a digression on the social and economic purpose of business corporations. In this concluding post in the trilogy, I explore who are society’s main creators of wealth.
In so doing, I shall draw heavily on a lecture entitled “What Is the Wealth of a Nation?” that I delivered in 2002, at the end of a freshman economics course. Earlier posts in the trilogy drew on that lecture as well.
The lecture was inspired by the cover of a well-known business magazine that celebrated “America’s Great Wealth Creators,” with photos of dot-com heroes of the day and Jack Welch, the chief executive of General Electric until 2001. The magazine was celebrating, of course, the market capitalization of the companies led by these “wealth creators.”
This occurred toward the end of what we now call the dot.com bubble, as the price-to-earnings ratio — the market price of stocks relative to earnings — soared far above historical values, while silly books like “Dow 36,000: The New Strategy for Profiting from the Coming Rise in Stock” by James K. Glassman and Kevin A. Hassett were greeted with the utmost respect on Wall Street and in the media.
As it turned out, much of the what these “wealth creators” were said to have created was ephemeral (see the graph below and also my post “Jack Welch and the Lone Ranger Theory“), just as the subsequent fabulous wealth created by the financial sector during 2004-8 has been ephemeral.
The point of my lecture was not that businesses and their leaders do not contribute to creating the nation’s wealth. Far from it (see my paper “On the Not So Simple Steps Involved in Starting a Business Venture“). By organizing and focusing a variety of resources in a way that produces products and services designed to please someone, businesses make a significant contribution to the creation of value and wealth.
Yahoo General Electric stock performance over time, compared with major indexes. Black triangles indicate stock splits.
My point in the lecture was merely that the precise magnitude of the contribution a company makes to wealth is not easily measured, and certainly not by its market capitalization. Furthermore, I pointed out, the value and wealth contributed by companies and their leaders come only at the end of a long chain of wealth creation on which businesses capitalize, starting with the basic unit in society: the family.
It is now well recognized that the wealth of modern societies is dictated not so much by the natural resources at their disposal, but by their human capital — the knowledge and skill of human beings and their ability to learn and apply new knowledge on their own.
Anyone who has raised children to maturity appreciates the magnificent contribution conscientious parents can make to this human-capital formation, because much of the education of youngsters takes place in the home. Conscientious parents — and especially mothers — rank as the major wealth creators in modern societies, as, of course, do the offspring whose own effort is crucial in assembling that capital.
Next come educators, especially the visionary and dedicated elementary and high school teachers who succeed in getting their students interested in learning and motivated to amass human capital. The role of such teachers in the wealth-creation process is not sufficiently appreciated in our latitudes.
We at the level of higher education also contribute, of course, to the process of human-capital formation, but we have the privilege of preselecting our students and probably deserve less credit in the wealth-creation chain than do parents and high school teachers.
None of the forgoing is to say that being highly educated and skilled is either a necessary or a sufficient condition for contributing value and wealth to society. Anyone who works, be it for pay or as a volunteer, does so.
Finally, what about government? A common mantra in the United States is that “government does not create wealth, people do.” We shall hear it again and again in the Congressional campaigns this fall. What are we to make of that assertion?
In some sense, of course, the mantra is true. Government per se is just an inert set of legal contracts, as is any business. Thus one should really say: “Government and business do not create wealth. The people working in them do.”
If anyone doubts that the people working in government do not create wealth, let them imagine a society without a well-functioning government. Afghanistan immediately comes to mind.
Governments everywhere in modern societies provide the legal and much of the physical infrastructure on which private production and commerce thrive. Imagine a world in which private contracts can be adjudicated and enforced only by private thugs rather than in the civil courts.
Just as sports contests could not be fairly conducted without a strict set of rules and referees with power, so private markets could not thrive without regulations and regulators with power. A truly laissez-faire market economy would be apt to be a mess, as what Wall Street made of its own business in recent years reminds us.
In my lecture on wealth, I went to some length to provide other examples in which government contributes directly to the nation’s wealth and is, indeed, a holder of much concrete wealth on our behalf.
A nation’s wealth is truly a joint creation in which individuals, families, business and government all play crucial parts. Finding just that mix of efforts and regulations that will maximize society’s well-being is a tricky and never-ending quest.
http://economix.blogs.nytimes.com/2010/05/21/who-creates-the-wealth-in-society/
How Businesses Create Wealth (Part 2 of 3)
MAY 7, 2010, 6:00 AM
How Businesses Create Wealth
By UWE E. REINHARDT
Uwe E. Reinhardt is an economics professor at Princeton.
In last week’s post I offered a near metaphysical definition of wealth that set off a lively round of commentaries.
This week I explore how companies create “value” and distribute it among various stakeholders.
That value can be consumed on the spot to produce other goods and services or to create a consumer’s well-being. Alternatively, it can be saved and stored in the form of some asset. Freshman economics texts define an economic unit’s wealth as the market value of all of its assets minus its liabilities. Value creation and wealth are thus related.
Let’s imagine a company called ABC Inc., which produces a standard, ordinary commodity, by which I mean that society does not hold particular ethical strictures on its distribution (as we, for example, do for health care and education). The chart below sketches the value flow caused by the production of some volume of output. (The pipes going in and out of the company are not drawn to scale.)
Uwe E. Reinhardt
The large pipe in the upper left corner labeled “Gross Value Created” represents the maximum revenue ABC Inc. could have extracted from its customers if each unit of output could have been auctioned off, one after the other, to the highest bidder — an arrangement economists call “perfect price discrimination.” This hypothetical, maximum extractable revenue is the economist’s measure of the “social value” of ABC Inc.’s output.
Evidently, by thus defining social value, economists tacitly assume that rich people, who can bid a higher price for a thing, “value” the thing more than do poor people, even though rich people may not crave it any more than do poor people and possibly even less. It often surprises students that modern economics is solidly based on that legerdemain, which I admit to them in a memo entitled: “How We Economists Bastardized Benthamite Utilitarianism and Became Shills for the Wealthy.”
Leaving aside this important fine point, the sketch is drawn to show that ABC is not able to capture in the form of “sales revenue” all of the gross value it creates.
This is because in most markets, output is sold at a single, common price to all customers, which allows many of them to obtain units of the output at market prices below the maximum bid prices they would have offered in our hypothetical auction. The difference between the two prices is called “buyers’ surplus.” It is a kind of intangible profit that sellers must cede to buyers.
ABC Inc. now distributes the value it captures as “sales revenue” to sundry stakeholders as follows.
Usually the largest fraction is allocated to employees in the form of “employee compensation.” For most employees, the gross value they extract from the corporation as compensation exceeds their so-called “reservation wage.” The latter is the minimum compensation they would have to be paid to attract them to and retain them in the corporation.
This “reservation wage,” of course, is strongly influenced by what the employee could earn in the next best employ — the employee’s “opportunity costs” of working for ABC Inc. — but it also is influenced by how much employees like working there.
The difference between an employee’s actual compensation and his or her reservation wage is the net value employees extract from the corporation. Economists view it as a form of profit, too.
Indeed, it may astound union leaders that many companies bestow more profits of this type on their employees than they bestow profits on their shareholders. It almost surely is so in heavily unionized industries — e.g., the automobile or transportation industries. But it can easily be true even in non-unionized industries.
Brushing lightly over the fraction of ABC’s sales revenue (which is captured gross value) that flows to creditors in the form of interest, to suppliers of non-labor inputs, and to government in the form of taxes, we arrive at a residual that accrues to the owners as “profit available for distribution to shareholders.”
Management and the company’s directors may decide to distribute some of that residual to shareholders in the form of cash dividends. But usually the bulk or even all of it is plowed back into the company in the form of “retained earnings.” Few shareholders take out much of the gross value their companies create in the form of cash.
Wall Street bases its estimate of the company’s “market capitalization” solely on the residual “profit available for shareholders” pipe, eclipsing from view the entire value-flow that accrues to other stakeholders. Unfortunately, many journalists and pundits in the financial press then mistake that “market capitalization” as the sole measure of the “wealth” the company creates, not realizing that this metric can rise or fall for reasons other then genuine value creation by the company.
Suppose, for example, that a company’s volume of output has not changed, but that it somehow manages to raise prices paid by some or all buyers, capturing more of an unchanged gross value created by the company’s output. The company’s market capitalization would be likely to rise as a result of the price increase. But would that add to the nation’s stock of wealth? Or would it merely be a redistribution of wealth from buyers to shareholders?
Similarly, suppose new management takes over and changes nothing other than reducing or eliminating retiree health benefits promised to already retired workers during their working years, albeit in a contract that can be broken (as many such contracts can be broken). If those savings in expenses then flow through to the owners’ profits, the company’s market capitalization would be likely to increase. But is that an increase in national wealth?
I would argue that a corporation contributes to national wealth only if it does something to increase the “total gross value” of what it produces. Someone will then get that added gross value — the buyers in the form of buyers’ surplus or employees in the form of added compensation (perhaps mainly executive bonuses) or the shareholders, and so on.
Regardless of its distribution among stakeholders, and even if none of it flows to the company’s owners, that added gross value can be viewed an addition to national wealth, at least at that moment, before it may be burned up in production elsewhere or on consumption.
http://economix.blogs.nytimes.com/2010/05/07/how-businesses-create-wealth/
How Businesses Create Wealth
By UWE E. REINHARDT
Uwe E. Reinhardt is an economics professor at Princeton.
In last week’s post I offered a near metaphysical definition of wealth that set off a lively round of commentaries.
This week I explore how companies create “value” and distribute it among various stakeholders.
That value can be consumed on the spot to produce other goods and services or to create a consumer’s well-being. Alternatively, it can be saved and stored in the form of some asset. Freshman economics texts define an economic unit’s wealth as the market value of all of its assets minus its liabilities. Value creation and wealth are thus related.
Let’s imagine a company called ABC Inc., which produces a standard, ordinary commodity, by which I mean that society does not hold particular ethical strictures on its distribution (as we, for example, do for health care and education). The chart below sketches the value flow caused by the production of some volume of output. (The pipes going in and out of the company are not drawn to scale.)
Uwe E. Reinhardt
The large pipe in the upper left corner labeled “Gross Value Created” represents the maximum revenue ABC Inc. could have extracted from its customers if each unit of output could have been auctioned off, one after the other, to the highest bidder — an arrangement economists call “perfect price discrimination.” This hypothetical, maximum extractable revenue is the economist’s measure of the “social value” of ABC Inc.’s output.
Evidently, by thus defining social value, economists tacitly assume that rich people, who can bid a higher price for a thing, “value” the thing more than do poor people, even though rich people may not crave it any more than do poor people and possibly even less. It often surprises students that modern economics is solidly based on that legerdemain, which I admit to them in a memo entitled: “How We Economists Bastardized Benthamite Utilitarianism and Became Shills for the Wealthy.”
Leaving aside this important fine point, the sketch is drawn to show that ABC is not able to capture in the form of “sales revenue” all of the gross value it creates.
This is because in most markets, output is sold at a single, common price to all customers, which allows many of them to obtain units of the output at market prices below the maximum bid prices they would have offered in our hypothetical auction. The difference between the two prices is called “buyers’ surplus.” It is a kind of intangible profit that sellers must cede to buyers.
ABC Inc. now distributes the value it captures as “sales revenue” to sundry stakeholders as follows.
Usually the largest fraction is allocated to employees in the form of “employee compensation.” For most employees, the gross value they extract from the corporation as compensation exceeds their so-called “reservation wage.” The latter is the minimum compensation they would have to be paid to attract them to and retain them in the corporation.
This “reservation wage,” of course, is strongly influenced by what the employee could earn in the next best employ — the employee’s “opportunity costs” of working for ABC Inc. — but it also is influenced by how much employees like working there.
The difference between an employee’s actual compensation and his or her reservation wage is the net value employees extract from the corporation. Economists view it as a form of profit, too.
Indeed, it may astound union leaders that many companies bestow more profits of this type on their employees than they bestow profits on their shareholders. It almost surely is so in heavily unionized industries — e.g., the automobile or transportation industries. But it can easily be true even in non-unionized industries.
Brushing lightly over the fraction of ABC’s sales revenue (which is captured gross value) that flows to creditors in the form of interest, to suppliers of non-labor inputs, and to government in the form of taxes, we arrive at a residual that accrues to the owners as “profit available for distribution to shareholders.”
Management and the company’s directors may decide to distribute some of that residual to shareholders in the form of cash dividends. But usually the bulk or even all of it is plowed back into the company in the form of “retained earnings.” Few shareholders take out much of the gross value their companies create in the form of cash.
Wall Street bases its estimate of the company’s “market capitalization” solely on the residual “profit available for shareholders” pipe, eclipsing from view the entire value-flow that accrues to other stakeholders. Unfortunately, many journalists and pundits in the financial press then mistake that “market capitalization” as the sole measure of the “wealth” the company creates, not realizing that this metric can rise or fall for reasons other then genuine value creation by the company.
Suppose, for example, that a company’s volume of output has not changed, but that it somehow manages to raise prices paid by some or all buyers, capturing more of an unchanged gross value created by the company’s output. The company’s market capitalization would be likely to rise as a result of the price increase. But would that add to the nation’s stock of wealth? Or would it merely be a redistribution of wealth from buyers to shareholders?
Similarly, suppose new management takes over and changes nothing other than reducing or eliminating retiree health benefits promised to already retired workers during their working years, albeit in a contract that can be broken (as many such contracts can be broken). If those savings in expenses then flow through to the owners’ profits, the company’s market capitalization would be likely to increase. But is that an increase in national wealth?
I would argue that a corporation contributes to national wealth only if it does something to increase the “total gross value” of what it produces. Someone will then get that added gross value — the buyers in the form of buyers’ surplus or employees in the form of added compensation (perhaps mainly executive bonuses) or the shareholders, and so on.
Regardless of its distribution among stakeholders, and even if none of it flows to the company’s owners, that added gross value can be viewed an addition to national wealth, at least at that moment, before it may be burned up in production elsewhere or on consumption.
http://economix.blogs.nytimes.com/2010/05/07/how-businesses-create-wealth/
Where All That Money Went (Part 1 of 3)
APRIL 30, 2010, 6:00 AM
Where All That Money Went
By UWE E. REINHARDT
Uwe E. Reinhardt is an economics professor at Princeton.
2:50 a.m. | Updated
“We’ve lost almost $11 trillion of household wealth in the last 17 or 18 months,” lamented Senator Christopher J. Dodd, the Connecticut Democrat, on last Sunday’s “Meet the Press,” as he urged Congress to proceed with speedy deliberations on a finance reform bill.
Eleven trillion dollars! That’s over three-quarters of our current gross domestic product.
Where did all this wealth go? Did other folks get it? Or did it just go up in smoke?
For that matter, what precisely is “wealth”? Is it something tangible we can see, or is it something intangible – something merely imagined?
In an illuminating paper on asset values and wealth, the economist Michael Reiter defined wealth in a way that makes sense to economists:
“Wealth” is the present value of the expected stream of future utility [human happiness] that an “infinitely lived individual or a dynasty” [or a nation] could hope to extract from the real resources available now and in the indefinite future, assuming these real resources are allocated and managed now, and over time, so as to maximize that present value of future utils (at the “proper” discount rate).
Two practical points can be extracted from this abstract definition.
First, economists think of wealth not just in monetary terms — as cash, stocks, bonds and real estate — but in terms of human well-being.
Second, and most importantly, the wealth a nation believes itself to possess is based strictly on the citizenry’s expectations about the future. It is in good part a figment of the citizens’ imagination.
To be sure, these imaginations are anchored in the tangible and intangible resources a nation has at any moment and hopes to have in the future. Among these resources are patents and blueprints that represent the current technological state of the art.
But the same set of current resources can trigger vastly different levels of imagined “wealth,” depending on the citizens’ mood.
To illustrate that these are not just the abstract musings of an econ-geek, let us look at the value of something concrete: a building. Here I draw on a tongue-in-cheek paper I once penned for Princeton alumni entitled “How Much is a Building Worth?”
What could be more real and concrete than a building?
Imagine, then, a new building that, fully leased at current rental rates, currently yields the owner $20 million in cash per year, after all of the owner’s expenses of operating and maintaining the building.
Assume the building will be in operation for 40 years, after which it will be torn down at costs that are just covered by selling the land underneath it. That assumption allows us to view the current value of the building to its owner, or to a prospective buyer, as the time-value adjusted sum of the annual net cash flows accruing to the owner(s) over the next 40 years.
The term “time-value adjusted” refers to the idea that, say, $1,000 receivable one year hence is worth less to the recipient than it is now, because something less than $1,000 could be invested today at some interest rate to grow to $1,000 a year hence.
If the relevant interest rate were 5 percent, then $952.31 would do the trick. It would grow to $1,000 in one year. The “present value of $1,000 receivable one year hence at a discount rate of 5 percent” therefore is $952.31. By similar logic, and assuming one could earn a compound-interest rate of 5 percent on money invested for 20 years now, $1,000 receivable, say, 10 years from now has a present value of only $376.89, and so on.
The graph below shows the present value of our building at different discount rates and for three assumed annual growth rates in the annual cash flow from the building. The exercise clearly shows just how sensitive the value of long-lived assets, such as an office tower, is to assumptions about the future. It can explain why Hong Kong real estate values literally fell by half as part of the Asian financial meltdown of 1997.
Uwe E. Reinhardt
The discount rate used in this exercise should be thought of as the rate of return that a prospective buyer of the building would expect minimally to earn on that investment to find the deal attractive. That rate is driven by three key factors:
It is here that mood enters the picture.
If investors are exuberantly optimistic about the future growth of the economy and future rental rates, and if they believe there is little risk in such long-term investments, the risk premiums they demand tend to be low and real estate values correspondingly high. Completely irrational exuberance of the sort we have seen in recent years can easily lead to serious “underpricing of risk” and, thus, to real estate bubbles.
On the other hand, if investors are very pessimistic and worried about the risk inherent in such investments, their risk premiums rise and asset values fall. Irrational despondency can lead to overpricing risk and underpricing real estate.
Now, what is true for real estate also applies to other assets — home values, stock prices, bond prices and so on.
So let’s go back to the lost $11 trillion in wealth lamented by Senator Dodd. Where did it go? For the most part, I suspect, it just went up in smoke. It represents a loss of wealth that once exuberant folks imagined to have had and now imagine they no longer have.
True, with its clever but untoward shenanigans, Wall Street has sucked billions of dollars out of the pockets of hard-working folks on Main Street and transferred them into the financiers’ own pockets. In this connection, merely read these articles to see how it was done.
But they didn’t amass $11 trillion. The bankers did not get that rich.
In next week’s post I will explore who creates a nation’s wealth — businesses or households or government, or all of them?
http://economix.blogs.nytimes.com/2010/04/30/where-all-that-money-went/
Where All That Money Went
By UWE E. REINHARDT
Uwe E. Reinhardt is an economics professor at Princeton.
2:50 a.m. | Updated
“We’ve lost almost $11 trillion of household wealth in the last 17 or 18 months,” lamented Senator Christopher J. Dodd, the Connecticut Democrat, on last Sunday’s “Meet the Press,” as he urged Congress to proceed with speedy deliberations on a finance reform bill.
Eleven trillion dollars! That’s over three-quarters of our current gross domestic product.
Where did all this wealth go? Did other folks get it? Or did it just go up in smoke?
For that matter, what precisely is “wealth”? Is it something tangible we can see, or is it something intangible – something merely imagined?
In an illuminating paper on asset values and wealth, the economist Michael Reiter defined wealth in a way that makes sense to economists:
“Wealth” is the present value of the expected stream of future utility [human happiness] that an “infinitely lived individual or a dynasty” [or a nation] could hope to extract from the real resources available now and in the indefinite future, assuming these real resources are allocated and managed now, and over time, so as to maximize that present value of future utils (at the “proper” discount rate).
Two practical points can be extracted from this abstract definition.
First, economists think of wealth not just in monetary terms — as cash, stocks, bonds and real estate — but in terms of human well-being.
Second, and most importantly, the wealth a nation believes itself to possess is based strictly on the citizenry’s expectations about the future. It is in good part a figment of the citizens’ imagination.
To be sure, these imaginations are anchored in the tangible and intangible resources a nation has at any moment and hopes to have in the future. Among these resources are patents and blueprints that represent the current technological state of the art.
But the same set of current resources can trigger vastly different levels of imagined “wealth,” depending on the citizens’ mood.
To illustrate that these are not just the abstract musings of an econ-geek, let us look at the value of something concrete: a building. Here I draw on a tongue-in-cheek paper I once penned for Princeton alumni entitled “How Much is a Building Worth?”
What could be more real and concrete than a building?
Imagine, then, a new building that, fully leased at current rental rates, currently yields the owner $20 million in cash per year, after all of the owner’s expenses of operating and maintaining the building.
Assume the building will be in operation for 40 years, after which it will be torn down at costs that are just covered by selling the land underneath it. That assumption allows us to view the current value of the building to its owner, or to a prospective buyer, as the time-value adjusted sum of the annual net cash flows accruing to the owner(s) over the next 40 years.
The term “time-value adjusted” refers to the idea that, say, $1,000 receivable one year hence is worth less to the recipient than it is now, because something less than $1,000 could be invested today at some interest rate to grow to $1,000 a year hence.
If the relevant interest rate were 5 percent, then $952.31 would do the trick. It would grow to $1,000 in one year. The “present value of $1,000 receivable one year hence at a discount rate of 5 percent” therefore is $952.31. By similar logic, and assuming one could earn a compound-interest rate of 5 percent on money invested for 20 years now, $1,000 receivable, say, 10 years from now has a present value of only $376.89, and so on.
The graph below shows the present value of our building at different discount rates and for three assumed annual growth rates in the annual cash flow from the building. The exercise clearly shows just how sensitive the value of long-lived assets, such as an office tower, is to assumptions about the future. It can explain why Hong Kong real estate values literally fell by half as part of the Asian financial meltdown of 1997.
Uwe E. Reinhardt
The discount rate used in this exercise should be thought of as the rate of return that a prospective buyer of the building would expect minimally to earn on that investment to find the deal attractive. That rate is driven by three key factors:
- (1) what one could earn on a risk-free investment, e.g., a United States Treasury Inflation Protected Security (also known as TIPs),
- (2) the investor’s expectations about future annual inflation rates, and
- (3) a risk premium to compensate the investor for the perceived uncertainty inherent in investing in long-lived assets such as real estate.
It is here that mood enters the picture.
If investors are exuberantly optimistic about the future growth of the economy and future rental rates, and if they believe there is little risk in such long-term investments, the risk premiums they demand tend to be low and real estate values correspondingly high. Completely irrational exuberance of the sort we have seen in recent years can easily lead to serious “underpricing of risk” and, thus, to real estate bubbles.
On the other hand, if investors are very pessimistic and worried about the risk inherent in such investments, their risk premiums rise and asset values fall. Irrational despondency can lead to overpricing risk and underpricing real estate.
Now, what is true for real estate also applies to other assets — home values, stock prices, bond prices and so on.
So let’s go back to the lost $11 trillion in wealth lamented by Senator Dodd. Where did it go? For the most part, I suspect, it just went up in smoke. It represents a loss of wealth that once exuberant folks imagined to have had and now imagine they no longer have.
True, with its clever but untoward shenanigans, Wall Street has sucked billions of dollars out of the pockets of hard-working folks on Main Street and transferred them into the financiers’ own pockets. In this connection, merely read these articles to see how it was done.
But they didn’t amass $11 trillion. The bankers did not get that rich.
In next week’s post I will explore who creates a nation’s wealth — businesses or households or government, or all of them?
http://economix.blogs.nytimes.com/2010/04/30/where-all-that-money-went/
****Eight lessons of investing
Eight lessons of investing
I believe the fundamentals of equity investing remain unscathed and investors should learn eight key lessons.
By Kevin Murphy
Published: 7:31AM BST 26 May 2010
During the past 18 months we have seen unprecedented economic events, but I believe the fundamentals of equity investing remain unscathed and investors should learn eight key lessons.
LESSON ONE: PATIENCE IS A VIRTUE
Market sentiment can create exceptional opportunities for investors with patience. At times of market ''panic'', share prices fluctuate far more than underlying fundamentals of many businesses warrant. This creates great opportunities.
There have been many bargains over the past 18 months, Next is a particularly good example. The retailer saw share prices fall from £24 at the peak, to £8 at the trough.
This reflected investors' fears about global recession, but Next seemed a robust company with low net debt and unlikely to go bust. With shares seemingly trading at a low of four times normalised earnings this was a chance to acquire a quality business at a low price. Shares have shot back to more than £20.
LESSON TWO: IGNORE ECONOMISTS
While fund managers are frequently asked their economic views, macro-forecasting is notoriously difficult. The process relies on predicting a range of interrelated variables.
The number of economists proven wrong during this crisis highlights the scale of the challenge. There is little point forecasting economic outlook or using macro-forecasts to determine company values.
Economic growth often has an inverse relationship with subsequent stock market performance.
Research from the London Business School shows stock market returns are no higher in countries with high GDP growth and countries with low GDP growth can exhibit the best stock market performance.
This is an intuitive trend. Stock markets are discounting mechanisms that always look forward and equity markets can rally even while economic growth remains low.
LESSON THREE: CHEAP IS BEST
If macro trends are not the best indicator of stock market returns, valuation remains the surest guide to future investment performance and data illustrates that buying securities on low valuations gives the best opportunity for future returns.
Buying shares at around 5-10 times earnings, would usually see annualised returns for the next 10 years of more than 10pc. In contrast, buying shares on 25-30 times would see extremely disappointing future returns.
LESSON FOUR: GOOD COMPANIES ARE NOT ALWAYS A ''BUY''
Buying a ''good'' company at the wrong price can seriously affect overall returns.
GlaxoSmithKline, a very good company, generated earnings per share of about 50p in 1999-2000 and was trading at around £20 – equivalent to 40 times earnings.
Despite good earnings growth, it did not offer good value at that price. Ten years on, earnings have doubled while the share price has halved. The stock is more attractive now.
LESSON FIVE: IT IS THE AVERAGE THAT COUNTS
Peaks and troughs are part of operating and share price performance, but there is a tendency to revert to averages.
Companies with high profits are unlikely to generate that growth forever and companies with low profits are unlikely to be stuck in long-term ruts.
When valuing companies, strip out peaks and troughs and look at average long-term earnings potential – the intrinsic value or ''normalised'' profit potential.
Barclays' share price was about 700p in 2007, with earnings per share (EPS) of 70p. However, EPS looked unsustainably high given a ''normalised'' earnings estimate of 45p per share.
Mean reversion worked its magic and by April 2009 earnings forecasts dropped to 12p per share and shares to 50p.
Barclays faced obvious pressures, but this seemed a good company whose long-run earnings potential did not appear to have changed. The shares seemed to be trading at just one times normalised earnings – a low valuation that has corrected significantly in the past year.
LESSON SIX: DIVIDEND HISTORY IS KEY
As investors search hard for yield, it is important to note companies' long-term ability to pay dividends, rather than being swayed by short-term distributions.
Some utility companies need to increase their debt every year in order to maintain their dividend at its current level.
Conversely, a company such as AstraZeneca looks to be generating £8-9bn net cash each year, and is paying around £4bn in dividends. This is clearly sustainable and also gives the company flexibility.
LESSON SEVEN: SIZE DOESN'T MATTER
Tracking error (how different a fund looks from its benchmark index) is a widely used ''risk'' measure, but it is inappropriate to assess portfolios on this alone. Not owning a large FTSE All-Share constituent like British American Tobacco results in a higher tracking error and, theoretically, a higher 'risk'.
However, is it more or less 'risky' for investors to buy a company simply because it accounts for a large proportion of the index, and potentially overpay?
It is preferable to assess investments in terms of absolute risk, looking at
valuation risk (the risk of overpaying),
earnings risk (the risk earnings decline over time) and
financial risk (the risk of insolvency).
If an investment's potential returns significantly outweigh the balance of risks, it should be viewed as an attractive long-term opportunity, regardless of index size.
LESSON EIGHT: DON'T FOLLOW THE HERD
Willingness to go against the crowd (and for your fund to look different to the index) is fundamental for generating superior long-term returns.
Given ongoing search for yield and the disappearance of the banks as major dividend payers, many income funds have been forced into a smaller set of high yielding stocks. In many cases, these are among the biggest stocks in the market – names like BP, Royal Dutch Shell, BHP Billiton and Tesco.
This trend has left many funds in the income sector clustered in just a handful of stocks. This is not the way to produce superior performance.
Kevin Murphy is the manager of the Schroder Income Fund
http://www.telegraph.co.uk/finance/personalfinance/investing/shares-and-stock-tips/7765851/Eight-lessons-of-investing.html
Eight lessons of investing
I believe the fundamentals of equity investing remain unscathed and investors should learn eight key lessons.
By Kevin Murphy
Published: 7:31AM BST 26 May 2010
During the past 18 months we have seen unprecedented economic events, but I believe the fundamentals of equity investing remain unscathed and investors should learn eight key lessons.
LESSON ONE: PATIENCE IS A VIRTUE
Market sentiment can create exceptional opportunities for investors with patience. At times of market ''panic'', share prices fluctuate far more than underlying fundamentals of many businesses warrant. This creates great opportunities.
There have been many bargains over the past 18 months, Next is a particularly good example. The retailer saw share prices fall from £24 at the peak, to £8 at the trough.
This reflected investors' fears about global recession, but Next seemed a robust company with low net debt and unlikely to go bust. With shares seemingly trading at a low of four times normalised earnings this was a chance to acquire a quality business at a low price. Shares have shot back to more than £20.
LESSON TWO: IGNORE ECONOMISTS
While fund managers are frequently asked their economic views, macro-forecasting is notoriously difficult. The process relies on predicting a range of interrelated variables.
The number of economists proven wrong during this crisis highlights the scale of the challenge. There is little point forecasting economic outlook or using macro-forecasts to determine company values.
Economic growth often has an inverse relationship with subsequent stock market performance.
Research from the London Business School shows stock market returns are no higher in countries with high GDP growth and countries with low GDP growth can exhibit the best stock market performance.
This is an intuitive trend. Stock markets are discounting mechanisms that always look forward and equity markets can rally even while economic growth remains low.
LESSON THREE: CHEAP IS BEST
If macro trends are not the best indicator of stock market returns, valuation remains the surest guide to future investment performance and data illustrates that buying securities on low valuations gives the best opportunity for future returns.
Buying shares at around 5-10 times earnings, would usually see annualised returns for the next 10 years of more than 10pc. In contrast, buying shares on 25-30 times would see extremely disappointing future returns.
LESSON FOUR: GOOD COMPANIES ARE NOT ALWAYS A ''BUY''
Buying a ''good'' company at the wrong price can seriously affect overall returns.
GlaxoSmithKline, a very good company, generated earnings per share of about 50p in 1999-2000 and was trading at around £20 – equivalent to 40 times earnings.
Despite good earnings growth, it did not offer good value at that price. Ten years on, earnings have doubled while the share price has halved. The stock is more attractive now.
LESSON FIVE: IT IS THE AVERAGE THAT COUNTS
Peaks and troughs are part of operating and share price performance, but there is a tendency to revert to averages.
Companies with high profits are unlikely to generate that growth forever and companies with low profits are unlikely to be stuck in long-term ruts.
When valuing companies, strip out peaks and troughs and look at average long-term earnings potential – the intrinsic value or ''normalised'' profit potential.
Barclays' share price was about 700p in 2007, with earnings per share (EPS) of 70p. However, EPS looked unsustainably high given a ''normalised'' earnings estimate of 45p per share.
Mean reversion worked its magic and by April 2009 earnings forecasts dropped to 12p per share and shares to 50p.
Barclays faced obvious pressures, but this seemed a good company whose long-run earnings potential did not appear to have changed. The shares seemed to be trading at just one times normalised earnings – a low valuation that has corrected significantly in the past year.
LESSON SIX: DIVIDEND HISTORY IS KEY
As investors search hard for yield, it is important to note companies' long-term ability to pay dividends, rather than being swayed by short-term distributions.
Some utility companies need to increase their debt every year in order to maintain their dividend at its current level.
Conversely, a company such as AstraZeneca looks to be generating £8-9bn net cash each year, and is paying around £4bn in dividends. This is clearly sustainable and also gives the company flexibility.
LESSON SEVEN: SIZE DOESN'T MATTER
Tracking error (how different a fund looks from its benchmark index) is a widely used ''risk'' measure, but it is inappropriate to assess portfolios on this alone. Not owning a large FTSE All-Share constituent like British American Tobacco results in a higher tracking error and, theoretically, a higher 'risk'.
However, is it more or less 'risky' for investors to buy a company simply because it accounts for a large proportion of the index, and potentially overpay?
It is preferable to assess investments in terms of absolute risk, looking at
If an investment's potential returns significantly outweigh the balance of risks, it should be viewed as an attractive long-term opportunity, regardless of index size.
LESSON EIGHT: DON'T FOLLOW THE HERD
Willingness to go against the crowd (and for your fund to look different to the index) is fundamental for generating superior long-term returns.
Given ongoing search for yield and the disappearance of the banks as major dividend payers, many income funds have been forced into a smaller set of high yielding stocks. In many cases, these are among the biggest stocks in the market – names like BP, Royal Dutch Shell, BHP Billiton and Tesco.
This trend has left many funds in the income sector clustered in just a handful of stocks. This is not the way to produce superior performance.
Kevin Murphy is the manager of the Schroder Income Fund
http://www.telegraph.co.uk/finance/personalfinance/investing/shares-and-stock-tips/7765851/Eight-lessons-of-investing.html
I believe the fundamentals of equity investing remain unscathed and investors should learn eight key lessons.
By Kevin Murphy
Published: 7:31AM BST 26 May 2010
During the past 18 months we have seen unprecedented economic events, but I believe the fundamentals of equity investing remain unscathed and investors should learn eight key lessons.
LESSON ONE: PATIENCE IS A VIRTUE
Market sentiment can create exceptional opportunities for investors with patience. At times of market ''panic'', share prices fluctuate far more than underlying fundamentals of many businesses warrant. This creates great opportunities.
There have been many bargains over the past 18 months, Next is a particularly good example. The retailer saw share prices fall from £24 at the peak, to £8 at the trough.
This reflected investors' fears about global recession, but Next seemed a robust company with low net debt and unlikely to go bust. With shares seemingly trading at a low of four times normalised earnings this was a chance to acquire a quality business at a low price. Shares have shot back to more than £20.
LESSON TWO: IGNORE ECONOMISTS
While fund managers are frequently asked their economic views, macro-forecasting is notoriously difficult. The process relies on predicting a range of interrelated variables.
The number of economists proven wrong during this crisis highlights the scale of the challenge. There is little point forecasting economic outlook or using macro-forecasts to determine company values.
Economic growth often has an inverse relationship with subsequent stock market performance.
Research from the London Business School shows stock market returns are no higher in countries with high GDP growth and countries with low GDP growth can exhibit the best stock market performance.
This is an intuitive trend. Stock markets are discounting mechanisms that always look forward and equity markets can rally even while economic growth remains low.
LESSON THREE: CHEAP IS BEST
If macro trends are not the best indicator of stock market returns, valuation remains the surest guide to future investment performance and data illustrates that buying securities on low valuations gives the best opportunity for future returns.
Buying shares at around 5-10 times earnings, would usually see annualised returns for the next 10 years of more than 10pc. In contrast, buying shares on 25-30 times would see extremely disappointing future returns.
LESSON FOUR: GOOD COMPANIES ARE NOT ALWAYS A ''BUY''
Buying a ''good'' company at the wrong price can seriously affect overall returns.
GlaxoSmithKline, a very good company, generated earnings per share of about 50p in 1999-2000 and was trading at around £20 – equivalent to 40 times earnings.
Despite good earnings growth, it did not offer good value at that price. Ten years on, earnings have doubled while the share price has halved. The stock is more attractive now.
LESSON FIVE: IT IS THE AVERAGE THAT COUNTS
Peaks and troughs are part of operating and share price performance, but there is a tendency to revert to averages.
Companies with high profits are unlikely to generate that growth forever and companies with low profits are unlikely to be stuck in long-term ruts.
When valuing companies, strip out peaks and troughs and look at average long-term earnings potential – the intrinsic value or ''normalised'' profit potential.
Barclays' share price was about 700p in 2007, with earnings per share (EPS) of 70p. However, EPS looked unsustainably high given a ''normalised'' earnings estimate of 45p per share.
Mean reversion worked its magic and by April 2009 earnings forecasts dropped to 12p per share and shares to 50p.
Barclays faced obvious pressures, but this seemed a good company whose long-run earnings potential did not appear to have changed. The shares seemed to be trading at just one times normalised earnings – a low valuation that has corrected significantly in the past year.
LESSON SIX: DIVIDEND HISTORY IS KEY
As investors search hard for yield, it is important to note companies' long-term ability to pay dividends, rather than being swayed by short-term distributions.
Some utility companies need to increase their debt every year in order to maintain their dividend at its current level.
Conversely, a company such as AstraZeneca looks to be generating £8-9bn net cash each year, and is paying around £4bn in dividends. This is clearly sustainable and also gives the company flexibility.
LESSON SEVEN: SIZE DOESN'T MATTER
Tracking error (how different a fund looks from its benchmark index) is a widely used ''risk'' measure, but it is inappropriate to assess portfolios on this alone. Not owning a large FTSE All-Share constituent like British American Tobacco results in a higher tracking error and, theoretically, a higher 'risk'.
However, is it more or less 'risky' for investors to buy a company simply because it accounts for a large proportion of the index, and potentially overpay?
It is preferable to assess investments in terms of absolute risk, looking at
- valuation risk (the risk of overpaying),
- earnings risk (the risk earnings decline over time) and
- financial risk (the risk of insolvency).
If an investment's potential returns significantly outweigh the balance of risks, it should be viewed as an attractive long-term opportunity, regardless of index size.
LESSON EIGHT: DON'T FOLLOW THE HERD
Willingness to go against the crowd (and for your fund to look different to the index) is fundamental for generating superior long-term returns.
Given ongoing search for yield and the disappearance of the banks as major dividend payers, many income funds have been forced into a smaller set of high yielding stocks. In many cases, these are among the biggest stocks in the market – names like BP, Royal Dutch Shell, BHP Billiton and Tesco.
This trend has left many funds in the income sector clustered in just a handful of stocks. This is not the way to produce superior performance.
Kevin Murphy is the manager of the Schroder Income Fund
http://www.telegraph.co.uk/finance/personalfinance/investing/shares-and-stock-tips/7765851/Eight-lessons-of-investing.html
Double-dip fears over worldwide credit stress
Double-dip fears over worldwide credit stress
The global credit system is flashing the most serious warning signals in almost a year on triple fears of a Spanish banking crisis, escalating political risk in Asia, and a second leg to the US housing slump.
By Ambrose Evans-Pritchard
Published: 9:20PM BST 25 May 2010
Flight to safety drove yields on 10-year German Bunds to 2.56pc, below the levels touched in the depths of the Great Depression. The spreads over peripheral European debt rose sharply again, jumping to 137 basis points for Italy, 157 for Spain and 220 for Ireland.
The strains in Europe's sovereign debt markets are nearing levels that forced EU leaders to launch their "shock and awe" rescue package. "If a $1 trillion (£700bn) bail-out did not finally turn sentiment, I struggle to see what can," said Tim Ash, an economist at RBS.
Dollar Libor rates gauging stress within the interbank lending market have jumped to a 10-month high of 0.5363pc, with credit contagion spreading to every area. The iTraxx Senior financials index – banks' "fear gauge" – rose 20 basis points on Tuesday to 184. "It turns out we weren't seeing the light at the end of the tunnel after all, but a train with a big light on it coming towards us of double-dip," said Dr Suki Mann, at Societe Generale.
While the Libor rate is still far below peaks reached during the Lehman crisis, the pattern has ominous echoes of credit market strains before the two big "pulses" of the credit crisis in August 2007 and September 2008. In each case a breakdown of trust in the interbank market was a harbinger of violent moves in equities and the real economy weeks later.
RBS's credit team said Libor strains were worse than they looked since most banks in Europe were paying much higher spreads, especially in Spain. The "implied" forward spreads were nearer 1.1pc.
The damage has spilt over to corporate bonds, effectively shutting the market for new issues. May will be the worst single month for debt issues since December 1999, with seven deals being cancelled in recent days. Volume has collapsed to $47bn from $183bn in April, according to Bloomberg.
Mr Ash said North Korea's decision to cut all ties with the South and abrogate its non-aggression pact – coming days after Thailand sent tanks into Bangkok to crush the Red Shirts – has played into the chemistry of angst gripping markets, adding it was a reminder that Asia has "political/social stress points". This risk was overlooked during the honeymoon phase of emerging markets when investors were intoxicated by the China story.
Fears that America may slip back into a double-dip recession are returning. Larry Summers, the White House economic tsar, has called for a second stimulus package to keep the recovery on track, warning that the US economy is still in a "very deep valley".
The S&P Case-Shiller index of home prices is declining again as incentives for homebuyers expire and the slow-burn effect of rising delinquencies exacts its toll. Prices fell 3.2pc in the first quarter of this year. "There are signs of some renewed weakening in home prices", said David Blitzer from S&P.
The epicentre of the credit crisis is moving to Spain where the seizure by the central bank of CajaSur over the weekend has torn away the veil on credit damage from Spain's property crash.
Bank stocks fell 6pc in Madrid in early trading on Tuesday on fears that funding will dry up for the cajas – or the savings banks – setting off a broader credit crunch. The cajas hold the lion's share of loans to property companies and developers, estimated at €445bn (£380bn) or 45pc of GDP by Goldman Sachs.
Spanish construction reached 17pc of GDP at the height of the bubble as real interest rates of minus 2pc set by the European Central Bank for German needs played havoc with the Spanish economy. This was almost double the level in the US during the sub-prime booms. The result is an overhang of unsold Spanish properties equal to four years' demand.
Markets have been rattled by reports in the German media that the Greek rescue deal contains two secret clauses. The package will be "immediately and irrevocably cancelled" if it is found to breach the EU Treaty's "no bail-out" clause, either in a ruling by the European court or the constitutional courts of any eurozone state. While such an event is unlikely, it is not impossible. There are two cases already pending at Germany's top court in Karlsruhe, perhaps Europe's most "eurosceptic" tribunal.
The second clause said that if any country finds it cannot raise funding for the rescue at interest rates below the 5pc charge agreed for Greece, it may opt out of the bail-out. BNP Paribas said this would escalate quickly into a systemic crisis if Spain were in such a position, because the other countries cannot carry an ever-rising burden. The bank warned the euro project itself may start to disintegrate rapidly if these rescue provisions are ever seriously put to the test.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7765383/Double-dip-fears-over-worldwide-credit-stress.html
The global credit system is flashing the most serious warning signals in almost a year on triple fears of a Spanish banking crisis, escalating political risk in Asia, and a second leg to the US housing slump.
By Ambrose Evans-Pritchard
Published: 9:20PM BST 25 May 2010
Flight to safety drove yields on 10-year German Bunds to 2.56pc, below the levels touched in the depths of the Great Depression. The spreads over peripheral European debt rose sharply again, jumping to 137 basis points for Italy, 157 for Spain and 220 for Ireland.
The strains in Europe's sovereign debt markets are nearing levels that forced EU leaders to launch their "shock and awe" rescue package. "If a $1 trillion (£700bn) bail-out did not finally turn sentiment, I struggle to see what can," said Tim Ash, an economist at RBS.
Dollar Libor rates gauging stress within the interbank lending market have jumped to a 10-month high of 0.5363pc, with credit contagion spreading to every area. The iTraxx Senior financials index – banks' "fear gauge" – rose 20 basis points on Tuesday to 184. "It turns out we weren't seeing the light at the end of the tunnel after all, but a train with a big light on it coming towards us of double-dip," said Dr Suki Mann, at Societe Generale.
While the Libor rate is still far below peaks reached during the Lehman crisis, the pattern has ominous echoes of credit market strains before the two big "pulses" of the credit crisis in August 2007 and September 2008. In each case a breakdown of trust in the interbank market was a harbinger of violent moves in equities and the real economy weeks later.
RBS's credit team said Libor strains were worse than they looked since most banks in Europe were paying much higher spreads, especially in Spain. The "implied" forward spreads were nearer 1.1pc.
The damage has spilt over to corporate bonds, effectively shutting the market for new issues. May will be the worst single month for debt issues since December 1999, with seven deals being cancelled in recent days. Volume has collapsed to $47bn from $183bn in April, according to Bloomberg.
Mr Ash said North Korea's decision to cut all ties with the South and abrogate its non-aggression pact – coming days after Thailand sent tanks into Bangkok to crush the Red Shirts – has played into the chemistry of angst gripping markets, adding it was a reminder that Asia has "political/social stress points". This risk was overlooked during the honeymoon phase of emerging markets when investors were intoxicated by the China story.
Fears that America may slip back into a double-dip recession are returning. Larry Summers, the White House economic tsar, has called for a second stimulus package to keep the recovery on track, warning that the US economy is still in a "very deep valley".
The S&P Case-Shiller index of home prices is declining again as incentives for homebuyers expire and the slow-burn effect of rising delinquencies exacts its toll. Prices fell 3.2pc in the first quarter of this year. "There are signs of some renewed weakening in home prices", said David Blitzer from S&P.
The epicentre of the credit crisis is moving to Spain where the seizure by the central bank of CajaSur over the weekend has torn away the veil on credit damage from Spain's property crash.
Bank stocks fell 6pc in Madrid in early trading on Tuesday on fears that funding will dry up for the cajas – or the savings banks – setting off a broader credit crunch. The cajas hold the lion's share of loans to property companies and developers, estimated at €445bn (£380bn) or 45pc of GDP by Goldman Sachs.
Spanish construction reached 17pc of GDP at the height of the bubble as real interest rates of minus 2pc set by the European Central Bank for German needs played havoc with the Spanish economy. This was almost double the level in the US during the sub-prime booms. The result is an overhang of unsold Spanish properties equal to four years' demand.
Markets have been rattled by reports in the German media that the Greek rescue deal contains two secret clauses. The package will be "immediately and irrevocably cancelled" if it is found to breach the EU Treaty's "no bail-out" clause, either in a ruling by the European court or the constitutional courts of any eurozone state. While such an event is unlikely, it is not impossible. There are two cases already pending at Germany's top court in Karlsruhe, perhaps Europe's most "eurosceptic" tribunal.
The second clause said that if any country finds it cannot raise funding for the rescue at interest rates below the 5pc charge agreed for Greece, it may opt out of the bail-out. BNP Paribas said this would escalate quickly into a systemic crisis if Spain were in such a position, because the other countries cannot carry an ever-rising burden. The bank warned the euro project itself may start to disintegrate rapidly if these rescue provisions are ever seriously put to the test.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7765383/Double-dip-fears-over-worldwide-credit-stress.html
How to Succeed at M&A
STRATEGY & INNOVATION May 26, 2010, 4:40PM EST
How to Succeed at M&A
All too often, mergers and acquisitions fail dismally. That, says Innosight's Mark Johnson, is because executives don't understand what they're really buying
Companies constantly seek new growth opportunities, but organic new growth is far from a sure bet. While business model innovation is a powerful path to sustained, robust growth, new businesses can take years to mature. The skills needed to conceive and incubate them present a unique set of challenges that many companies find difficult to overcome. "A large enterprise has trouble making an investment in innovation," says Brad Anderson, the recently retired CEO of electronics retailer Best Buy (BBY). "It's in part because Wall Street has trouble imagining a new way to operate but, more important, because people inside the company can't see the value of a new idea and so won't allocate the resources and support the new initiative needs to succeed."
But organic growth is not the only option available to companies seeking transformational growth. Though most of my book Seizing the White Space: Business Model Innovation for Growth and Renewal is dedicated to developing new business models within incumbent organizations, I don't mean to imply that incumbent companies shouldn't seek to achieve transformative growth and exploit opportunities in their white space through mergers and acquisitions—they should. Building models in-house is not the only option for companies seeking transformational growth. Corporations can transform their business models through acquisitions as well. When Anderson took over Best Buy, in fact, he led the company through a series of strategic acquisitions that helped it grow beyond a pure retail sales model.
But it's no news to point out that acquisitions, at the best of times, are tricky. Study after study finds that acquisitions tend to disappoint, variously estimating that half to as many as 80 percent fail to create value. The high-profile struggle of AOL (AOL) after its $180 billion acquisition of Time Warner (TWC) is one obvious example of an acquisition gone bad. But there are others: Daimler/Chrysler, Sprint/Nextel, and Quaker Oats/Snapple, to name only a few. Quaker Oats paid $1.7 billion for the Snapple brand in 1994 but sold it to Triarc three years later for a mere $300 million.
BUSINESS MODEL DEVELOPMENT
I believe many M&A disappointments stem from a failure to understand the fundamentals of business model development. When one company buys another, what it's really purchasing is the target company's business model—its customer value proposition, its profit formula, its resources, and its processes. The new company's resources can be folded into the core of the acquiring company, but new business models resist such integration. Consequently, successful acquisitions tend to fall into one of two camps.
- An acquirer can buy a company solely for its resources, which it would then fold into its own business model, while jettisoning the rest. The bulk of Cisco's (CSCO) acquisitions follow that pattern.
- Alternatively, a company can seek to acquire another company's business model, which it then needs to keep separate, but can strengthen by injecting into it its own resources. That's what Best Buy did with Geek Squad.
Johnson & Johnson (JNJ) has understood this, buying business models at an early stage and then keeping them separate. For example, its Medical Devices & Diagnostics (MD&D) division bought three business models that were fundamentally new to its respective markets: Vistakon (disposable contact lenses), LifeScan (at-home diabetes monitoring), and Cordis (artery stents used in angioplasty procedures). J&J bought these companies young and incubated them into the larger enterprise, where they became the growth engine of the MD&D division for many years.
All too often, attempts to fold an acquired business into the core can kill what made it unique in the first place. Video game maker Electronic Arts (ERTS) learned this the hard way. Propelled by investor expectations, rising development costs, and an industry consolidation trend, EA aggressively bought up small companies led by creative teams that had found success in the market. To profit from anticipated economies of scale, it built up a standardized technical infrastructure and imposed streamlined production processes on its new acquisitions.
The results were abysmal. EA fell into a pattern of producing mediocre products based on movie licenses and sports franchises, which were updated each year. Forcing creative teams to follow core processes was killing their innovative spirit. Luckily, CEO John Riccitiello saw the writing on the wall and announced a sea change in EA's operations: Independent creative studios would operate as "city-states" within the EA corporate structure.
ACQUIRED MODEL TAKES WHAT IT NEEDS
Most of the principles that govern the incubation, acceleration, and transition of homegrown new business models apply to acquired ones as well. Equally important is leadership's ability to allow a newly acquired business model to pull what it needs from the core, rather than having elements of the core model pushed onto it. Best Buy's Brad Anderson expressed this idea succinctly when, referring to the Geek Squad deal, he said, "Geek Squad bought Best Buy, not the other way around."
Anderson knew that the new model would produce growth and transformation for the company, but he also knew that the low-margin, high-volume, retail mentality of Best Buy could easily suffocate the high-touch, high-margin service orientation of Geek Squad. He let Geek Squad pull from Best Buy what it needed to thrive. At the time of acquisition, Geek Squad had 60 employees and was booking $3 million in annual revenue. Today, working out of 700 Best Buy locations across North America, Geek Squad's 12,000 service agents clock nearly $1 billion in services and return some $280 million to the retailer's bottom line.
As Vijay Govindarajan and Chris Trimble noted in Ten Rules for Strategic Innovators, a newly acquired business based on a model distinct from the core should decide what it can borrow from the parent, what it should forget (or forget about), and what it will do or learn that is completely new. The key to understanding what to forget and what to learn lies in the business model. You must understand both your own business model and the new company's model completely, so you won't throw away the most valuable thing you bought—the very thing that will help your company grow.
Mark W. Johnson is Chairman and Co-Founder of innovation consulting and research firm, Innosight. He is the author ofSeizing the White Space: Business Model Innovation for Transformative Growth and Renewal, (Harvard Business Press, February 2010) and a co-author of The Innovator's Guide to Growth (Harvard Business Press, July 2008).
Dow slipped below 10,000
US stocks fall as China reviews holdings
May 27, 2010 - 7:06AM
Wall Street staged yet another late-day reversal on Wednesday to end lower as news suggesting China was reassessing its euro-zone debt holdings pushed investors into profit-taking mode.
The Dow slipped below 10,000, with the late turnaround in stocks showing investor psyche remains fragile, and investors are inclined to sell strength in this volatile rumor-driven market.
The Financial Times said representatives of China's State Administration of Foreign Exchange, which manages the reserves under the country's central bank, has been meeting with foreign bankers in Beijing in recent days to discuss the issue.
What you need to know
"There is still nervousness out there. Yesterday's turnaround does not mean the market correction is over or that investors are confident about the direction of European policy or the success of European policy," said Tim Ghriskey, chief investment officer of Solaris Asset Management in Bedford Hills, New York.
The S&P 500 has fallen more than 10 percent from a closing high on April 23, putting the benchmark index into correction territory.
Large-cap liquid holdings, including Microsoft Corp and McDonald's Corp, led the Dow lower as the software giant's stock dropped 4.1 per cent to $US25.01 and the fast-food restaurant operator lost 2.7 per cent to $US66.01. At the same time, Apple Inc, which shed 0.5 per cent to $US244.11, managed to surpass Microsoft to become the second- largest company in market cap behind Exxon Mobil Corp.
The Dow Jones industrial average dropped 69.30 points, or 0.69 per cent, to 9974.45. The Standard & Poor's 500 Index fell 6.08 points, or 0.57 per cent, to 1067.95. The Nasdaq Composite Index lost 15.07 points, or 0.68 per cent, to 2195.88.
Late-day volatility has been a hallmark during the recent slide on Wall Street, with investors quick to pull the trigger at the slightest provocation. On Tuesday, Wall Street staged a furious rally toward the end of trading to reverse initial declines of more than 3 per cent.
"It really seems like the same old thing," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati, Ohio.
"This is the kind of intraday volatility that we will be seeing continuously."
Earlier in the session, data showed sales of new US homes hit their highest level in nearly two years in April as buyers rushed to take advantage of an expiring government tax credit.
The Dow Jones US Home Construction Index added 0.3 per cent, while the PHLX Housing Sector Index edged up 0.2 per cent.
Luxury home builder Toll Brothers Inc gained 0.8 per cent to $US20.78 after it said its quarterly loss narrowed from the previous year.
Elsewhere on the economic front, orders for durable goods rose in April to their highest level since September 2008.
Volume was solid, with about 12.44 billion shares traded on the New York Stock Exchange, the American Stock Exchange and Nasdaq -- well above last year's estimated daily average of 9.65 billion.
Advancing stocks outnumbered declining ones on the New York Stock Exchange by a ration of about 3 to 2, while on the Nasdaq, nearly five stocks rose for every four that fell.
Reuters
May 27, 2010 - 7:06AM
Wall Street staged yet another late-day reversal on Wednesday to end lower as news suggesting China was reassessing its euro-zone debt holdings pushed investors into profit-taking mode.
The Dow slipped below 10,000, with the late turnaround in stocks showing investor psyche remains fragile, and investors are inclined to sell strength in this volatile rumor-driven market.
The Financial Times said representatives of China's State Administration of Foreign Exchange, which manages the reserves under the country's central bank, has been meeting with foreign bankers in Beijing in recent days to discuss the issue.
What you need to know
"There is still nervousness out there. Yesterday's turnaround does not mean the market correction is over or that investors are confident about the direction of European policy or the success of European policy," said Tim Ghriskey, chief investment officer of Solaris Asset Management in Bedford Hills, New York.
The S&P 500 has fallen more than 10 percent from a closing high on April 23, putting the benchmark index into correction territory.
Large-cap liquid holdings, including Microsoft Corp and McDonald's Corp, led the Dow lower as the software giant's stock dropped 4.1 per cent to $US25.01 and the fast-food restaurant operator lost 2.7 per cent to $US66.01. At the same time, Apple Inc, which shed 0.5 per cent to $US244.11, managed to surpass Microsoft to become the second- largest company in market cap behind Exxon Mobil Corp.
The Dow Jones industrial average dropped 69.30 points, or 0.69 per cent, to 9974.45. The Standard & Poor's 500 Index fell 6.08 points, or 0.57 per cent, to 1067.95. The Nasdaq Composite Index lost 15.07 points, or 0.68 per cent, to 2195.88.
Late-day volatility has been a hallmark during the recent slide on Wall Street, with investors quick to pull the trigger at the slightest provocation. On Tuesday, Wall Street staged a furious rally toward the end of trading to reverse initial declines of more than 3 per cent.
"It really seems like the same old thing," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati, Ohio.
"This is the kind of intraday volatility that we will be seeing continuously."
Earlier in the session, data showed sales of new US homes hit their highest level in nearly two years in April as buyers rushed to take advantage of an expiring government tax credit.
The Dow Jones US Home Construction Index added 0.3 per cent, while the PHLX Housing Sector Index edged up 0.2 per cent.
Luxury home builder Toll Brothers Inc gained 0.8 per cent to $US20.78 after it said its quarterly loss narrowed from the previous year.
Elsewhere on the economic front, orders for durable goods rose in April to their highest level since September 2008.
Volume was solid, with about 12.44 billion shares traded on the New York Stock Exchange, the American Stock Exchange and Nasdaq -- well above last year's estimated daily average of 9.65 billion.
Advancing stocks outnumbered declining ones on the New York Stock Exchange by a ration of about 3 to 2, while on the Nasdaq, nearly five stocks rose for every four that fell.
Reuters
Wednesday 26 May 2010
A quick look at IOI (26.5.2010)
A quick look at IOI (26.5.2010)
http://spreadsheets.google.com/pub?key=t6k-5R8Ct5ImEhMAU1ZokUA&output=html
A quick look at KLK (26.5.2010)
A quick look at KLK (26.5.2010)
http://spreadsheets.google.com/pub?key=tiqZWoM_oZRjfGawqsN8J8w&output=html
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