4 Myths and 1 Truth About Investing

by | Oct 18, 2012 | Investing, Trends

Today is the 25th anniversary of the 1987 stock market crash that saw the worst ever one-day percentage decline on Wall Street.  Worse even than during the Great Depression.  It’s a reminder that the market has had several October “crashes;” not only 1929 and 1987 but 1989, 1998, 2001 and 2007.

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For some people this serves as a reminder to invest very, very cautiously.  For others it is seen as market hiccups that present buying opportunities. For many it is an admonition to follow the investing advice of Mark Twain (although often attributed to Will Rogers) and pay more attention to the return of your money than the return on your money.

I’ve been investing for 30 years, and like most people I did it pretty badly.  For the first 20 years the annual review with my Merrill Lynch stock broker sounded like “Kent, why is it I’m paying fees to you, yet would have done better if I simply bought the Dow Jones Industrial Average?”  Across 20 years, almost every year, my “managed” account did more poorly than this collection of big, largely dull, corporations.

A decade ago I dropped my broker, changed my approach, and things have gone much, much better.  Simply put I realized that everything I had been taught about investing, including my MBA, assured I would have, at best, returns no better than the overall market.  If I used the collective wisdom, I was destined to perform no better than the collective market.  Duh.  And that is if I remained unemotional and disciplined – which I didn’t assuring I would do worse than the collective market!

Remember, I am not a licensed financial advisor.  Below are the insights upon which I based my new investing philosophy.   First, the 4 myths that I think steered me wrong, and then the 1 thing that has produced above-average returns, consistently.

Myth 1 – Equities are Risky

Somewhere, somebody came up with a fancy notion that physical things – like buildings – are less risky than financial assets like equities in corporations.  Every homeowner in America now knows this is untrue.  As does anybody who owns a car, or tractor or even a strip mall or manufacturing plant.  Markets shift, and land and buildings – or equipment – can lose value amazingly quickly in a globally competitive world.

The best thing about equities is they can adapt to markets.  A smart CEO leading a smart company can change strategy, and investments, overnight.  Flexible, adaptable supply chains and distribution channels reduce the risk of ownership, while creating ongoing value.  So equities can be the least risky investment option, if you keep yourself flexible and invest in flexible companies.

Hand-in-glove with this is recognizing that the best equities are not steeped in physical assets.  Lots of land, buildings and equipment locks-in the P&L costs, even though competitors can obsolete those assets very quickly.  And costs remain locked-in even though competition drives down prices.  So investing in companies with lots of “hard” assets is riskier than investing in companies where the value lies in intellectual capital and flexibility.

Myth 2 – Invest Only In What You Know

This is profoundly ridiculous.  We are humans.  There is infinitely more we don’t know than what we do know.  If we invest only in what we know we become horrifically non-diversified.  And worse, just because we know something does not mean it is able to produce good returns – for anybody!

This was the mantra Warren Buffet used to turn down a chance to invest in Microsoft in 1980.  Oops. Not that Berkshire Hathaway didn’t find other investments, but that sure was an easy one Mr. Buffett missed.

To invest smartly I don’t need to know a lot more than the really important trends.  I don’t have to know electrical engineering, software engineering or be
an IT professional to understand that the desire to use digital mobile
products, and networks, is growing.  I don’t have to be a bio-engineer to know that pharmaceutical solutions are coming very infrequently now, and the future is all in genetic developments and bio-engineered solutions.  I don’t have to be a retail expert to know that the market for on-line sales is growing at a double digit rate, while brick-and-mortar retail is becoming a no-growth, dog-eat-margin competitive world (with all those buildings – see Myth 1 again.)  I don’t have to be a utility expert to know that nobody wants a nuclear or coal plant nearby, so alternatives will be the long-term answer.

Investing in trends has a much, much higher probability of making good returns than investing in things that are not on major trends.  Investing in what we know would leave most people broke; because lots of businesses have more competition than growth.  Investing in businesses that are developing major trends puts the wind at your back, and puts time on your side for eventually making high returns.

Oh, and there are a lot fewer companies that invest in trends.  So I don’t have to study nearly as many to figure out which have the best investment options, solutions and leadership.

Myth 3 – Dividends Are Important to Valuation

Dividends (or stock buybacks) are the admission of management that they don’t have anything high value into which they can invest, so they are giving me the money.  But I am an investor.  I don’t need them to give me money, I am giving them money so they will invest it to earn a rate of return higher than I can get on my own.  Dividends are the opposite of what I want.

High dividends are required of some investments – like Real Estate Investment Trusts – which must return a percentage of cash flow to investors.  But for everyone else, dividends (or stock buybacks) are used to manipulate the stock price in the short-term, at the expense of long-term value creation.

To make better than average returns we should invest in companies that have so many high return investment opportunities (on major trends) that the company really, really needs the cash.  We invest in the company, which is a conduit for investing in high-return projects.  Not paying a dividend.

Myth 4 – Long Term Investors Do Best By Purchasing an Index (or Giant Portfolio)

Stock Index chart 10.20.12

Go back to my introductory paragraphs.  Saying you do best by doing average isn’t saying much, is it?  And, honestly, average hasn’t been that good the last decade.  And index investing leaves you completely vulnerable to the kind of “crashes” leading to this article – something every investor would like to avoid.  Nobody invests to win sometimes, and lose sometimes. You want to avoid crashes, and make good rates of return.

Investors want winners.  And investing in an index means you own total dogs – companies that almost nobody thinks will ever be competitive again – like Sears, HP, GM, Research in Motion (RIM), Sprint, Nokia, etc. You would only do that if you really had no idea what you are doing.

If you are buying an index, perhaps you should reconsider investing in equities altogether, and instead go buy a new car. You aren’t really investing, you are just buying a hodge-podge of stuff that has no relationship to trends or value cration. If you can’t invest in winners, should you be an investor?

1 Truth – Growing Companies Create Value

Not all companies are great.  Really.  Actually, most are far from great, simply trying to get by, doing what they’ve always done and hoping, somehow, the world comes back around to what it was like when they had high returns.  There is no reason to own those companies.  Hope is not a good investment theory.

Some companies are magnificent manipulators.  They are in so many markets you have no idea what they do, or where they do it, and it is impossible to figure out their markets or growth.  They buy and sell businesses, constantly confusing investors (like Kraft and Abbott.)  They use money to buy shares trying to manipulate the EPS and P/E multiple.  But they don’t grow, because their acquired revenues cost too much when bought, and have insufficient margin.

Most CEOs, especially if they have a background in finance, are experts at this game.  Good for executive compensation, but not much good for investors.  If the company looks like an acquisition whore, or is in confusing markets, and has little organic growth there is no reason to own it.

Companies that are developing major trends create growth.  They generate internal projects which bring them more customers, higher share of wallet with their customers, and create new markets for new revenues where they have few, if any competition.  By investing in trends they keep changing the marketplace, and the competition, giving them more opportunities to sell more, and generate higher margins.

Growing companies apply new technologies and new business practices to innovate new solutions solving new needs, and better solve old needs.  They don’t compete head-on in gladiator style, lowering margins as they desperately seek share while cutting costs that kills innovation.  Instead they ferret out new solutions which give them a unique market proposition, and allow them to produce lots of cash for adding to my cash in order to invest in even more new market opportunities.

If you had used these 4 myths, and 1 truth, what would your investments have been like since the year 2000?  Rather than an index, or a manufacturer like GE, you would have bought Apple and Google. Remember, if you want to make money as an investor it’s not about how many equities you own, but rather owning equities that grow.

Growth hides a multitude of sins.  If a company has high growth investors don’t care about free lunches for workers, private company planes, free iPhones for employees or even the CEO’s compensation.  They aren’t trying to figure out if some acquisition is accretive, or if the desired synergies are findable for lowering cost. None of that matters if there is ample growth.

What an investor should care about, more than anything else, is whether or not there are a slew of new projects in the pipeline to keep fueling the growth. And if those projects are pursuing major trends.  Keep your eye on that prize, and you just might avoid any future market crashes while improving your investment returns.

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Waiting for the economy? That won’t work.

by | Feb 24, 2010 | Current Affairs, Food and Drink, General, Leadership

Every day it seems someone tells me they "are looking forward to an improved economy."  When I ask "Why?" they give me a horrified look like I must be stupid.  "Because I want my business to improve" is the most frequent answer.  To which I ask "What makes you think an improved economy will help you?"

This recession/depression is the result of several market shifts.  What people/businesses want, and how they want it, has changed.  They no longer are willing to part for hard earned (and often saved) dollars for the same solutions they once purchased.  They want advances in technology, manufacturing processes, communications and all aspects of business to give them different solutions.  Until that comes along, they are willing to put money in the bank and simply wait.

Take for example restaurants.  Many owners and operators are complaining business was horrid in 2009, and still far from the way it was years ago.  And regularly we hear it is due to "the recession.  People fear they'll lose their jobs, so they don't eat out as often."  Nicely said.  Sounds logical. Makes for a convenient excuse for lousy results. 

Only it's wrong.

In "Dinner out Declines:  Economy Not Sole Factor" MediaPost.com does a great overview of the fact that dining out started declining in 2001, and has steadily been on a downward trend.  Across all age groups, eating out is simply less interesting – at least at current prices.  When the recession came along, it simply accelerated an existing trend.  Increasingly, people were less satisfied with cookie-cutter, similar establishments that had similar food (almost all of which was prepared somewhere else and merely heated and combined in the restaurant) and exorbitant drink prices.  For years restaurant prices had outpaced inflation, and simultaneously family changes – along with the growth of better prepared foods at grocers and specialty markets – was enticing people to eat at home.

This is true across almost all industries.  A revived economy will not increase demand for land-line phone service.  Nor for large V-8 American autos costing $60,000.  Nor for newspapers, or magazines – or even books most likely. Or for oversized homes that cost too much to heat and cool.   In fact, it was the trend away from these products which caused the recession.  People simply had all of these things they wanted, so they stopped buying.  Fearful of economic change, they simply accelerated a trend brought on by shifts in technology and underlying ways of doing things.  When we once again talk about better economic growth in America it will not drive people to these purchases.  Rather, people will be buying different things.

For the recession to go away requires a change in inputs.  Providers have to start giving buyers what they want.  They have to understand market needs, and give solutions which entice people to part with their money.  Waiting for "the economy" will make no difference.  Government stimulus can go on forever, but it won't create growth.  It can't.  Only new products and services that fulfill needs create growth.  That will cause spending (demand), which generates the requirement for supply.

There are companies that had a great 2009. Google, Apple and Amazon are popular names.  Why?  Not just because they are somehow "tech" or "internet" companies.  2009 saw the demise of Sun Microsystems and Silicon Graphics, for example.   The difference is these companies are studying the market, looking to the future and introducing new products and services which meet market needs.  Because of this, they are growing.  They are doing their part to revitalize the economy.  Not with stimulus, but with products that excite people to part with their cash.

Those who are waiting on the economy to improve are destined to find a rough road.  An improving economy will be full of new competitors with new solutions who did not wait.  To be a winner businesses today must be bringing forward new products and services that meet today's needs – not yesterday's.  And if we start getting winners then we will climb out of this economic foxhole.

New Decade – New Normal

by | Dec 31, 2009 | Current Affairs, Defend & Extend, General, Leadership, Openness, Web/Tech

HAPPY NEW YEAR!

We end the first decade in 2000 with another first.  In ReutersBreakingViews.com "Don't Diss the Dividend" we learn 2000-2009 is the first time in modern stock markets when U.S. investors made no money for a decade.  Right.  Worse performance than the 1930s Great Depression.  Over the last decade, the S&P 500 had a net loss of about 1%/year.  After dividends a gain of 1% – less than half the average inflation rate of 2.5%. 

Things have shifted.  We ended the last millenium with a shift from an industrial economy to an information economy.  And the tools for success in earlier times no longer work.  Scale economies and entry barriers are elusive, and unable to produce "sustainable competitive advantage."  Over the last decade shifts in business have bankrupted GM, Circuit City and Tribune Corporation – while gutting other major companies like Sears.  Simultaneously these changes brought huge growth and success to Google, Apple, Hewlett Packard, Virgin and small companies like Louis Glunz Beer, Foulds Pasta and Tasty Catering.

Even the erudite McKinsey Quarterly is now trumpeting the new requirements for business success in "Competing through Organizational Agility."  Using academic research from the London Business School, author Donald Sull points out that market turbulence increased 2 to 4 times between the 1970s and 1990s – and is continuing to increase.  More market change is happening, and market changes are happening faster.  Thus, creating strategies and organizations that are able to adjust to shifting market requirements creates higher revenue and improved operational efficiency.  Globally agility is creating better returns than any other business approach. 

A McKinsey Quarterly on-line video "Navigating the New Normal:  A Conversation with 4 Chief Strategy Officers," discusses changes in business requirements for 2010 and beyond.  All 4 of these big company strategists agree that success now requires far shorter planning cycles, abandoning efforts to predict markets that change too quickly, and recognizing that historically indisputable assumptions are rapidly becoming obsolete.  What used to work at creating competitive advantage no longer works.  Monolothic strategies developed every few years, with organizations focused on "execution," are simply uncompetitive in a rapidly shifting world.

And "the old boys club" of white men in top business leadership roles is quickly going to change dramatically.  In the Economist article "We Did It" we learn that in 2010 the American workforce will shift to more than 50% women.  If current leaders continue following old approaches – and generating anemic returns – they will rapidly be replaced by leaders willing to do what has to be done to succeed in today's marketplace.  Like Indra Nooyi of PepsiCo, women will take on more top positions as investors and employees demand changes to improve performance.   Leaders will have to be flexible and adaptive or they, and their organizations, will not survive.

Additionally, the information technology products which unleashed this new era will change, and become unavoidable.  In Forbes "Using the Cloud for Business" one of the creators of modern ERP (enterprise resource planning) systems (like SAP and Oracle) Jan Baan discusses how cloud computing changes business.  ERP systems were all about data, and the applications were stovepiped – like the industrial enterprises they were designed for.  Unfortunately, they were expensive to buy and very expensive to install and even more expensive to maintain.  Simultaneously they had all the flexibility of cement.  ERP systems, which proliferate in large companies today, were control products intended to keep the organization from doing anything beyond its historical Success Formula.

But cloud computing is infinitely flexible.  Compare Facebook to Lotus Notes and you start understanding the difference between cloud computing and large systems.  Anyone can connect, share links, share files and even applications on Facebook at almost no cost.  Lotus Notes is an expensive enterprise application that costs a lot to buy, to operate, to maintain and has significantly less flexibility.  Notes is about control.  Facebook is about productivity.

Cloud computing is 1/10th the cost of monolithic owned/internal IT systems.  Cloud computing offers small and mid-sized companies all the computing opportunity of big companies – and big advantages to new competitors if CIOs at big companies hold onto their "investments" in IT systems too long.  Businesses that use cloud architectures can rearrange their supply chain immediately – and daily.  Flexibility, and adaptability, grows exponentially.  And EVERYONE can use it.  Where mainframes were the tool for software engineers (and untouchable by everyone else), the PC made it possible for individuals to have their own applications.  Cloud computing democratizes computing so everyone with a smartphone has access and use.  With practically no training.

As we leave the worst business environment in modern times, we enter a new normal.  Those who try to defend & extend old business practices will continue to suffer  declining returns, poor performance and failure – like the last decade.  But those who embrace "the new normal" can grow and prosper.  It takes a willingness to let scenarios about the future drive your behavior, a keen focus on competitors to understand market needs, a willingness to disrupt old Lock-ins and implement White Space so you can constantly test opportunities for defining new, flexible and higher returning Success Formulas.

Here's to 2010 and the new normal!  Happy New Year!

Scenarios are so important – Dubai World debt crisis

by | Nov 27, 2009 | Current Affairs, General

So while most Americans are taking the traditional 4 day Thanksgiving holiday another debt crisis has emerged.  Easy enough for most Americans to miss the news, if only because they are vacationing or shopping.  But this debt crisis involves a company in a foreign land, so most Americans will say "Why should I even care?  This doesn't involve my bank."  That Dubai World looks to be unwilling to repay some of its debt, and will make no payments for 6 months, could be something a lot of Americans simply ignore – if for no reason than they simply can't link it to their work or life.

Dubai World is a very large real estate developer, owned by the Dubai government.  The banks that loaned Dubai World billions were more European than American.  Yet, we live in a global economy.  When things happen elsewhere, they have an impact on U.S. businesses and citizens.

American companies depend upon international banks to make local currency loans for their offshore operations.  And American companies depend upon businesses, and individuals, in foreign countries to borrow money in order to spend on American company goods.  With the U.S. economy in the doldrums, companies that have robust offshore businesses selling to people in the foreign markets have done considerably better than most U.S. focused companies.  But when these offshore banks don't get paid by Dubai World, they have to take write-downs.  And if they don't get payments, the bank's reserves dwindle.  As a result, these banks can't make loans – just like we've had happening in the USA since Bank of America, Citibank, etc. almost collapsed – due significantly to large real estate loan defaults.

Additionally, the U.S. government depends upon offshore entities – banks, businesses and individuals – to buy U.S. bonds.  Without offshore buyers, the U.S. government could not fund its recurring debts.  When a big corporation like Dubai World, part of a government backed with oil money, runs out of cash it causes a chain reaction of people not making loans.  Not investing.  And that can have a big impact on U.S. bond sales.  When the government can't sell bonds it has to increase the interest rate – which spells a worse economy or inflation.  So scared debt investors can have a quick impact on U.S. interest rates – because when U.S. Treasury bond rates go up all other rates, from municipal bonds to commercial loan rates to car loans, have to go up as well.

And this is why everyone needs to know about, and pay attention to, a big real estate developer in Dubai "restructuring" its debt and stopping payments.  In a global economy, the impact will be felt by Americans. 

  • This action can further exacerbate real estate price deflation – a major cause of economic weakness and wealth destruction globally.
  • If foreigners buy more stuff, Americans who sell this stuff will see lower sales – and that leads to less employment.
  • The debt collapse in America is causing huge problems for small and medium-sized companies to stay in business.  European banks trimming their loans will have similar negative impact on smaller businesses in many countries rolling-up to substantially larger population than America.
  • Higher interest rates further dampen any American recovery.
  • This could lead to less money available for lending in the USA, and a lot of additional lost jobs.

Scenario planning is not about predicting a collapse of Dubai World.  It's impossible to forecast such specific events with any accuracy.  But that doesn't mean U.S. companies shouldn't be spending a lot more energy thinking about global impacts on their business.  What happens by central banks, big companies and even real estate developers around the globe is important.  In prior years, when these collapses happened (Mexico, Korea, Japan) the USA stepped in to stop the collapse from cascading.  But the U.S. government is no longer in position to thwart future declines. 

It's important all companies undertake scenario plans that consider the impact of higher international interest rates, changes in currency valuations, import/export restrictions or tariffs and country-by-country unemployment rates.  Our businesses are increasingly dependent upon offshore companies as our suppliers, customers and investors.  If your scenario plans aren't considering the impact of global changes, like the disaster now happening to European banks, you may well find yourself  wondering what hit you in 2, 4 or 6 months when the impact hits home.

Call to Action – Why we have to change

by | Jul 31, 2009 | Current Affairs, Defend & Extend, General, In the Swamp, Innovation, Lock-in

"Deeper Recession Than We Thought" is the Marketwatch headline.  As government data reporters often do, today they revised the economic numbers for 2008.  We now know the start to this recession was twice as bad as reported.  The 3.9% decline was the worst economic performance since the Great Depression of the 1930s.  The consumer spending decline was the worst since 1951 (58 years – a very low percentage of those employed today were even born then.)  Business investment dropped a full 20%.  Residential investment dropped 27%.  Stark numbers.

How did business people react?  Exactly as they were trained to react.  They cut costs.  Layed people off.  Dropped new products.  Stopped R&D and product development.  They quit doing things.  What's the impact?  The decline slows, but it continues.  Just like growth begets growth, cutting begets more decline. 

Then really interesting bad things happen. 

"ComEd loses customers for first time in 56 years" is the Crain's headline.  There are 17,000 fewer locations buying electricity in the greater Chicago area than there were a year ago.  That is amazing.  When you see new homes being built, and new commercial buildings, the very notion that the number of electricity customers contracted is hard to fathom.  People aren't even keeping the lights on any more.  They've gone away.

In the old days we said "go west."  But that hasn't been the case.  Everyone remembers the dot.com bust ending the 1990s.  "Silicon Valley Unemployment Skyrockets" is the Silican Alley Insider lead.  Today unemployment in silicon valley is the highest on record – even higher than the dot bust days.  When even tech jobs are at a nadir, it's clear something is very different this time. 

The old approaches to dealing with a recession aren't working.  While optimism is always high, what we can see is that things have shifted.  The world isn't like it was before.  And applying the same approaches won't yield improved results.  "For Illinois, recession looking milder – but recovery weaker" is another Crain's headline.  Nowhere are there signs of a robust economy.

We can't expect an economic recovery on "Cars for Cash" or "Clunker" programs.  By overpaying for outdated and obsolete cars we can bring forward some purchases.  But this does not build a healthy market for ongoing purchases.  These programs aren't innovation that promotes purchase.  They are a subsidy to a lucky few so they pay significantly less for an existing product.  To recover we must have real growth.  Growth from new products that meet new customer needs in new ways.  Growth built on providing solutions that advantage the buyer.  Only by introducing innovation, and creating value, will customers (businesses or consumer) open their wallets. 

Advertising hasn't disappeared.  But it has gone on-line.  Today you don't have to spend as much to reach your target.  Instead of mass advertising to 1,000 in order to reach the 100 (or 15) you really want, today you can target that buyer through the web and deliver them an advertisement far cheaper.  I didn't learn about Cash for Clunkers from a TV ad, I learned about it on the web.  As did thousands of people that rushed out to take advantage of the program at its introduction – exceeding expectations.  It no longer takes inefficient mass advertising through newspapers or broadcast TV to reach customers – so that market shrinks.  But the market for on-line ads will grow. So Google grows – double digit growth – while the old advertising media keeps shrinking.  To get the economy growing businesses (like Tribune Corporation) have to shift into these new markets, and provide new products and services that help them grow.

I live in Chicago.  Years ago, in the days of The Jungle Chicago grew as an agricultural center. There was a time the West Side of Chicago was known for its smelly stockyards and slaughter houses.  But Chicago  watched its agricultural companies move away.  They moved closer to the farms.  They were replaced by steel mills in places like Gary, IN and Chicago's south side.  But those too shut down, moved to lower cost locations offshore.  These businesses were replaced with assembly plants, like the famous AT&T Hawthorne facility, and manufacturers such as machine tool makers.  Now, for the last decade, these too have been moving away.  With each wave, the less valuable work, the more menial work, shifted to another location where it could be done as good but cheaper and often faster. 

Historically growth continued by replacing those jobs with work tied to the shifting market – jobs that provided more value.  So now, for Chicago to grow it MUST create information jobs.  The market has moved.  Kraft won't regain its glory if it keeps trying to sell more Velveeta.  Kraft has not launched a major new product in over 9 years.  Sara Lee has been shedding businesses and cutting costs for 6 years – getting smaller and losing value.  McDonalds sold its high growth business Chipotles to raise money for defending its hamburger stores by adding new coffee machines.  Motorola has let mobile telephony move to competitors as it remained too Locked-in to old technologies and old products while new companies – like Apple and RIM – brought out innovations that attracted new customes and growth. 

Growth doesn't come from waiting for the economy to improve.  Growth comes from implementing innovation that gives us new solutions.  Every market, whether geographic or product based, requires new solutions to maintain growth.  If we want our economy to improve, we must change our approach.  We can't save our way to prosperity.  Instead we must create solutions that fit future scenarios, introduce new solutions that Disrupt old patterns and use White Space to help customers shift to these products.

If we change our approach we can regain growth.  Otherwise, we can expect to keep getting what we got in 2008.