Tag Archives: management

Maximizing Shareholder Value: A Dumb Idea?

Sometime in 2007, I called the Investor Relations head of a leading Indian power company. “I request for a meeting with your CFO,” I said. “Where are you calling from?” she asked back. “I work for an independent research company working for retail investors, and we are looking to initiate coverage on your stock,” I replied. “I had some questions before writing the report, and thus wanted to meet your CFO.” “Are you writing a Buy or a Sell report on our stock?” she asked. “How can I tell you that now?” I said. “I need to finish my research, and only then will I make a judgement on whether the stock is a Buy or a Sell.” “Wait, you are from a retail research organization, right?” she asked. “Sorry, we do not have a policy to meet companies focused on retail investors. We only meet the institutional guys because they can help up increase our market cap, not the retail guys. We want to maximize shareholders’ wealth, you see.” I loved her honesty, but was shocked to hear such a response from a public company, which had a policy of maximizing shareholder wealth, and fast, and by excluding a large set of its shareholders. What a Dumb Idea! Peter Drucker said in 1973: The only valid purpose of a firm is to create a customer. Drucker’s perspective was that the goal of a firm isn’t fundamentally about creating profits or maximizing shareholder value. Profits and shareholder value are the results of adding value to customers, not the goal. Even the legendary Jack Welch has come to see that maximizing shareholder value is “the dumbest idea in the world.” “On the face of it, shareholder value is the dumbest idea in the world,” Welch said, “Shareholder value is a result, not a strategy…your main constituencies are your employees, your customers and your products.” Seth Godin wrote in a recent post – The purpose of a company is to serve its customers. Its obligation is to not harm everyone else. And its opportunity is to enrich the lives of its employees. Somewhere along the way, people got the idea that maximizing investor return was the point. It shouldn’t be. That’s not what democracies ought to seek in chartering corporations to participate in our society. The great corporations of a generation ago, the ones that built key elements of our culture, were run by individuals who had more on their mind than driving the value of their options up. Contrast this with what most companies and their managers do, i.e., focus on short-term profits and stock price maximization, because this is an easy thing to do. Look at what the DCB Bank did recently. Some days back, the management announced that the bank’s profits would take a knock as it tries to double its branch network in the next one year. On this news, the stock price crashed 30% in quick time. Shattered by this crash in the stock, the management revised its plan saying that, “after consultations with analysts and its chairman,” it would now not rush with the opening of new branches. Instead of setting up 150 branches over the next one year, it will do this over two years. While I have no view on the bank or how this branch expansion would have helped or hurt it, the questions that arise are: How can a management change its corporate plan while keeping an eye on the stock price? How on earth can you consult stock market analysts on what you want to do as corporate managers? The answer, again, seems to be – focus on short-term profit and stock price maximization versus long-term goals. All CEOs and corporate managers appearing on business channels talking about their profits and next quarter’s or year’s performance are focused on just that – maximizing their company’s stock prices in the short term. Companies that never organize analyst meets or conference calls and become active when their stock price is rising are also focused on that – further maximizing their stock prices in the short term. Companies that pay dividends out of borrowed money are also doing the same. Steve Denning wrote this in his 2011 article on Forbes: CEOs and their top managers have massive incentives to focus most of their attentions on the expectations market, rather than the real job of running the company producing real products and services. The real market is the world in which factories are built, products are designed and produced, real products and services are bought and sold, revenues are earned, expenses are paid, and real dollars of profit show up on the bottom line. That is the world that executives control-at least to some extent. The expectations market is the world in which shares in companies are traded between investors-in other words, the stock market. In this market, investors assess the real market activities of a company today and, on the basis of that assessment, form expectations as to how the company is likely to perform in the future. The consensus view of all investors and potential investors as to expectations of future performance shapes the stock price of the company. Roger Martin wrote this in his book ” Fixing the Game “: What would lead [a CEO] to do the hard, long-term work of substantially improving real-market performance when she can choose to work on simply raising expectations instead? Even if she has a performance bonus tied to real-market metrics, the size of that bonus now typically pales in comparison with the size of her stock-based incentives. Expectations are where the money is. And of course, improving real-market performance is the hardest and slowest way to increase expectations from the existing level. Invest with People Focused on Customers, Not Stock Prices The problem with short-term stock price maximization is that it’s not particularly difficult. If a company has a big market share, or if it’s difficult for the customer to switch away from the company’s product, or if the customer lacks the knowledge of better options, it’s easy for the company to hurt its customers on the way to boosting what the shareholders say they want. So, it’s not difficult for Nestle ( OTCPK:NSRGY , OTCPK:NSRGF ) to be casual about what its super-branded food products contain (thanks to its large market share), or for Indian Railways to provide sub-standard travel experience (customers don’t easily switch), or for financial services companies to mis-sell bad products (customers lack knowledge about good products). But just because it works doesn’t mean that they should be doing it to maximize short-term profits, and in many cases, their stock prices. Contrast this with what Jeff Bezos and Larry Page are doing at Amazon (NASDAQ: AMZN ) and Alphabet ( GOOG , GOOGL ) respectively – focusing only, and only, on the customer. The reason they have created so much wealth for their shareholders is because they never cared about shareholder value maximization, but only about customer satisfaction. Consider the Purpose Statement of Procter & Gamble (NYSE: PG ) (emphasis mine) : We will provide branded products and services of superior quality and value that improve the lives of the world’s consumers, now and for generations to come. As a result , consumers will reward us with leadership sales, profit and value creation, allowing our people, our shareholders and the communities in which we live and work to prosper. For P&G, consumers come first and shareholder value naturally follows. As per the statement of purpose, if P&G gets things right for consumers, shareholders will be rewarded as a result. This, I am sure, has also been the mantra of India’s biggest long-term wealth creators like HDFC (NYSE: HDB ), Asian Paints ( OTC:ASNQY ), Sun Pharma ( OTC:SMPQY ), Infosys (NYSE: INFY ), and Wipro (NYSE: WIT ). They have created tremendous shareholder wealth as a result of their focus on their customers and building their business for the long term, and not the other way round. This is how you can also find a few of the future wealth creators – businesses where managements are not focused on shareholder wealth creation, but treat it just as a byproduct of delighting its customers, employees, and the society at large. Such are the businesses where you will find long-term sustainable moats. Every other moat – especially if it appears a lot on business television, is worshipped by everyone around, and where the management often touts its shareholder-friendliness – is often fleeting. “Mr. Market suffers from incurable emotional problems,” Ben Graham wrote while describing the daily madness of stock price movements. Why would you want to partner with business managers who focus on managing these incurable problems of Mr. Market, rather than minding their business?

Focusing On Revenue Is A Great Idea! But Do Not Forget About Stabilized Profit

I was feeling a bit sick this morning, so I stayed in bed and turned on CNBC. I NEVER watch CNBC, unless I am at home in bed sick. And it usually makes me feel worse. They were interviewing Reed Hastings, the CEO of Netflix (NASDAQ: NFLX ), who has clearly done a great job guiding that company. In 2005, Netflix did $682 million in revenue, and this past year, it did $5.5 billion in revenue. Quite an accomplishment. Yes, there are a lot of competitors out there, but he has clearly done a great job. So he was talking about how having negative free cash flow and very low profit is proof that the company is in this for the long run, and he is 100% correct. We are actually starting to operate our business the same way, as I said in a previous post about Dell’s new approach to growth. And this is exactly what you would want to see as an investor. HOWEVER, the problem with this is that most investors are not smart enough to do the trickle-down analysis of what this means. Amazon (NASDAQ: AMZN ) has the same issue, and it’s something I have lamented about over and over. What a good investor SHOULD do is analyze what the company would have made had it not reinvested. What would there profit be if the company stopped reinvesting and just operated normally for normal growth? That is exactly what you need to do to analyze the value of a business. Because at the end of the day, what is happening now is that with no profit and negative free cash flow, an investor’s eyes are growing wider and wider saying “The profit potential is infinite!” Clearly, it’s not infinite. Clearly, a company with $100 billion in revenue can’t make more than $100 billion in profit, which is also impossible. If Netflix, on a normalized basis, has 15% in profit, its $5.5 billion in revenue would lead to around $825 million in bottom line profit, and at 20 times earnings – which is high based on history, but we will give it that due to just me being overly optimistic – that’s a valuation of $16.5 billion. Now, I am not saying that its profit margin is 15%, because I know it to be. I am purely speculating. But Netflix is currently selling for a valuation of $47 billion. Hmmm. So, based on 20 times earnings, that’s a bottom line profit of $2.35 billion, which is over 42% margin. Not likely. The same goes with Amazon. In the company’s best year ever, it did 3.5% or so in bottom line profit margin. This last quarter, it made $75 million after making $500 million on its cloud-based AWS business, and that was on total revenue of over $25 billion. Not exactly something that I deem to be worth more than Wal-Mart (NYSE: WMT ), which has almost $500 billion revenue per year. Either way, the point is that valuing something today for future potential is fine, but you also have to be realistic about it and realize that you have to let things grow into what you hope them to be, without overpaying today for that. Make realistic assumptions about their profit margins based on other businesses in their markets and their gross margins. It’s too easy to get stuck in a market like this assuming the best will happen, since it has for the last 6 years. It is a game of musical chairs, and when the music stops – which it will – don’t be caught looking for a seat.

Best-Performing No Load Mutual Funds In Q3 Of 2015

It is always best to get the most out of one’s invested capital. One way of doing it is by cutting down on the expenses that investors have to bear for owning or selling mutual funds. So, buying funds that carry no sales is the best option. Sales loads are one-time fees that investors pay either at the time of purchase or when units are redeemed. The importance of sales load was all the more felt in the third quarter, when the key benchmarks posted their worst quarterly performance in four years. Just 17% of the mutual funds managed to finish in the green in the third quarter. This was a slump from 41% in the second quarter, which was again a sharp fall from 87% of the funds ending in the positive territory in the first quarter. Separately, a JPMorgan equity strategy note revealed that 67% of mutual funds underperformed their benchmarks in the third quarter. Around 34% of the funds underperformed their peers by a minimum of 250 basis points. The Dow, S&P 500 and Nasdaq declined 7.6%, 7% and 7.4%, respectively. In such torrid times, the list of best-gaining mutual funds for the quarter is dominated by no load mutual funds. Robust gains were restricted to Bear Market funds in the third quarter, and were followed by modest gains in other categories. However, the no load funds were unfazed, as they had enough representation in most of the categories. Among the top 100 performers in the third quarter, 85 funds carried no sales load. The best-performing fund in the quarter, ProFunds UltraShort Latin America Fund Inv (MUTF: UFPIX ), gained 67.1%, and needless to mention, it is a no load mutual fund. Comparative Study: No Load Funds’ Q3 Show Out of the 15,129 no load funds we studied, 2, 316 funds posted positive returns in the third quarter. The average gain for these funds came at 1.6%. Among the top 100 performers, the average gain was a significant 12.9%. This is a quite a feat for the top 100 funds that almost reached the top-performing category Bear Market’s quarterly gain of 13.1%. It was followed by Long Government and Long-Term Bond categories’ gains of respectively 4.3% and 1.7%. The disparity in gains among the categories is indicative of how tough a quarter it was for funds. The average gain for the top 100 no load funds in the second quarter was 8.9%. The average gain of the top 100 no load funds also outperformed the average 4.1% gain of the top 100 funds that carry sales load. The load-adjusted return for these funds would again bring down the 4.1% average return. Moreover, the best-performing no-load fund’s quarterly gain of 67.1% far outpaced the top-performing fund with sales load, Rydex Inverse Emerging Markets 2X Strategy Fund A (MUTF: RYWWX ), which gained 43%. RYWWX carries a maximum front-end sales load of 4.75%. (Note: These numbers include same mutual funds of varied classes) Top 15 No-Load Mutual Fund Performers Below we present the top 15 no load mutual funds with the best returns in 3Q of 2015: Fund Name Objective Description Q3 Total Return Q3% Rank vs. Obj. YTD Total Return % Yield Expense Ratio Minimum Initial Investment ($) Beta vs. S&P 500 Rydex Invr Emerging Mrkts 2X Str H Foreign 43.03 1 37.47 0 1.73 2500 -0.27 Rydex Inverse Russell 2000 2x Strat H Growth 24.5 1 8.81 0 1.82 2500 -2.4 Rydex Inverse Russell 2000 Strat H Growth 11.99 1 5.09 0 1.7 2500 -1.2 Rydex Inverse Dow 2X H Agg Growth 11.6 2 8.14 0 1.84 2500 -2.16 Rydex Inverse S&P 500 2x Str H Growth 10.24 1 5.08 0 1.77 2500 -2.02 Gabelli Comstock Capital Value AAA Flexible 10.05 1 3.3 0 2.42 1000 -0.96 Federated Prudent Bear C Growth 7.93 1 0.49 0 2.51 1500 -0.73 Rydex Inverse Mid Cap Strategy H Growth 7.86 1 2.42 0 1.65 2500 -0.97 ATAC Inflation Rotation Investor AssetAlloc 7.33 1 11.69 0.32 1.74 2500 -0.03 Arrow Managed Future Trend C AssetAlloc 7.22 1 4.09 0 2.91 5000 0.19 Rydex Govt Long Bond 1.2x Str Inv Government 6.8 1 -2.16 1.08 0.95 2500 -0.1 GAMCO Mathers Fund AAA Flexible 6.12 2 1.71 0 4.6 1000 -0.53 Fidelity Spartan Long Treas Inv Government 5.49 1 — 2.55 0.2 2500 -0.06 Goldman Sachs Managed Futures C AssetAlloc 5.46 1 12.27 0 2.26 1000 -0.07 Vanguard Long-Term Treasury Inv Government 5.44 2 0.08 2.63 0.2 3000 -0.04 Note: The list excludes the same funds with different classes, and institutional funds have been excluded. Funds having minimum initial investment above $5000 have been excluded. Q3 % Rank vs. Objective* equals the percentage the fund falls among its peers. Here, 1 being the best and 99 being the worst. The top half of this list of 15 best-performing no load mutual funds is dominated by funds that employ the short-selling or inverse strategy. Top performer, Rydex Inverse Emerging Markets 2X Strategy Fund A, seeks a return that is 200% of the inverse daily performance of the BNY Mellon Emerging Markets 50 ADR Index. RYWYX, however, now carries a Zacks Mutual Fund Rank #4 (Sell) . Similarly, the next four funds in the list, Rydex Inverse Russell 2000 2x Strat H, Rydex Inverse Russell 2000 Strat H, and Rydex Inverse Dow 2X H, Rydex Inverse S&P 500 2x Str H seek inverse returns. Funds from the Government Bond category also had a decent representation in this list of best gainers. Remember, this category was the second-best gainer among fund categories in the third quarter, according to Morningstar data. Rydex Government Long Bond 1.2x Strategy Fund Inv (MUTF: RYGBX ), Fidelity Spartan Long Term Trust Bond Index Fund Inv (MUTF: FLBIX ) and Vanguard Long Term Treasury Fund Inv (MUTF: VUSTX ) posted gains of 6.8%, 5.5% and 5.4%, respectively. Each of these three funds carries a Zacks Mutual Fund Rank #1 (Strong Buy) . Separately, ATAC Inflation Rotation Fund Inv (MUTF: ATACX ) and GAMCO Mathers Fund No Load (MUTF: MATRX ), which posted respective gains of 7.3% and 6.1%, carry a Zacks Mutual Fund Rank #3 (Hold) each. The best-performing RYWYX’s gain of over 43% was substantially higher than the second-quarter top scorer Matthews China Dividend Fund Inv ‘s (MUTF: MCDFX ) gain of 14.7%. However, while we have nine funds this time with sub 10% total return, only six had ended below 10% in the second quarter’s top performer list. Also, the lowest gain in the third quarter list of 5.4% compares unfavorably with the second quarter’s 15th-ranked Emerald Banking and Finance Fund Inv ‘s (MUTF: FFBFX ) gain of 8.2%. Original Post