I was in a heated argument this week with a stock broker. His claim was that all anyone should care about is earnings. I told him that was not true. In fact, what is most important to investors is the business growth which can lead to future cash flow.
Take WalMart for example. The company has continued to grow it’s EPS the last few years, but the stock has been mired in a trading range over the same period (see chart here). Why doesn’t WalMart stock price go up with earnings? Why does the price/earnings multiple decline? Because investors are very unsure how the existing management team will ever grow the business as it previously did, given that efforts to expand in Europe, South America and China have fallen flat. Wal-Mart is now trying to cut costs and buy back its stock in an effort to dress up earnings per share, but investors aren’t fooled as they see all the problems WalMart has faced and how the company’s old Success Formula simply isn’t as competitive any longer.
Or take a look at Tribune Company (see chart here). Just a few months ago Tribune announced it was repurchasing all its equity via a Sam Zell led leveraged buy-out, But recently the stock has fallen below the repurchase price. Investors have been made aware of how the management team manipulated earnings and cash flow last year to "dress up the pig" for market, and there is now risk if the bonds can be sold to generate the cash to buy the remaining stock (see article here.) When there is no growth in the business, such as the no growth scenario at Tribune, even debt investors realize that they cannot expect a return on their investment.
Just a week ago I quoted in this blog a Merrill Lynch daily report by David Rosenberg to be careful and not confuse financial re-engineering with business building. Rosenberg went on to quote the New York Times this week "a raft of bond offerings for recently announced deals… have been scaled back after facing resistance from investors." And "the term ‘loan covenants’ is making its way back into the investment lexicon." (see source here page 2.) Within two days Rosenberg said "there was supposed to be a $250bln corporate bond pipeline in the next few months to fund all these deals that have been announced, but in a sign this is no longer an ‘issuers market’, many are being scaled back or postponed" (see source here, page 3).
If you don’t keep growing your business, your value cannot grow. No matter if you are public, or want to be private. You must have a Success Formula that meets competitive customer needs and keeps you in the Rapids. You can’t count on unthinking debt investors to give you money, hoping you will let them "clip coupons" as you lazily sit in the Flats. Investors are wisening up, and realizing that you have to keep your business in the Rapids of business growth to create value – or you quickly lose value. And no one wants to be stuck in a ship without a current of growth pushing it.