Financial Utilities

My friend B is a truly prescient guy. He's had an enviable career in various parts of the financial service industry, the details of which I will spare the reader, in deference to B's wish for continued anonymity. He still does some consulting, and values his public persona, vis a vis his rather more unvarnished candor with me.

I can vividly recall my phone call with him in early 1996, when I was the first Director of Research for Oliver, Wyman & Co., now the financial services consulting unit of Mercer Management Consulting. As I was sitting in the firm's computer room, watching over the crunching of some data on my large-scale study of what accounted for superior returns in financial services companies, B and I were discussing trends in the industry. He predicted that, henceforth, the money center banks of the day would conglomerate further into only 3-4 financial "utilities." By that he meant money center banks plus ancillary businesses- brokerage, asset management, and insurance. Or variants thereof.

Well, we're there now. With Citigroup as the vanguard of the then-illegal union of banking and securities businesses, there are now three roughly interchangeable giant financial utilities in the US: Citi, BofA, and Chase. BofA acquired MBNA, and Chase's merger with Banc One combined a huge chunk of midwestern bank assets with the second-largest New York City banking company.

In a recent exchange of phone calls and emails, B commented that in the most recent quarter, all three companies had similar results, proportionally, with likewise similar strong and weak unit performances. He wondered aloud whether we are now at a point where these financial utilities are essentially on autopilot, and need not really be "led" by anyone. In short, the CEOs have become largely irrelevant and interchangeable.

I think B is right. The current CEOs of Chase and Citi are very, very pale shadows of David Rockefeller and Walter Wriston, titans who led much more dynamic and unique institutions in their days. I don't even know offhand who runs BofA, but I see from its Yahoo profile page that it is indeed Ken Lewis, the surviving CEO of what was once, long ago, NCNB. Or First Union. I can't recall which of them eventually got BofA, and which is now "Wachovia."

Even the second-tier utilities are pretty similar as well. Conglomerations of what we used to call "regional" banks. Wells Fargo and Wachovia are all that remain of First Interstate, Security Pacific, First Bank System, Wachovia, and one of the two Charlotte-based banks that isn't now BofA.

To continue, B suggested I go check the market performance of the three major financial utilities to see if those performances, too, have become very similar. I did, and I think one would say, "yes," they are not so very different now.

The top of this post features a Yahoo-generated price chart for some 30 years, as a sort of long-term secular trend reference. While it is not, technically, a total return chart, the change in stock prices, assuming reasonably similar dividend policies, is close.

What I note from the very long term is that, distortions of compounding on very recent years aside, the performances of Chase and Citi have been nearly identical since 1995. Since roughly 1992, all three seem to perform similarly.

Very recently, Chase seems to have gained a bit more acceleration. But with the recent spate of acquisitions, it's not clear what the longer-term, steady-state performances will be.

Overall, though, I think my colleague B's observations and insights are correct. It really doesn't much matter who is at the helm of these utilities anymore. With a few exceptions, such as Citi's recent swap of asset management for a brokerage business, they are now subject to the same global and US forces, have similar business and asset bases, face similar raw material (i.e., money) and operating costs. And thus, I would be surprised if any of the three financial utilities, Citi, Chase and BofA, achieve consistently superior total returns in the future that none of them have attained in the past. It's not something one usually sees in diversified financial service firms alone, let alone 'this' diversified and gargantuan.

Chase Manhattan Bank: A Reunion

A little-known integration occurred this past year. When Banc One and Chase (ok, JP Morgan Chase) merged, two former Chase-executive-led pieces of banking were rejoined. Banc One contained, among its various components, the old First Chicago Bank.

A few years before I joined Chase Manhattan, in 1983, it experienced an internal conflict which, to judge from the then still-audible echoes, rivaled that of the English Reformation. Chase's eventual COO, Tom Labrecque, had marshalled support to defeat an opposing team of senior executives in order to claim the mantle of succession passed down from, and through, the legendary David Rockefeller. David's presence was still felt at the bank, if only as a guiding spirit. The losing faction, led by Barry Sullivan, departed to run First Chicago. As I was told, such was the animosity, that Sullivan's compensation package allegedly included the provision that he would be paid slightly more than whatever the CEO of Chase Manhattan was earning.

From a longer-term perspective, the re-integration of these two Chase management teams reinforces a lesson for me. Strategies, size and specific economic conditions notwithstanding, the split didn't really matter after all.

Now, those two asset bases, and much, much more, including the very large and also mediocre old Chemical and Manufacturers Hanover Banks, are all one larger group of unremarkably-managed assets and businesses. In the end, to this point, it didn't matter what route the businesses took, nor who ran them. A consolidating industry slammed them all together under ever more colorless and less strategically innovative management.

Thus, the observations of my friend and colleague, B (he still plies his trade in parts of the industry) have come to pass. A few very large, faceless, nearly-identical financial "utilities" now dominate the sector.

More on this in my next post.

WSJ's SmartMoney's Fuzzy Thinking

Efficiency. Effectiveness. Productivity. Oh, what the heck...does it matter which term we use?

Actually, it matters very much. As I first realized ten years ago, when I wrote a paper on the detailed relationships between these terms, their misuse has been the source of much bad thinking and writing in business publications.

This past Thursday, the Wall Street Journal featured its "SmartMoney Stock Screen" on page D3. The subtitle of the boxed piece was, "Efficiency Experts." It discussed how to use and interpret ROE for a company, alternately describing it as "managerial effectiveness," and "how efficiently its managers are using the plants, equipment and other resources...."

Well, it can't be both. So which is it?

I prefer to call ROE a "total factor productivity" measure. It can be deconstructed into labor productivity (Value Added/# Employees), operating efficiency (Net Income/Value Added), and Capital Intensity (# Employees/Equity). The benefit of this decomposition is to provide a view of the resources typically used by any business: people, capital, and expense dollars. Using value added removes the distorting effects of revenue attributed to a business that was, in fact, merely passed through as a purchase from a vendor.

Thus, ROE, or ROI, for that matter, as it was also mentioned in the WSJ article, may be interpreted as both total factor productivity measures, as well as simple equity or capital employed productivity measures.

I have found that efficiency typically refers to inputs. As such, what most economists and business writers call "efficiency," and measure with dollars/input unit, I find more sensibly called "volume efficiency" and measured with units/input unit. How a firm efficiently produces a product or service may be understood irrespective of the market-provided value of that product or service. I find this leads to clearer appreciation of the production efficiency issues typically under consideration when discussing "efficiency."

For labor productivity, I prefer value added divided by the number of employees, as this does provide a valuation measure for an input. The same is true for operating efficiency, which measures the productivity of expense dollars in producing a dollar of net income.

After much thinking and wrestling with the terms I found at hand in 1996, it became clear that more terms were needed, not fewer.

And certainly not a perspective that equates "efficiency" and "effectiveness." Good Lord! Can you get any fuzzier than that?

By the way, as is this deliberate, or, more sadly, unrecognized obfuscation was not sufficient, the writer, Jack Hough, concluded with the comforting sentence, "As always, please remember that stock screens produce research lists, not buy lists." What the heck does that mean? I just wasted my time reading his piece, only to find he really doesn't believe anything he just wrote? That he wants to publish his "research," but for God's sake, don't use it to actually, you know, buy a stock! Just mull it over, and talk about it at your next weekend dinner party.

No wonder the public is better-served by just buying managed funds, rather than individual stocks. With "help" like this, can you blame them?

Wal-Mart: Further Insights on Retail Brand Repositioning

Given the recent pieces I've written regarding Wal-Mart, and the piece I wrote back in September, I thought I'd check my thinking with a friend who has vast retail experience.

I ran into Bob two days ago at the squash club. Bob is a retired retail executive and consultant. He's worked for many major retailers, as well as consulted them and others. Plus he's older than me, which I like, because he remembers things of which I am not even aware.

When I queried him about "the wheel of retailing," retailers moving upmarket, and Wal-Mart, he was guarded in his remarks. Essentially, he feels that a retailer may, if they move very slowly, creep upmarket. But he was much less optimistic about doing so in a consistently profitable manner.

As I expected, he dwelt on the omnipresent risks in such a strategy of losing one's original market segment, especially when the move is on economic dimensions, rather than on, say, pure style or even product niche. He nodded vigorously when I suggested that maybe Les Wexner's Limited was a better example of how to reach new customer segments, via added brands, rather than repositioning your current one.

So, after that discussion, and from even the past two days' news concerning Wal-Mart's fears regarding inventory management, gasoline prices, and sales growth, I still feel comfortable with my comments in September of last year. I do not believe Wal-Mart will be able to successfully reposition itself by moving upmarket and perform with consistent profitability and consistently superior returns for shareholders.

That's my expectation, and I'm sticking to it.

Ayn Rand & CEO Compensation

The fever pitch of media frenzy concerning CEO compensation have brought a couple of new thoughts to my mind in the past day.

First, the entire topic has taken on a kind of Randian quality now. Witness yesterday's, and today's, prominent pieces in the Wall Street Journal focusing on Dr. William McGuire, CEO of the very successful UnitedHealth Group. Dr. McGuire is one of the few large-cap CEOs to have actually earned his considerable compensation, by consistently creating superior shareholder returns during his tenure. However, by yesterday afternoon, he was already giving an interview on CNBC, pointing out that he had recommended to his board that he and other senior executives have now earned 'enough,' and need no more options grants.

Does this not remind you of "Atlas Shrugged," wherein the masses enjoy the fruits of an inventive few, but demand to control how those value-creators are compensated? The WSJ article pinpointed the concern that, while many pay rising health care costs, the publicly-held UNG has chosen to pay, from its shareholders' pockets, very large amounts of compensation to Dr. McGuire for creating stunningly large amounts of shareholder value.

The nerve!!!!! That private individuals, in their role as common shareholders, should decide how to spend their own money! Can you imagine? Why, it smacks of....of..... capitalism!

It has crossed my mind frequently in the past few days that the obvious solution for this is going to be a marriage of successful companies and private equity. What if the masses, through political and regulatory intimidation, excessively constrain compensation for those who successfully perform the very difficult task of consistently earning superior total returns for large company shareholders? Would this not be an ideal situation for private equity owners to take such a firm out of public hands, compensate the CEO appropriately, and enjoy the subsequent shareholder returns split among fewer owners? Out of the public spotlight?

Ironically, the net result, taken to the extreme, could be fewer well-run firms left among public companies, thus denying "the masses" the opportunity to profit, as small shareholders in well-run large-cap firms. I do not think that is a healthy development for American capital markets, nor its economy in general. It strike me instead as a short-sighted, bone-headed move to encumber otherwise-competitive US corporations.

Why didn't the WSJ, in conjunction with some compensation 'experts,' instead spotlight the most over-compensated CEOs in the US, relative to the shareholder wealth they have created for the past 5-10 years? That is the real problem. Boards of underperforming companies which continue to pay their CEOs as if they are creating value, when they are not. But except for Alan Murray, in his column in today's WSJ, and in his appearance on CNBC, nobody else seems to really be focusing on this part of the problem.

Sadly, I'm afraid that Ayn Rand would be smiling at all this and nodding her head in understanding.

CEO Compensation- Again.....and again...

My partner was right. This topic just doesn't quit. This morning, CNBC coordinated with the Wall Street Journal to target the CEO of UnitedHealth Group, Bill McGuire. Dr. McGuire has commited the sin of having a board of directors who have now paid him options totalling in excess of $1.5 billion.

According to just the price charts alone, the company's stock has risen some 300% in the past five years, and has a current market value of $67.4 billion. By my reckoning, the company's market value was in the neighborhood of $20B five years ago, to account for the total return in the interim. Thus, it appears that Dr. McGuire led the firm to increase shareholder wealth by roughly a factor of 48 times the value of the options granted to him for said performance.

Not a bad deal for the shareholders, actually.

On CNBC this morning, they asserted that various UNG investors who had been interviewed held a range of opinions. Some, like me, felt McGuire had earned his compensation, and were happy to have had the opportunity to pay him for the performance. Others were outraged.

What was of more interest, though, was some of what the 'executive compensation' expert, invited on the program for this segment, had to report. Among founder-led firms, such as Dell and Microsoft, there is no single policy. Gates gets no stock, nor options. Michael Dell, on the other hand, receives options from his board.

I think this alone is very insightful. There simply is no "right" answer. But everyone agreed that the board was responsible and accountable for the compensation situation. The "expert" then went on to babble about more disclosure of options granted, rescinded, etc. It sounded like maybe the SEC has something afoot here.

Taking all this together, plus my earlier posts, I think the situation boils down to this.

1. Boards have created this mess by having retired CEOs, most of whom were probably overcompensated in their time, continue the tradition of overpaying the CEOs of the firms on whose boards they sit for similarly mediocre performance, i.e., it is a learned trait.

2. CEOs who consistently create superior returns for their shareholders deserve extraordinary compensation for their extraordinary performance.

3. CEOs who do not consistently create superior returns deserve modest fixed compensation. Their bonus compensation should definitely depend upon the superior shareholder returns they cause to occur. No superior returns, no wealthy CEOs.

4. Change takes time. Americans aren't particularly good at being patient. But, if one would give market forces a chance, and not rush to legislation, this "problem" of CEO (over)compensation should be self-correcting in not too long a time. I have suggested how this might happen here.

It reminds me of the mess that our politicians have created with Federal election campaign finance "reform." The more they have tinkered with it, the worse the problem has become. Had they simply opted for full disclosure of campaign financing to begin with, the whole matter would probably have been self-correcting there, too.

Sometimes, you have to let markets, even "information" markets, take a little time to work. But they do. Rushing them usually creates unintended consequences of significant proportions.

Wal-Mart: Consistently Superior Success or Failure ?

As I read yesterday's comment on my Wal-Mart post, it occurred to me to revisit my thoughts of last fall concerning the company.

When I read the two posts together, they portray me as perhaps a bit schizophrenic in my assessment of the company's fortunes. Back in September, I classified Wal-Mart as an aging and no-longer consistently superior performing retail giant which will probably not regain its luster. I noted that it has not been in my equity portfolio selections for many years. Yesterday, I referred to it as having usually outperformed the S&P during the last 25 years.

Some clarification is in order.

My proprietary research unearthed performance benchmarks which, when applied to large-cap companies, increased the probabilities that a given firm could outperform the S&P's total return consistently over a period of multiple years. The benchmarks differ for low-growth and high-growth firms. However, firms that would adhere to their respective operating benchmarks would have statistically significant increases in the likelihood that investors would reward such performance with consistently superior total returns, in the form of stock price increases.

When these insights are applied to the selection of equity portfolios, some adjustments must be made. A CEO may, or may not, adhere to my benchmarks, and still enjoy some periods of superior total returns. Further, whether or not the firm meets my investment criteria, it may still do better than the S&P over various periods.

However, as an investor, I need to use better quality criteria for portfolio construction than I would advise a CEO to use for actually running his company. This is because the CEO has some control, or at least influence, over his firm's operating characteristics and performance. Thus, the level of certainty of achieving the recommended operating benchmarks is probably higher for the CEO than for me as an investor. I don't have any control over the assets I own, whereas the CEO has control, via business strategies and resource allocation.

So a company, such as Wal-Mart, may, ex post, have outperformed the S&P for some years, yet still not, ex ante, have displayed investment quality performances that would have merited its inclusion in my equity portfolios.

Thus, as a business strategist and observer, I observe that Wal-Mart has created shareholder value at a superior rate, relative to the S&P, for most of the past 25 years. As a disciplined equity investor, however, I observe that the company's evolving performance characterisitics over the same time period did not warrant risking investment in the firm, relative to other opportunities in the S&P500, in order to construct portfolios which had significant likelihoods of consistently outperforming the same index.

I still doubt that Wal-Mart's new thrust to move upmarket with its retail brand will succeed. By "succeed," I mean consistently create superior total returns for shareholders over the next 5-10 years. The company may eventually move its brand franchise up the "wheel of retailing," but I believe the time and cost will not, in the end, have been warranted, relative to other strategic opportunities available to the firm. I wrote of these in my earlier piece.

This is not to say that I think it cannot occasionally realize better total returns than the S&P in the next few years. However, my guess is that its fundamental performance will continue to keep it out of my equity portfolios. Its current strategy is, in my opinion, unlikely to provide the performance consistencies which I have found to be the hallmarks of desirable investment opportunities among large-cap companies in the S&P500.

This is one of the conundrums of using the same shareholder return performance measure from inside a company, as opposed to an investor's perspective. The CEO may achieve above-average, though statistically unlikely, total return performances for a while, thus rewarding shareholders. But the chances of that occurring consistently may be so low as to make owning those shares too risky, from a disciplined investment process perspective. The CEO will have succeeded, and done well for some shareholders at certain times. But that does not mean, ex ante, it was an attractive stock to own.

Mediocrity, Discipline, & Long Term Performance

I've written recently of my insights on why corporations continue to exhibit so much mediocrity and inability to, it would seem, to learn from their experiences. My piece on Ford discussed why, even when the owner is still in control, consistently excellent performance remains a rarity.

On Friday, CNBC aired various reruns to fill time, as the markets were closed for the Good Friday holiday. One of these is their old standby, David Faber's program about Wal-Mart.

I have seen some of this piece before, as it is by now at least a year old. However, the portion which I viewed Friday left me awestruck. A former chairman of the firm, whose name I do not recall, related in an interview that the senior management of Wal-Mart "...wakes up everyday worrying about how the company is going to survive and continue to grow...." Seldom have I seen such a visceral statement of an attitude which must be present in a firm which has a chance at attaining consistently superior total returns for its shareholders.

The Faber piece also featured video clips of Wal-Mart's intensive focus on employee (yes, I know, "associate") training and the sharing of best practices. These people are nothing if not commited to learning from their mistakes, as well as their successes. When asked about some recent public gaffes, CEO Lee Scott freely admitted that, even in Wal-Mart, some managers are going to be "knuckle heads," and he could not control that. However, it was clear that the firm assiduously tries to minimize its mistakes, both in hiring and managing, as it moves forward in time.

This discipline shows in the company's performance history. While, like Ford, Wal-Mart has had periods of underperformance, over 25 years, they have pretty consistently outperformed the S&P500 index. For the past 5 years, they have only begun to experience a performance decline about 12 months ago.

Of course, no company can control all the variables which affect its success. In Wal-Mart's case, it appears that two things happened to cause this failure to continue its attainment of consistently superior total returns.

One has been, evidently, the ever-present "wheel of retailing" phenomenon, in which customers move up the retail ladder to more expensive, more service-intensive and better assortment-offering chains. In the middle of last year, as the business media began to grudgingly admit that maybe the US was in the midst of a continued low-inflation, solid expansion, concern began to arise that perhaps Wal-Mart's target market was leaving it behind and moving upscale.

The second challenge Wal-Mart has begun to face is, quite simply, the penalty for large-scale success in the US. Like IBM, CDC, Xerox, and Microsoft before it, to name but a few, Wal-Mart has drawn the ire of various consumer and governmental organizations. "Follow the money," as it were.

Nevertheless, it was refreshing to see interviews with former and current senior officers of a company that "gets it." That they can never become complacent, resting on their laurels. That they continue to manage and execute with discipline. Whether Wal-Mart's planned move upmarket into more fashionable goods will succeed (and I have argued here that it is unlikely to do so) or not, I give them credit for being hungry and concerned all the time. It's a trait a few other large US companies, such as Ford, GM and Time Warner, would do well to emulate.

HP Under Hurd Shows New Promise

First, let me apologize for incorrectly dating the announcement of Coca Cola's new board compensation policies. I was off by a week, as I read an older Wall Street Journal while catching up on back issues. Never the less, my post concerning this topic did precede my becoming aware of the change.

In another article from the WSJ pages of recent weeks, I read with great interest, and admiration, how Mark Hurd, late of NCR, now CEO at HP, is revamping the sales force.

What was of particular interest to me is the depth of focus Hurd is reported to have given to an issue that, allegedly, Carly Fiorina acknowledged, and failed to solve, on her multi-year watch at the helm of the ailing tech firm. Kudos to Hurd for quickly assessing the situation, diagnosing the problem, and, most importantly, ramming home changes in the sales organization to both trim unproductive middle-layers, and realign the function with the way HP markets to its customers.

This is the kind of CEO performance which, when effective, can be worth whatever price the shareholders pay for it. While I do not own HP, I genuinely hope Hurd successfully restores it to a high-revenue growth path, with consistently superior total returns following not far behind.

It gives me great satisfaction to see a company have the courage to oust an ineffective CEO, hire a new one, and have done a good job recruiting a new CEO who will actually fix the company's problems, rather than merely enjoy his lucrative new compensation package.

Corporate Governance in a Liquid Market

My recent series of posts concerning CEO and board compensation, and corporate governance, has led me to a heretofore unrealized question. Is "corporate governance" a viable or relevant concept in our modern financial markets?

Generally, when I have read pieces on corporate governance, going back at least a decade, they typically assume, it seems, some long-term, faceless group of ever-present shareholders. Or, worse, a "stakeholder" group, only some of which are assumed to be shareholders. Thus, the perspective of these writings is usually more political in nature. By that I mean, they deal with corporate policy within the context of our socio-economic and governmental environments in the US.

However, it occurs to me that the existence of deep, liquid financial markets in the US, available at very low prices, changes this perspective radically.

What is the relevance of long-term "corporate governance," and the debates about how to affect it, when any disappointed shareholder can become a non-shareholder in a matter of seconds, for about $9/trade, at retail. For institutional investors, the cost is pennies per share.

Why does there need to be any debate over CEO compensation, board compensation, etc? If you, as an investor, don't like a company's policies, but its performance is superior, do you really care? If a company is a paragon of corporate governance excellence, but can't outperform the S&P500, are you still going to hold its shares?

It seems to me that an overlooked aspect of the corporate governance debate, and the debate over CEO compensation, is that the exit cost for even a small shareholder is de minimus. It's far easier to fix the problem by selling the shares than it is to attempt corporate "reform."

As I have noted elsewhere, it seems to me that some investors have an inability to accept their limits as investors in, rather than as employees or majority owners of a firm. To me, liquidity is a Godsend. If the companies whose stocks I own do not perform up to expectations, selling them is a trivial matter. What could be a better remedy than this?

To follow this logic, if many investors felt similarly, the stock of the company in question would fall. If this would not galvanize a board into action, what would?

As with many aspects of our relatively free-market economy, I suspect that, in the matter of excessive and inappropriate CEO compensation, and other board-originated problems, too, price signals are much more effective than any regulatory or political "solutions."

Coca Cola’s New Board Compensation Changes

In a feat of truly incredible timing, I wrote yesterday of some changes in corporate board requirements and management that I feel would have positive effects for shareholders. Incidentally, I believe such changes as I suggested may help curb the current epidemic of overpaid, underperforming CEOs. It was my intention to write next about how a company might transition from current common CEO and board compensation practices to those which I suggested. However, the recent Coca Cola announcement is too good to pass up as a topic for this piece.

Coca Cola has just announced, as reported in this morning’s Wall Street Journal, new board compensation policies aimed at placing directors in nearly the same position as the shareholders whom they are elected to represent. Henceforth, most of a Coke board member’s compensation will be dependent upon the fundamental operating performance of the company over several years.

This is a good start, but still woefully inadequate. Coke should have tied the directors’ compensation to total returns of the company’s stock, relative to that of the S&P500 for the same, multi-year time period.

For example, in a recent article in Business Week, entitled, “Blue Chip Blues,” the author alleges that

“…What exasperates the leaders of these corporations is that it seems there's little they can do about (it)…….delivering the earnings growth, but investors aren't responding. At work are forces largely beyond their control.”

If this is true, then Coke is targeting the wrong performance measure. However, regarding the BW article’s contention, I beg to disagree. A sizable portion of the valuation response of investors is, in fact, very much within the control of a CEO.

My proprietary research has shown, conclusively, that investors respond to long-term revenue growth more than simply to earnings growth alone. It’s up to the incredibly-well-compensated CEO to know this, and to figure out what performance will move his firm’s stock price. Then deliver that performance.

It is my contention that CEOs and board members should be compensated only for total return performance above that which investors could experience in an S&P500 Index fund.

Having discussed why total return performance is the relevant measure for shareholders to use for CEO and board member performance, rather than a fundamental target such as earnings growth, I wish to next return to the issue of whether “corporate governance”, per se, should be of concern to shareholders.

The "Real" CEO Compensation Issue: Boards of Directors

As I reread my post on CEO compensation of the other day, it occurred to me that I am guilty of leaving you, the reader, hanging on an important aspect of this issue.

I attributed the mess to board members, particularly those on the compensation committees, but failed to suggest solutions for their actions. If it was not for their dereliction, on behalf of shareholders, more underperforming CEOs would be shown the exits, and shareholders would be better served. At least they would theoretically pay less for the underperformance they receive from a poorly-performing CEO.

So the question we should ask is, how do shareholders affect the recruitment, retention and behavior of board members, so that the boards behave effectively and responsibly in their oversight of the company and its CEO?

I doubt I'm going to solve this rather momentous question in one post on this blog. However, I intend to begin, as Einstein would call them, "thought experiments" on the subject. Chances are, musings about various solutions may uncover key attributes of what the solution should contain and "look like."

The overwhelmingly attractive alternative in my mind is to truly align the board members' interests with the shareholders, i.e., not stopping with doing so for the CEO, but extending this concept to his/her overseers. I would propose, and feel better about companies which, required board members to own and retain voting control of, some minimum number of shares or value of shares of the company. Today, it's a rare board member who is not already a retired CEO or a sitting senior executive or CEO of another firm. So, requiring someone to have a lot of money to be a director is really not such a major departure from current practices. About the only people it would weed out would be token appointments of unqualified, but politically acceptable directors, for public relations reasons.

This alternative makes being a board member into a rather interesting, and potentially lucrative, job. Someone could, in theory, borrow money to buy shares and run for a corporate board, intending to exercise effective oversight, in order to profit from the company's presumed increased total return.

It seems very clear to me, as I write this, that the major problem with today's corporate board structure is that it fails to require the board members to share the most important interest of the shareholders- personal financial gain or loss of a significant nature, based upon the firm's performance. In this regard, Ed Lampert's role in Sears and K Mart are a good example of expecting to make money by buying your way onto a board. In his case, he didn't stop with only "another" board seat, but became CEO.

If you think about it, the modern corporate form began in an era when most other company CEOs had contributed a significant amount to their own firm's success. Thus, filling a board with other CEOs usually meant recruiting active, successful talent on whom you could rely to know how to get superior performance from a company and its CEO.

Nowadays, though, with so much ineffectual overcompensation of underperforming CEOs, I suspect most boards are comprised of members who both have not actually demonstrated the success they are meant to foster on the board on which they serve, and who do not have a truly material interest in the success of the company in the first place. And the result is self-propagating. We see learned behavior of rewarding incompetence spread from company to company.

If a company actively publicized that its board was filled with people who met my qualifications, perhaps they would become a more attractive company to own, simply because the overseers of the CEO had the shareholders' interests as their own. And would, in time, cause better returns, which would reward shareholders appropriately.

So, at this point in my thinking, I believe that CEO compensation is simply an outgrowth of a deeper problem- incompetent, insensitive corporate boards. If board members had to own substantial amounts of a company's stock to serve, and, thus, profit, as a board member, I think the CEO compensation issue would resolve itself in short order.

My next piece on this topic will probably address how a company makes the transition from one with an ineffectual board, to the type of firm I am envisioning in this post. Perhaps a good case would be to imagine how one would transform GE from what it is now, to a truly well-run company. One which compensated its CEO appropriately for his performance, rather than rewarding him for consistent underperformance, as it now does?

If Only It Were That Easy: CNBC Advises GM

CNBC has been running a special series this week, featuring their automotive sector reporter, Phil Lebeau. He has been providing the answers on how GM should build better cars "and" a better car company.

If this weren't so hysterically ridiculous, it would be merely good comedy.

I'm guessing at least half a dozen of the country's larger consulting firms- McKinsey, Bain, Accenture, Booz Allen, BCG, AT Kearny - are calling on Rick Wagoner to pitch their solutions. While I may not believe they can cure what ails GM, I'm pretty sure doing so involves more of what they will do than what Phil Lebeau is doing.

I can just imagine the producer(s) at CNBC huddling with the staff to discuss how to capitalize on GM's troubles....."and let's have Phil do some pieces on how they should get out of this mess. After all, he's our auto guy....."

If only it were that simple. Lebeau basically stands in Toyota factories and solemnly intones that GM should "be more like Toyota, which is doing GREAT!" He must know that what he is saying sounds superficial and silly. How can one lightweight, on air sector reporter really suggest that he can deliver the solution for GM in a few 3-minute blurbs?

Suffice to say, some consulting firms will be booking millions in fees before GM bites the dust, or staggers into some semblance of life as a much-shrunken vehicle assembler. It's not going to be because Rick Wagoner was watching CNBC this week.

I think it's pretty embarrassing for CNBC. It suggests that they aim so low in order to reach their audience's level of comprehension. Or, they simply are filling up air time because they have nothing better to offer. The truth is probably somewhere in between.

Either way, I think GM needs more than a news reporter telling them to make better cars with more cool features and fewer defects.

Overpaid CEOs: Does It Really Matter?

Once again, the issue of CEO compensation is in the headlines. I wrote a piece on this topic here a few months ago. My feelings and thoughts have not changed. However, they have gotten a little more nuanced.

Rather than rewrite what you can read by following the link in the first paragraph, let me address a few aspects of the public outcry over this topic.

First, I do not think it is an appropriate matter for any type of legislative or governmental interference. These are publicly-held companies, with boards of directors and bylaws governing their behavior. The companies in question have stock listed on exchanges where a shareholder may easily dispose of his stake in the firm, if he dislikes the way the firm is managed or directed.

Second, I think this issues is moot for any firm whose total return performance has consistently exceeded or is exceeding the S&P500 index return for a period of five years. When a CEO delivers the goods, who cares how much he was paid? This type of performance is so rare that, if a CEO actually enriches his shareholders, continually, at an above-market rate, those shareholders should be thrilled to pay that CEO very handsomely.

Third, the "issue," as it exists, exists only for those companies whose total returns are either consistently below the index for 5 years or so, or inconsistenly not much different than the index. Simply put, why should anyone pay excessive amounts of compensation for the right to hold a single stock, with its attendant concentration risk, and earn no more than the market return?

But, even here, the culprits are not the CEO. No, the culprits are the board members- particularly the compensation committe members. These snoozing guardians of the corporate treasuries abet the "excessive CEO compensation crisis" by failing to set realistic and appropriate corporate total return requirements for the CEO to achieve in order to enrich himself. For more details, see my post on Jeff Immelt, the overpaid, underperforming CEO of GE.

Realistically, pragmatically, what is the average shareholder to do? Or even, for that matter, the average institutional fund manager to do? As I wrote on a related topic recently, it baffles me why any investor honestly thinks s/he can affect the behavior of a large corporation in which s/he owns shares. Or why s/he should even try. Does it not make more sense to simply sell shares of a poorly-run company, and buy shares of one whose performance, or prospective performance, you prefer?

Thus, my "final" answer is, I think the spotlight being shone on these overpaid loser CEOs is great. The Wall Street Journal's "CEO Compensation" section in yesterday's issue is about as good as it gets. Provide sunshine, full information, and let shareholders make their choice with their investment dollars.

After all, we want free, liquid, fully-informed markets and investors, right? Why should anyone be doing anything but applying the "disinfectant" of fully-disclosed performance and compensation information for the benefit of investors?

Followed to its logical conclusion, I suppose, in a perfect world, a company like, say, GE, which consistently overpays its CEO for poor performance, would see investors head for the exits, and its stock price and total return plunge. Then, ideally, that CEO would be dismissed, a la my prior post guidelines. And if the new CEO got things back on track, s/he would be amply rewarded, and investors would return to hold a consistently-superior performing stock.

So I stand by my earlier recommendations: handsomely reward performers, and fire the already-wealthy underperformers. Pay all the CEOs with less cash and more stock. Make them wealthy by leading a company to consistently-superior total return performance, and nothing less.

Ford: When The Founding Family Still Cares

Two news stories today concerning Ford caught my attention. The first concerned the departure of their President, Jim Padilla. He is credited with an earlier "turnaround" at Ford, but is stepping down now, and will not be replaced. The other story concerned Ford's pulling all of its professional golf-related advertising and promotion spending, to focus on another sport (the identity of which, frankly, has already passed from my mind).

These stories caused a flurry of discussion on CNBC's Squawkbox concerning Ford's current turnaround attempts. Hearing this, I pulled up a couple of stock performance charts for Ford and the S&P500 for the last 5 and 25 years, to ascertain the firm's total return consistency over those periods.

The recent 5 years look pretty ghastly, as I expected. Except for a brief period during 2003, the firm has underperformed the index throughout the period. For the entire timeframe, Ford underperformed the S&P500 by about 85 percentage points. It would appear to be a consistently inferior-performing firm for the last half-decade.

The picture for the past 25 years, however, is noticeably better. For the period from 1985-2000, Ford usually matched the index, and briefly outperformed it during 1986-1989. It also had a brief run of superior performance during the mid-1980s and early 1990s.

Taken together, the Ford situation leads me back to my earlier post about UAL, the preponderance of mediocre employees in many, if not most, large US companies, and long-term performance. How is it that so many firms lose competitive advantage, become complacent, and slip into mediocrity? Or worse, recent inferiority, as is the case with Ford.

It seems to me that a firm with the same name as the CEO's would be the least likely to suffer from a simple case of caretaker-CEO neglect. Ford has had a succession (although not unbroken) of family members running the company since its founding. If these guys are not motivated stay on top, and preserve their pride and fortune, who is?

I think the Ford performance picture shows us what is probably "natural" for an attentively-led firm. Even when the founding family is involved, a firm's fortunes wax and wane over time. Ford has had its periods of triumphs, such as the massive overhaul in the early 1980s. But even they became complacent, and by the early 1990s, had slipped in terms of total return performance.

By comparison, GM, for the same period, did much worse. On a percentage basis since roughly 1978, the S&P rose 1000%, Ford to near 250%, while GM slipped to a loss. Both companies reached a nadir of performance in the early 1980s, but whereas Ford took off to run with the index for most of 15-16 years, GM remained stuck with a nearly 0% total return for the entire period. Could this be the cost of disinterested, nameless CEOs paid handsomely, without risk, to run a large firm full of mediocre, dispassionate employees?

My hypothesis is precisely this. Left with a procession of bean-counters becoming well-paid CEOs, regardless of their successes or failures, GM has seen no performance cycles for over 20 years. Ford has.

Next, I'll offer some insights on why businesses seem to have to go through the same lessons and crises repeatedly, as we've seen in the cases of Ford and UAL.

The Lucent-Alcatel Merger: Part 2

I discussed the Lucent takeover by Alcatel the other day in a post- no point in pretending it's a "merger" at this point.

Upon having a little more time today, I went to Yahoo and produced some total return charts for Lucent, Alcatel and the S&P500 index. The time periods I looked at were 5 and 14 years (9 for Lucent).

Not surprisingly, the total return chart for both firms over the last 5 years are nearly identical, and woefully underperforming the S&P nearly every year. Both had such a disastrous decline in 2001-02 that 2003 was better than average just because, evidently, they didn't go out of business. However, both companies have been consistently inferior performers.

For the longer periods, each company again significantly underperforms the S&P for the entire timeframe. While each temporarily outperformed the index for 1996-2000, this was, of course, a function of the double-counted and excessive demand for telecom equipment preceding the collapse of the late '90s tech boom. Each again experienced a brief period of outperformance during the reflexive snap-back of 2003-4, after losing 75% of their market value in a little over a year.

What is evident to me is that neither company is now, nor has ever been, a consistently superior-performing company among their large-cap peers. Even at their best, these companies simply filled orders, riding a swelling tide of demand, rather than intelligently managing their businesses for sustainable, long-term growth.

Given the sub-par performance of both companies, doesn't it make you wonder why so much air time and/or ink is being spent on this combination? And why nobody seems to be asking how Pat Russo, based upon her dismal track record running Lucent, could possibly take the combined firm somewhere, performance-wise, neither company has ever been before?

The "Urge to Merge"

CNBC has been celebrating merger activity this week on their Squawkbox morning program. Their so-called economics guru, Steve Leisman, presented a summary of some old and new academic M&A research the other day. It told the expected story, for anyone who has studied this area at all, that most large, publicly-held company mergers and acquisitions destroy value for the acquirer. Some relatively obscure finance assistant professor from a second-tier school was interviewed regarding her recent study, and it pretty much sustained the work of 30 years ago.

Apparently, CNBC feels that recent trend in the volumes of M&A indicated a heightened "urge to merge." The reason opined for this was basically stronger stock prices provided an overvalued currency with which large companies can take out competitors, quickly grab needed pieces of their evolving business model, or simply spend the overvalued currency while it's buying power is so great.What I found provocative was Leisman's question, 'are companies doing any better making these combinations work?' The answer from the academic was, essentially, "no."That's also not surprising to me. In fact, I would guess that the value destruction percentages would be fairly stable over time as well. However, I would guess that, aside from the last reason for the increased volume of M&A deals recently, there are two other reasons.The first, in my opinion, is the increasing cost of mediocrity to large organizations. As I wrote in my last post, and will expand upon in future posts, mediocrity is a necessary companion to the modern large company. Such mediocrity means that most companies are in a position of being unable to develop, competently, themselves, what they can occasionally buy more easily in the form of another public company.

I think a different, but related, reason is the role of business technology in today's world. The rate of growth of a successfully-launched business concept today is probably unprecedented, even in America's fast-changing economic environment. Thus, as deep and liquid capital markets, plentiful outsourcing opportunities, and various technological resources are available, a new company can become a viable threat to an old, mediocre one much faster now than it probably could have, say, even 10 years ago.

With this kind of advantage to the newer entrants in a market, it's not surprising to me that more large companies are rushing to buy what they may not have time to build effectively. It causes me to have this image of a herd of large, old elephants being surrounded by packs of cheetahs, tigers and lions.

For example, Blockbuster, founded in 1982, is now being eviscerated by Netflix, founded in 1997. The stock price charts of the two, after Netflix's arrival nine years ago, are close to mirror images.

This is the sort of fear-inducing situation I can see accelerating acquisition activity at many large firms. Any guess as to how much longer Netflix has before a flood of web-based digital-on-demand sites gut its business model?

UAL "Best Practices"

The Wall Street Journal carried a rather breezy piece last week describing how United Air Lines is now sending its ramp crews to "Nascar U" for training to work as a team in turning around a race car in the pits. The idea is to discover and train teams in "best practices" for turning airliners around on the gate ramps. Incredibly, according to the article, UAL training for this has always been "optional," and the FAA has been displeased to find procedural differences among cities in which UAL operates.

What strikes me as so odd about this story are the following.

First, wouldn't you think a major airline would have studied, benchmarked and applied best practices to something as crucial and frequent as airliner serving at the gate by now? Hasn't UAL been through at least one bancruptcy, and several CEOs, trying to become more financially successful? Would you not think that functions like this would have been among the first to have been studied, improved and standardized by a competent management?

I worked for the predecessor to Accenture, Ltd, the old Andersen Consulting, in the 1990s. Even back then, they were flogging "best practices" mercilessly in virtually every sector and function they could cover. How could an airline as large as UAL not have been besieged by Andersen-cum-Accenture, and/or its many competitors, to submit something so key as operationally turning airliners around on the ground between flights, to "best practices" studies?

Second, what does this WSJ story indicate about the ability of a large, modern corporation to simply get the basics right in its operations? How could such sloppy, undisciplined management and implementation exist in one of the largest companies in such a visible sector?

My partner and I discussed this at length a few days ago, as we typically talk about noteworthy business news of the past week after playing squash. What emerged was conceptual framework I am confident you won't find at any leading business school (and we each matriculated at one of the best). The initial element of it is as follows.

Essentially, I think that widespread mediocrity is a necessary consequence of a successful capitalistic economic system. As a capitalistic system allows innovative leaders to emerge and succeed with their enterprises, those enterprises paradoxically employ many mediocre people who, by themselves, would have difficulty creating as much value alone as they do when employed by a successful capitalist.

To see this more clearly, think of a similar situation from our species' past. When we were primitive hunters, don't you think the best hunter, and his family, were better-fed and bred larger families, than other hunters with less skill? Back then, the lesser-skilled would suffer more drastic consequences such as starvation, and lack of genetic survival. Perhaps even then, the less-skilled homo sapiens followed the more-skilled, who might have consequentially emerged as early leaders of such primitive "enterprises."

However, with the rise of civilized societies, and capitalism, people who may not have even survived in an earlier time now can find average jobs, wear suits to work, and live "normal" lives. When you pack large, modern companies with a preponderance of these "followers," you're not going to get many nimble, consistently-superior-performing companies.

Instead, I think you're going to get a lot of UALs. Companies in which the best ideas don't propagate throughout the firm. And this will be the norm, because, thanks to modern civilization, there is a viable safety net for the average person. It's my guess that, in a "knowledge" economy, the value foregone by having mediocre people in most positions is probably far greater than it is in a primarily industrial economy.

Add a hefty dose of our current technological change, and it's a wonder that even the best CEOs can overcome this kind of inertia. Even with an army of consultants begging to study and implement "best practices." The consultants will study and leave, but the mediocre employees remain to function "normally."

This insight has led me to several conclusions that I will be discussing in coming posts. Suffice to say, they reinforce the basic conclusions of the research that drives my equity portfolio management process: consistently superior performance is rare and fleeting, even for the best-led companies in the most opportune product/markets. And consistent success only leads to longer and longer odds of continuing that success, no matter how good the leadership of the company.

The Failure At Lucent

This weekend's announcement of Lucent's "merger" with Alcatel has brought forth a flurry of commentary and analysis by the business news and entertainment media today. Most of it seemed to focus on two topics: the prospects of success for the combination, and Pat Russo becoming France's first female CEO.

Both topics seem, to me, much simpler than they are being made out to be in the media.

First, let me state that I have never bought Lucent for my portfolio. While it was a high flying growth stock upon its IPO, it came down to earth long before it would have qualified as a consistently superior performer for inclusion in my portfolio. Suffice to say, I see its eventual collapse and, now, rescue via merger, as a testament to the validity of the research and philosophy underlying my equity portfolio strategy.

Regarding the combination of firms, I think you can safely say that Lucent is being taken over, but not "bought," per se, by Alcatel. As frequently occurs in this sort of deal, it's called a merger, and the weaker firm's CEO is often given the resulting CEO position, to placate investors and employees of that firm. However, since the resulting company is clearly being called "French," this, I think, leaves little doubt as to which of the two firms will, in fact, exercise the greater influence in the future.

Next, we come to Pat Russo. What better situation for the French at Alcatel to create than giving Ms. Russo the titular honor of being the "first woman CEO" of a French firm? It's already been widely pre-announced that lots of riot-causing layoffs will be required. Who better to blame than this vanguard of the French boardrooms?

Does anyone honestly think that, with Alcatel controlling the combination, and probably dominating the resulting senior staff, giving Russo the CEO job is meant as anything more than providing a sacrificial lamb? It's my guess that in a year or so, things won't be working out as expected, Russo's cultural differences will be blamed, and she will "retire to pursue other interests." Alcatel's management will be able to get back to business their way, without the distractions of American interlopers in the C-suite.

By the way, who really thinks the CEO of either of these limping telecom vendors deserves to be running the combined firm? Russo can hardly be said to have succeed in leading Lucent to success. Does it really seem likely that either CEO can succeed in leading the resulting firm to consistently superior returns in the next few years as a high-growth company? A place neither seems to have visited recently?

Investment Horizons Part 2: "There Will Be Headlines....."

This morning, on CNBC, an energy market guru was being interviewed to explain and predict oil and refined products prices, and the related prices of the companies that produce them.

During the conversation, the guy referred to the seemingly-unjustified rise in oil futures prices, given various inventories, drawdowns, seasonality of usage, etc. Then he said something pithy that made it all come together for me.

He said, "....well, this is largely a headline-driven market," after which he went on to explain that the various unexpected news regarding things like the Hess refinery being offline a week longer than expected was moving prices.

This elegantly and consisely states what I was grappling with in my earlier post on this topic....."There will be headlines."

Many investors, traders really, attempt to anticipate, and then trade on, actual headlines. And because those headlines are "news," they do move markets. But which headlines will occur on which days is, of course, impossible to predict consistently.

Thus, my strategy's style is to assume that "there will be headlines" over the long term, say, six months. I don't know which ones on which days, but it's a good bet that they will occur. Currently, my selection process has remained significantly invested in energy equities. It appears that, the incredible volatility of January and February notwithstanding, the headlines are even now pushing energy prices back up.

You would think that, from a distance, it would be clear that the global energy picture has not changed since Katrina in a way that will deliver substantially more supply to a growing global economic system. So my strategy's selections continue to include energy equities.

But, "there will be headlines." During the months I am holding energy stocks, other "investors" will be playing those daily headlines, like so many surfers trying to ride every big waved into the beach standing up. Rather than spending time and money trying to capture every headline's effect on the market, my research has convinced me that it's just as lucrative, but less risky, to get the longer-term trends right, and let the headline-chasers roil the daily markets without me.

Investment Horizons

Much of my initial academic training was in marketing, rather than finance. Thus, I continue to be fascinated by the way in which people interpret the buying and selling of financial products, such as equities.

If you watch television coverage of a day's market activity, or read a summary in the Wall Street Journal, you will typically find the market personified. Phrases such as "it's not a stock market right now, it's a market of stocks" abound.

When I see or hear comments like that, it takes me back to my days stocking shelves and driving a delivery car for a high-end grocery store during high school. Pricing for items like food is usually very different than for stocks. Yet how many times do we hear market pundits infer meaning from the tape? Using just volumes and prices, motives are attributed to the many different investors who have traded that day.

Yet, buying investment products is certainly quite different than buying food in a grocery store. When someone buys a can of soup, you can bet they plan on eating it fairly soon. And we don't obsess over the "valuation" put on the can of soup, because the seller prices each can alike, usually irrespective of daily demand for soup.

When someone trades a stock, all we really know for sure is that, at that moment, that stock was the least profitable perceived place for the money represented by that stock's price. And we know that the price at which the stock traded is surely not the value of the stock to either party. It's below the value to the buyer, and above the value to the seller. These gaps would seem to be the most interesting information about the trade, but, of course, we are stuck with just the trade price and quantity. So those pieces of information are analyzed in lieu of the truly valuable information about the market activity.

Another aspect of such shallow and, almost certainly, incorrect analysis, which fascinates me is investment horizons. Taken together with over-analysis of the tape, I notice that immediate value judgements are imputed as a class to those who bought, or sold, some stock. Or perhaps even all sellers, or buyers, on a given day.

But what about those who own the stocks, and didn't trade that day? Or who simply needed to raise cash for other purposes? How are these motives divined?

Despite trading only a few times during the year, and typically out-performing the S&P500 by doing so, I still follow the markets daily. So, I am an investor, but the motives attributed to me, as such, are wrong for all but perhaps 2-4 days per year. In an investing sense, I do not "see" the other days. I follow them for informational purposes, in order to understand more about how my portfolios fare on a given day or week, but not in order to trade them because of such performance.

If this is true for me, how many other investors' behaviors, or lack thereof, are similarly mis-attributed?

I believe the truth is that the "stock market" is very much like a grocery store, in that it offers a concentrated location where many similar goods may be bought. However, I believe the stock market is always a "market of stocks." Individual issues are bought or sold for many different reasons, and not always just because of market-level dynamics. In fact, it is largely because such short-term forces affecting individual stocks are, behaviorally, so difficult to understand, that I hold portfolios for comparatively long time horizons. What may be a clear trend over some months can get hopelessly muddied in the daily volatility of stock prices.

Still, it can be amusing to watch people who are paid to deliver entertainment on a daily basis, reporting daily market activity as if each day's action had real direction or purpose, and the market is a deliberative person. Reminds me of that old adage about silk purses.....

CNBC's New Contest

The staff of CNBC's Squawkbox has been flogging the show's new contest this week. It consists of selecting a "portfolio" of equities for an eight-week duration. The entrant with the best return over the contest's duration wins a very expensive Masserati.

What struck me about this event is the duration. Eight weeks?

When I think of "portfolio," I think of a selection of financial instruments whose objective is to provide long-term return for appropriate risk levels.

Instead, this eight-week financial sprint being offered by CNBC makes a mockery of the concept. While it's not my style at all, I would guess the winner will be found to have simply chosen the hottest momentum stocks du jour. Or be extremely lucky with one pick. Then again, the promos for the contest did not rule out using "inside" information, and it is not, technically, "real" investing which would make using such information illegal.

I guess what the contest makes very clear, though, is CNBC's commitment to entertainment over value-added. It's easy to imagine the network brass and the show's producers arguing over how long to let the contest run. The network probably wanted a few months of heightened attention, to justify the expense of the prize. I would guess the producers felt anything longer than one or two weeks would exceed the attention span of their audience.

If this is the paragon of responsible television financial news, we are badly served. I can't recall the CNBC slogan just now- I think it is something like "America's financial news source." What a pity. When we need investors to realize that longer investment horizons make for healthier portfolios, not to mention avoiding individual stocks in favor or paid, professional money managers, we have this nonsense pushing people in the other directions.

Phantom Trade "Deficits"

Thursday's Wall Street Journal contained an editorial of stunning import. The title was "Trade Deficit Disorder."

While it would be duplicative and overly ambitious to attempt to restate the piece here, let me note the its key points.

First, and most informative, was its reference to a 1776 U.S. Advisory Committee on the Presentation of Balance of Payment Statistics. That group recommended that the words "surplus" and "deficit" be avoided, for their improper fostering of perceptions of, respectively, "good" and "bad" effects.

Second, as I have long believed, the US receives more payments from foreigners, to hold our IOUs, because we have a combination of the most vibrant, productive, and legally safe economy and country on the planet. There is no other country which offers these attractive elements for investor funds.

Third, the piece debunked the commonly-held notion that the US is now a "debtor" nation. Rather, by analyzing and including rates of return on our liabilities and our assets, a Harvard study from the Kennedy School finds that "American assets abroad earn higher than normal rates of return because of noncounted factors....." Since our liabilities are Treasuries, paying much lower rates of returns, we are, still, a net creditor nation in terms of income flows. In fact, the study determined that China is a net debtor to us.

Thus, as I have thought for many years, many pundits have the trade flow situation entirely backwards. It is our country's attractive investment climate that causes it to receive inflows from abroad. They desire access to our innovative economy, our system of strong legal protection of tangible and intellectual property, and our people's business acumen.

As with most strategy and long-term planning, having the right data is critical to making intelligent moves. It would appear most media pundits have been reading the wrong data, and drawing incorrect inferences therefrom.

Blog Name

As time has passed, and I have generated a fair number of posts on a variety of topics, a theme is evidently taking shape.

My brother commented on that, as we discussed my recent GE compensation post. As a result, I've toyed with various new names for this blog. The original one is quite forgettable and nondescript.

Thanks to my brother, who labelled my perspective, "the emperor has no clothes," I am leaning toward some descriptive title of that nature. This one, "The Reasoned Sceptic," attempts to strike a balance.

My partner cautioned me to not be constantly negative, or "angry." However, I pointed out that, because most people are so mediocre, most of my commentary is going to be critical. He agreed. In fact, I owe this revelation to my old boss and mentor from Chase Manhattan. He demonstrated to me, frequently, that using sensible logic and reason, with some facts, typically results in a strategist being sceptical of the schemes being hatched by most (average or below-average) managers.

So, in that spirit, I am trying out this new name for my blog. If you read this and have any suggestions, please feel free to express them, either in a post, or via email.

Google Growth

The past few weeks have seen some interesting stories about Google surface.

First, their CFO announced that revenue growth may indeed slow. Then some internal forecasts appeared in analysts' packages by mistake, causing the stock's price to tumble again. There were all sorts of comments from the Street about how fast growth is perhaps causing mistakes in execution at the firm. Though minor, the ones that appeared were cited as perhaps portending more serious problems at the firm.

I don't know that I agree with all of gravitous inductive reasoning. However, something else occurs to me about Google. As my partner and I discussed the recent company gaffes, he commented about their extraordinary growth and pioneering so many world-shaking information-handling initiatives.

Railroads in the 1800s, and airlines in the last century were both known for causing great turmoil as they rose to prominence. They also were known for having been terrible investments, in the aggregate. A lot of British investors lost a lot of money building and owning American rail lines. Similarly, many investors lost bundles in the fashionable business of airlines.

My point is, companies which participate in truly landscape-changing initiatives sometimes cause so much havoc, and require such vast amounts of capital to do so, that they wind up being mediocre investments. While being fashionable, and drawing competitive responses, sometimes investors continue to assume a later payoff, when, in fact, all the changes have drained value from the entire competitive landscape.

Radically new approaches to problems, like rail, air, and Google, sometimes seem to be so efficient that they fail to earn consistently superior returns themselves, even as they gut older business models and their value-adding structures.

The next few years should be quite interesting, as we see how Google performs over the longer term.

Acceptance of Limits

Jesse Eisinger, of the Wall Street Journal's "Money & Investing" section, wrote a piece this week concerning how investors might see warning sign's of a company's demise before the management of the same company could.

Within the article, a fund manager is reported to have had a large position in one firm, Lear, a maker of automobile seats and interiors. The manager attempted to urge the management to take some specific actions regarding debt refinancing, which the firm's management evidently chose not to heed.

It appears that one of Mr. Eisinger's favorite topics is to cast institutional investors, such as the fund whose manager he quoted in his article, as frustrated, well-intentioned would-be saviors of incompetently managed firms across the US.

What is it about liquid markets and capitalism Mr. Eisinger and his favorite sources don't get? In my equity portfolio strategy, I select companies whose management I trust. Managements that have a clear track record of unambiguously superior fundamental and technical performance. Why on earth would I want to tell them how to run the company?

More to the point, why would any fund manager buy shares of a firm, hoping to persuade the management to do things differently? Doesn't that strike you as a rather low-probability, indirect and usually futile way to make money for retail investors? Counting on human behavior changing that easily seems to me to be a sure-fire recipe for disappointment.

Fund managers may occasionally win these battles. But it often becomes a private equity play, or, similarly, as in the case of Sears Holdings and Ed Lampert, a case of the fund manager buying the company for a public fund. Thus, his job changes, he owns the problem, and has foregone the benefit of market liquidity.

However, it seems to me that this is needless concentration of investor assets. And a lack of acknowledgement of the practical limits of being an institutional investor. One of the greatest benefits for a modern institutional investor is market liquidity. When a management no longer has the investor's confidence, it is relatively inexpensive and simple to sell the position and buy a more promising company's shares.

Why would any fund manager wish to complicate the already difficult job of out-performing the market by also trying to manage individual companies in his portfolio? And why does Jesse Esinger continue to write about those that do?

Who Will Win the Online Media Access Game?

This week, Amazon announced its plans to offer downloadable video content, for rental or purchase. This is the "other shoe" dropping.

With digital media, entertainment content truly is simply a good which may be stored, inexhaustably replicated and sold at near-zero marginal cost, from any source which legally is allowed to sell it.

Yes, Amazon still has to cut deals with the various IP rights holders to do this, but isn't the handwriting on the wall now? Anybody with a functioning order fulfillment model and enough money can play in this game.

This being the case, I was reflecting on what, among the various dimensions of consumer choice, will ultimately create a dominant online non-real-time video content purveyor? Since sufficient competition will probably exist to force prices within a narrow range, I would expect that it will be the vendor with the superior user interface. Whoever makes it easiest to use existing, and evolving, technology, to access, pay for, view and control the viewing of stored video content will probably dominate the market. Perhaps, like the early Merrill Lynch CMA account, some competitor will even patent an especially successful user interface, in order to protect their market position.

What about real-time video content? As it happens, today's Wall Street Journal featured a page one article concerning online "geofiltering." This is the process by which existing content providers, such as local TV affiliates, are prohibiting geographically unwanted consumers from accessing their program content.

Enter the Slingbox. Two brothers from, where else, California, have developed hardware to allow you to view local content from a different network location. For instance, a consumer could watch programming from the TV in their home by accessing it via the internet and a Slingbox. Think a bit more broadly, and the ability to disintermediate any geofiltered, online realtime video signal becomes obvious. Even if broadcasters employ IP address identification to exclude certain viewers, it's easy to imagine a service developed solely to provide "appropriate" geographic IP addresses, for a price. This was done for long-distance least-cost routing years ago.

It seems to me that the companies who are really in trouble now, as the WSJ article suggests, are the local TV affiliates. How much sense can it possibly make to "sell" the same rerun, or even first run, TV program, to hundreds of local affiliates in a world where it can more easily be accessed on demand from a single URL? There goes hundreds of millions of dollars of ad revenue, and, probably, your local TV station. Perhaps it can combine with your remaining local paper to operate a zip-code-localized information-content provider. But non-local content? How can it possibly economically justify its existence for that in the coming years?

Wrigley: A New Growth Story to Watch?

Saturday's feature Wall Street Journal piece about the Wrigley Company was a breath of fresh air.

The article described the radical break from past "business as usual" management by the current Wrigley heir and CEO, William Wrigley, Jr. It was most refreshing. To judge from his remarks, as reported, Wrigley may well be coming into my portfolio in the near future.

It's always been my contention, given my marketing roots, that any product/market segment can be grown, if one is sufficiently creative. Old stalwarts of seemingly-dead segments routinely get picked off by someone with a better idea for a sleepy niche. Perdue did that with chickens, for example. So why not gum, candy and confectionary items?

The raw innovative and consumer-directed energy that came out of the new Wrigley's mouth are promising indeed. I had actually forgotten that he had stepped up to buy Hershey, when it put itself on the auction block a few years ago.

With so much dismal management incompetence to observe, and on which to comment, it's a real joy to read and write about someone actually understanding the need for growth, risks included. The real risk to a company is not growth, and the uncertainty it can bring, but the certainty of death without growth.

Goodbye Dubai- The Port Operations Management Case

This week brought mixed feelings for me regarding our American democratic government experiment.

Perhaps never before have I been so proud and supportive of President Bush. His clear-sighted, broad-minded statements of concern for a growing isolationism among Congressional members, and our need for friends among Mideast states in this war on terror, caused me to have new respect and admiration for our President.

At the same time, the voices of many of our Congressional members causes me great concern for our geopolitical and economic well-being in the near- and longer-term. My own state's ill-informed and wrong-headed Senators were at the front of the legislative crowd now displaying a very un-American revulsion to free trade.

What most concerns me about this was voiced, separately, by none other than Tom Wolfe, in yesterday's excellent interview with him, written in the Wall Street Journal. Wolfe focused many of his remarks on the unique greatness of our country, in that it genuinely allows people to be free and express themselves with few limits. By being who we are as a nation, and the best that can be, we are not replicable.

This is very important economically. Friends of mine, especially liberal ones, chide me on the size of US debt held by other nations. I reply that this is no great concern, because they see the matter incorrectly.

Where else on the planet will a wise nation or individual place their trust and wealth? Which other nation offers the rule of law, opportunities to innovate, and our freedoms? We needn't worry yet, because no other nation can absorb the size of capital flows ours can, and also be trusted by the world. The day we need to worry is the day India or China are as trustworthy as is the US on the matter of transparency of government and law, and the unequivocal rule of law.

Thus, it is not good enough to say, "well, India, China, or the UAE would NEVER allow a US company to own port operations in their countries. Why should we be different?"

We should be different because that is who we are as a country. We ARE different. It is what sustains our economic lifeblood and allows us the unique ability to run large trade deficits. We don't so much owe the world, as the world wants part of our economic success, and will pay to gain that access.

In that light, the Dubai port operations management mess is a very troubling behavioral indicator. I believe our President is right to worry about the protectionist, un-American signal it may send to the Mideast Arab states, and to the world at large. This could cause lasting economic damage to the US far beyond what most of our mediocre legislators comprehend.

As usual, in our democracy, we get the government we deserve. A capable President in this case, but 535 ill-informed, small-minded headline grabbers.