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.

Patent Nonsense: RIM, NTP & Intel

My partner and I had a long discussion last week about the recent scuffle between NTP and Research In Motion. RIM, as the latter is better known, produces and markets the ubiquitous Blackberry.

As I understand it, the major interests in this debacle have staked out two, opposing positions. On one hand, you have large corporations, such as Intel, RIM, and others, who feel that ownership of patents which they require for their own products and services, when in the possession of a company which does not itself market a competing service, is moot. If a company does not market a product, then it is viewed as a "patent troller" which has scooped up a valuable patent solely to impede, and extract a financial windfall from, a larger company that markets an affected product or service.

The general counsel of Intel wrote an editorial in the Wall Street Journal this week protesting that NTP had 'played chicken' with RIM, threatening to shut down its Blackberry service.

On the other hand, you have the patent owners. They feel that the US legal system, and patent law, entitles them to non-infringement of their patent, on penalty of the offending party being directed to cease violating the patent, or come to a settlement.

This seems very clear to me. Intel and its ilk are attempting to use their size and power to unlawfully take what patents are in their way. If you have ever dealt with a large corporation, then you know that their financial staying power, their "deep pockets," can fend off a smaller patent holder for decades without restitution.

Does anyone else recall the infamous case of the inventor of the variable-speed car windshield wiper? He sued Ford for infringement. It took many years, while Ford callously dismissed his attempts to protect his patent rights. As I recall, he won damages from Ford and the other major auto makers who had purloined his invention.

So, in my opinion, RIM and Intel are spouting an entirely self-serving line of reasoning. They claim that they give inventors a "fair royalty" for their patent interests. But is it not true that each case is different? Who can say whether RIM adds more value to a Blackberry if it does not own a key patent for the service? It's entirely up to the two parties to determine what the relative values are, or if there will be a Blackberry. Too bad RIM's management was so sloppy as to let the matter get to this point.

Why does it matter whether the patent holder is the actual inventor, or a purchaser of the patent from the inventor? If it is the latter, does this not indicate that the large corporation in question pursued a flawed product strategy by neglecting to either secure the patent itself, or buy the rights before marketing the affected product? It seems obvious to me that if you market a product and don't control a key patent, then you have found yourself a new partner, or you don't have a product.

It's not like the RIM decision will squelch innovation. Far from it. Now, small inventors everywhere know that their patent rights are less liable to be taken illegally by larger companies. I think it is shameful that a company like Intel allows its general counsel to write an article like the one published in this week's Wall Street Journal decrying the RIM settlement.

The "New" AT&T Part 3 : Innovation

There is one other personal experienced-based observation I'd like to add in this series of posts. It concerns the old AT&T, and innovation.

The AT&T that I joined in 1979 was a very effective hindrance to telecommunication innovation. There is no doubt in my mind that, without the breakup of the firm in 1983, we would not be enjoying much of the information revolution that has occurred since then.

What most people probably do not recall is that the DOJ's requested remedy for AT&T's alleged monopolistic practices was the divestiture of the equipment design and manufacture business units. These were key to AT&T's profitability and control over the market.

By using creative and aggressive transfer pricing when "selling" equipment manufactured by AT&T's Western Electric unit to the wholly-owned operating telephone companies, AT&T boosted the fixed asset base on which it was allowed to collect a rate of return by the various regulatory authorities. The company zealously guarded this equipment monopoly by delaying the vetting of "foreign" equipment for safe connection to "the network." Thus, both price and non-price means assured AT&T of many years of control over its marketplace.

Thanks to this type of management, end users of telephones in the US saw, in the 1960s, the introduction of the Princess phone, with a lighted dial. That was about it. A decade later, you got a push-button phone, to replace the dial. That was because it was cheaper to produce and maintain the telephone you were forced to lease, rather than allowed to buy. It wasn't to give you more features.

I can attest, from my experience in the Business Marketing group of AT&T's premises equipment business, that we were seriously hampered in our plans to address the future without end-to-end control of information management. Of particular concern was our need to interface, and exchange and store content with and from, computers.

The mere lack of a single network management entity in the US post-1983 contributed a great deal to the growth in creative uses of information, if for no other reason than the removal of a skilled, experienced and monolithic influence on telecommunications policy and legislation- the old AT&T.

So, while it may appear that the 1980s era breakup of AT&T has now been substantially nullified, I don't think that's true. We are experiencing communications technology change and benefits at heretofore unheard of rates, and I believe that is the direct result of the demise of the "old" AT&T.

The "New" AT&T Part 2 : Content vs. Delivery

It strikes me as odd that most, if not all of the commentators and analysts addressing the AT&T-BellSouth merger focus on an apparent future of content over digital wideband loops, without coldly assessing the skills of the company's to do so.

For example, I asked my partner today at lunch if he thought it would be reasonable for GM to enter the online video content business. He replied he thought not, because it's not something they have ever done before, and there is already competent competition. Just so.

Thus, I can't understand why anyone would think a phone company could enter the content business, either. Phone companies are the ultimate delivery business. Since inception, they have focused purely on connectivity, being a "pipe," not on the content over the pipe. Why would anyone think they have any relevant expertise in the hoped-for revenue-growth enhancing areas of video and other content-on-demand?

What is more likely, per Holman Jenkins' WSJ piece yesterday, is that AT&T, Verizon, which is spending like crazy on fiber, and the cable companies will all see the value of their physical high-speed connectivity assets fall with the coming of ubiquitous, high-speed wireless wideband access.

The game, for Verizon and AT&T, seems to be to add high-speed access revenues before the declining landline business forces them to the brink of insolvency. Cable companies are likely to be reduced to carriage, too, as much of their television content revenues become priced per-usage as online access consumption.

To me, this is appropriately Schumpterian. As Jenkins wrote yesterday, these investments are not guaranteed- they are, whether realized or not, just attempts at survival in a very uncertain competitive environment.

One thing continues to stick out in my mind this week, as I continue to reflect on the merger. Lately, I have reconnected with one of my earliest, post-graduate school supervisors for whom I worked at AT&T over 25 years ago. He's still in the area, with a telecom consulting firm. At the time he and I worked together, a then-upstart consulting firm, The Yankee Group, would publish regular pieces on AT&T and its premises equipment business efforts. However, the image I still recall is a chart showing net positive cashflow over time, beginning in about 1975. The line was headed solidly downward even then. AT&T was pouring cash into its efforts to fend off competition and prepare for some sort of deregulated environment. It was obvious to me, as I contemplated that macro view with my growing knowledge of our competitive positions in various product markets, that the entire business was headed for greater customer features, functions and services, at ever-shrinking margins and price levels.

I don't think that has ever stopped. This week's merger is really just a continuation, punctuated temporarily by Judge Greene's mistaken ruling, of that trend. The combination will help lessen some of the operating costs for AT&T, but it can't affect the continuing downward pressure on its revenues.

As I sit here writing these two posts, I sit only ten miles from the headquarters of the "old" AT&T, where I once worked. Mapquest tells me it is eighteen hundred miles from here to the "new" AT&T headquarters in San Antonio. It sure doesn't feel that the company has moved very far, or that very much has changed in terms of its fortunes.

The "New" AT&T Part 1

It has taken me all week to reflect on the news this past Monday that the "new" AT&T now includes BellSouth.

While others, with shorter memories and less visceral experience in the matter than me, have quickly analyzed the event in terms of current market opportunities, I take a different, multi-faceted approach in my response.

First, I must credit Alan Murray and Holman Jenkins, Jr., both of the Wall Street Journal, for their excellent written and spoken pieces this week regarding the ATT-BellSouth merger. In email exchanges with both of them, I confirmed that, beyond agreeing with their thoughts and insights, they also largely agree with my own further musings.

As both of them wrote, this is primarily a defensive move on the part of two aging CEOs who hail from the days of the original MFJ- the Modified Final Judgement which split the old AT&T into the various parts, including the seven regional bell holding companies. Despite Judge Greene's animosity toward AT&T, stemming from his involvement in an earlier antitrust case, as part of the DOJ, and his consequent decision to split the company up, much of AT&T's structure was always a necessity of minimum economic size in the telecommunications industry.

The problem was never with the monopoly on local, or even long-distance, services. It was with the cross-subsidization of equipment design and manufacture by local and toll call revenues. In fact, this was the actual relief sought by the DOJ when they brought the case. And, in the end, it probably would have been better for everyone had Charlie Brown, then-CEO of AT&T, simply acceded to the DOJ's wishes.

So, this week's reunification of more pieces of the old local service monopoly simply demonstrates that even Judge Greene's venom could not overwhelm the longer-term economic laws of costs and revenues in this sector. The purveyors of old, landline-based telecommunications are in a bad spot now. This merger may stave off economic hardship for the two companies, but it in no way has anything to do with their future growth.

Holman Jenkins, Jr.'s piece provided detail on this point. I will go further. Cellular and broadband internet access are already destroying the remaining landline telephonic revenue streams of Verizon, AT&T, and Qwest. They are fervently hoping to somehow play in the new world of broadband content before they implode with the unplugging of the last landline phone. Mr. Jenkins pointed to the arrival of WiMax as causing the ultimate collapse of even the cable monopolies. He is right.

The key point about this entire situation is that it is, as Mr. Jenkins ends his piece, "far from over." Telephone companies must, to merely survive, migrate from copper wires, but even this massively expensive move doesn't guarantee them anything. Ask Mike Armstrong, one-time CEO of the failed "old" AT&T's similar strategy. By the way, I stand by my remarks of a few months ago, that the AT&T name should be retired, in order not to make it endure the same failure, twice, by different inept managers.

To Be Continued in Part 2- Content vs. Delivery

Rewarding Losers: GE

It was only last Tuesday that I wrote of my reaction to Fortune Magazine's recent "most admired companies" survey.

At that time, I discussed GE CEO Jeff Immelt's inferior record of shareholder wealth creation, in comparison to the S&P500 index, over the past 5 years. Yesterday's Wall Street Journal provided the particulars.

In a piece buried inside the lead section, Immelt's 2005 compensation is described, along GE's continued lackluster performance. Let me get right to the heart of this piece. The WSJ piece states that Immelt owns just "...800,000 shares of his company's stock, valued at $29.1 million based on GE's $33.06 share price......Mr. Immelt receives quarterly dividends on his performance shares; he received $1 million in cash dividends in 2005, the company said."

What did not surprise me is that Immelt's 2005 salary was $3.2 million, and this year's is set at $3.3 million. He also received a cash bonus of $5.3 million in 2004.

The article goes on to detail Immelt's "request" that various performance, or bonus, shares of GE stock awarded to him be "totally aligned" with shareholders. Measures used are to include revenue, cash flow, earnings/share, and return on capital. Oh, and Immelt said he will not keep half of a 180,000 share bonus grant if total returns on GE stock don't beat those of the S&P500 over a two-year period.

Thus, despite Immelt's apparent concern with his company's shares, and their performance relative to the S&P, we see that Immelt is already a very wealthy man, any GE performance notwithstanding. At roughly $3.2 million per year since 2001, plus the $5.3 million 2004 bonus, he's already cleared at least $21 million pre-tax for heading up GE in the wake of Welch's departure. This is for running the company so that it underperforms the S&P500.

That's right. Some guy down at Vanguard in Philadelphia is getting paid probably no more than hald a million dollars a year, tops, for running a bare-bones index fund that gives its shareholders a better annual return over five years than Immelt has gotten for his shareholders. I'f I'm wrong on the Vanguard manager's compensation by a factor of 2, he's still only getting paid a tenth of Immelt's largesse, although he has outperformed the latter.

This, I maintain, is the real problem with US CEO compensation. Immelt has already "won" the compensation game. He can mouth platitudes about beating the S&P all he wants- it doesn't really matter now. Unless he has gambling, alcohol, or drug addictions, he's pretty much financially set for life right now. Think what you will, it must be hard to actually spend the roughly $15 million after-tax salary he's received, not to mention the upcoming bonuses, special share grants, and lush retirement compensation.

There is no way Immelt is going to take the risks needed to truly turn GE into a market-return-beating large-cap company anytime soon. It didn't do it under Welch over several decades. What makes you think it will happen under a guy who doesn't need the added compensation that would come from outperforming the index? A measly $3 million extra for actually beating the S&P? And, if he risks GE's current business mix to do so and fails, what does he incur? Ignominy, possible dismissal, and a fall from grace. Hardly worth risking those public humiliations for less than a quarter of his cumulative after-tax salary to date as CEO of the company.

I feel sorry for GE's shareholders. They are saddled with a board that is rewarding a loser as CEO, and have little prospect of things improving anytime soon.

What would get my respect and attention? If Immelt had taken the CEO job for $500,000 in annual salary, with the prospect of, say, $10 million of GE stock awarded annually and retroactively, for consistently beating the S&P500 over a five year period, I'd say he was putting his money where his mouth was.

By the way, beating the S&P over a two-year period is, according to my proprietary research, far easier than doing it over five years. The probability of beating the S&P over a two-year period is roughly five times greater than the likelihood of doing it over five years. And consistently outperforming the index for five years requires a much different approach by a CEO and his company's management team than simply aiming for a two-year sprint past the index's return.

As it now stands, Immelt has set a relatively modest performance target, the compensation for which will pale beside his other annual compensation. Some risk taking board and CEO.

It brings to mind Carl Icahn's comment of last summer, when interviewed on the subject of TimeWarner's CEO, and American CEOs in general. Icahn astutely opined that we are in danger of losing our global competitive edge at the CEO level as a result of lush, no-risk compensation packages. How right he is.

Googled

It was amazing to see the market's reaction earlier this week to comments from the CFO of Google regarding its future growth. Mr. Reyes acknowledged that the firm will need to find additional sources of revenue growth, and the stock fell 14% in intra-day, ending up down something like 7% at the market's close.

Obviously, this news was a big negative surprise for many investors. But how shocking can it really be to learn that a firm which has launched so many "free" services just this year believes it needs to find new sources of organic revenue growth?

I confess to still not fully understanding the profitability dynamics of Google. Fortunately, my own investment selection approach requires several years of actual performance in order to qualify as a candidate for inclusion into my portfolio. But generally speaking, I don't buy (or sell) what I can't understand. There are several reasons for this, one of which is best illustrated by the following story.

In the late '90s, I co-managed a venture with a hedge fund group. My role was the management of a static long-short version of my current equity strategy. In this capacity, I did marketing and sales work, including appearing with my colleagues at some hedge fund conferences.

On one of these sales trips, we had the occasion to dine with some Californians, among whom was a trustee and member of the investment committee of one of the state's better-known universities. At this time, Julian Robertson's Tiger Fund group had just gone out of business. Not being privy to the details of that group's fall, I opined that perhaps, like Long Term Capital, they had relied on historic correlations among various hedged instruments, and not adequately understood what would happen if their assumptions proved faulty. Upon hearing this, the university trustee exclaimed that that was exactly what had transpired. He then regaled us for some time with his story of hearing Robertson explain what had happened, as the university had invested in the Tiger fund. Essentially, the fund had hired some hot managers to do some hedging which, according to our acquaintance, Robertson himself had said he did not fully understand. The results are now well-known. That particular group made some horrendous bets which became "unhedged" and caused appalling losses which led to the liquidation of the Tiger funds. Apparently, Robertson lost it all by acquiesing to some managers whose approach he did not, in fact, comprehend.

Back to Google. From what I have read for several years, I still cannot fully understand what the revenue engine is for this firm. Can that many people be clicking on ads while using their search engine? Then there is that occasional story about click-fraud in connection with the websites using Google for their advertising.

In any case, Google's recent spread of activities into digitizing books, starting email and chat services, and global mapmaking, suggest to me, as I have written earlier, that they perceive their brand to be somewhat perishable, not to mention their current search engine advantage. Thus, it is not at all surprising to me that their CFO would admit that Google needs new sources of revenue to continue growing.

It makes me wonder how much of the investor interest in Google is purely momentum buying and holding, and how much represents fully-informed shareholders.

Hurricanes & False Positives

So now we are treated to video tapes of President Bush and his advisors being warned that Katrina was, in the "gut" of FEMA's then-head, 'the big one.'

It's all very well and good to judge in hindsight. I was driving yesterday and heard a news report on a local liberal classical music station that New Orleans Mayor Ray Nagin 'had a sinking feeling' when he heard of, or watched, the videotape. Nice dramatic touch- it's clearly his style. Find a scapegoat and pile on, while hoping everyone will forget your own culpability.

In reality, though, the situation was not nearly so clear prior to Katrina's landfall.

Let's remind ourselves of the two risks which exist in every hurricane situation. They are familiar to any data analyst. I am speaking of Type 1 and Type 2 error.

Type 1 error is that against which statisticians are trained to guard. It is the risk of rejecting an hypothesis which cannot, in fact, be confidently rejected. Most statistical tools focus on the rejection of hypotheses at some "confidence level." In this case, it is the risk of rejecting the premise, "Katrina is the ultimate lethal hurricane," or something similar, when, in fact, the premise is found later to be true.

Type 2 error is the risk of accepting a false hypothesis.

If Katrina had been judged, before it made landfall, to be as deadly as it ultimately was, then the correct decision would have been to order massive evacuations. If it turned out to be rather small instead, then authorities would have made a Type 2 error. They would have accepted the premise, "Katrina is the ultimate lethal hurricane," when, in fact, it was not. Don't think that great ridicule and anger would not have been unleashed on all authorities, beginning with President Bush, in that event. Ray Nagin would have been screaming, '...they told me to evactuate. it's not my fault that people died, were injured, and property was looted in the rush out of town.....'

As it now stands, authorities believed they should wait until they were more sure of the hurricane's strength than, evidently, the date and time of the recently-released videotape. They minimized Type 2 error, accepting a false premise, in favor of not needlessly disrupting a major city for a non-lethal hurricane. Either way, the administration was going to be criticized.

It's convenient, in the aftermath, for the mayor of New Orleans, and anyone else with a liberal-leaning agenda, to declare that the Federal authorities "knew" all along how deadly Katrina would be. But that's just not true, and it's an oversimplification of what most people understand is an always-difficult decision- if and when to evacuate a large population center in advance of a hurricane, attempting to balance the probable costs in lives and property of evacuation with those of staying put.

Taking a "Haircut"

As I waited at my barber's this morning, the result of a half hour's difference in our understanding of my appointment time, I had the occasion to skim through the most recent issue of Fortune Magazine. Most "haircuts," in the financial sense, cost you money. This morning, since I do not typically read Fortune, I got a free bonus- the theme for this piece.

This issue, the first in March, contained the magazine's "most admired companies." Naturally, I was surprised to see Jeff Immelt's face on the cover. When I think of companies I admire, my thoughts turn to those rare gems which can consistently outperform the S&P500 for several years- often up to five. When I read of a current survey, I assume the performance in question must be recent.

GE is not one of these companies. Go check its return versus the index on one of the free finance sites, such as Yahoo. It isn't even close. Not for the past 12 months. Not for 2 years. Not for 5 years. No contest- the race goes to the index.

I read a few more passages from the article, and noticed IBM was also touted. The phrase "turnaround" caught my eye.

So I checked IBM's return over the last five years versus the S&P500 Index. Care to guess whether this well-known information processing hardware, software and services titan did any better than GE?

IBM also failed to best the index over 1, 2 and 5 years in terms of total return. So much for a "turnaround."

Why would a business magazine such as Fortune waste so much ink and effort on "admired" losers? Is this what we have come to regard as business success in America? Maybe I'm the one who is out of step. I just can't see glorifying companies, and their managements, for underperforming an index you can buy for no more than two-tenths of a cent on the dollar from Vanguard.

My research and continuing portfolio management demonstrate that it's a rare, and "admirable" characteristic just for a company to consistently outperform the S&P500 over several years. As an investor, I could not care less what else the company does for the time I hold their stock, or how widely admired it is for other reasons, so long as they beat the index.

Did I mention that I don't subscribe to Fortune? Does it surprise you that this morning's quick read through their latest issue makes me feel I've made a wise decision?

Orwellian "Free" Trade and U.S. Port Operations

This week's Congressional hysteria over the imminent deal to allow a United Arab Emirates-owned company manage several large US port operations is a blow to American attempts to promote global free trade.

From what I have read and seen so far, there is no security issue whatsoever with the change in ownership of a company which currently manages several large US port operations, from a British to an Arab conglomerate. US port security is managed by Customs and the Coast Guard, not operational management of a port. This was clearly stated when CNBC interviewed the chairman of the firm which operates the port of Houston last week.

So what we actually have is some of our country's 535 legislators up in arms because an agreed-upon vetting process does not give them final say. Did I mention the Wall Street Journal's comment regarding campaign contributions to some key New York-area senators and representatives by local cargo-handling interests? There is probably a good reason for the vetting process being handled by the Executive branch. You can be pretty sure that if Congressional members are involved, influence-peddling won't be far behind.

Most damaging in this affair, though, is its effect upon the efforts of the US to influence freer trade on a global basis. Thanks to our typically short-sighted members of Congress, such as Senators Clinton, Menendez and Schumer, and Representative King, countries such as China now have an example to which to point in the US, when they refuse to open their own economies to more global competition. Another significant, perhaps lesser issue, is the damage these same legislators are causing by failing to understand that, as it now stands, their opposition looks like ethnic bigotry targeted at Arabs, rather than a legitimate US security concern. It isn't a question of US management versus foreigners, but "these" foreigners.

Hopefully, President Bush will stick to his guns on this issue, and, after a second vetting of the deal, it will be cleared and closed. Otherwise, we risk damage to both the cause of free trade, and our image in the Arab world.

Reforming Health Insurance: Cream Skimming vs. Responsibility

The Wall Street Journal carried an article last week featuring a South African life insurer which offers the equivalent of "frequent flyer" points to customers who engage in healthy activities. Without reprinting the entire piece here, suffice to say, the insurer rewards various activities, such as exercise, checkups, and other activities shown to be related to better health, with points which may be redeemed for various things, such as inexpensive stays at resorts, etc.

This insurer is now entering the US market with its programs. As might be expected, the company is being accused of "cream skimming," both in its home country, and in this one. Essentially, sceptics believe that this insurer seeks to hold costs down by insuring only the healthiest individuals, thus avoiding expensive claims which would depress profits.

This brings me to the point of this post. The salient issue of this situation is, quite simply, responsibility. Who is responsible for poor health? For disease? And, thus, who should pay for the condition?

What is wrong with incenting people to behave in healthier ways? Nothing. Merely incenting me to exercise more, not become obese, etc, is good for me, and the insurer.

Clearly, the key question is something more along the lines of the following example. Suppose a child is born with a serious disease which cannot be "cured." The child will be ill, and nonproductive, in the sense of being capable of living as a self-sustaining individual. Who is "responsible," who should pay for that outcome? If an insurer chooses not to underwrite that child, or the adult with the child, is that "wrong?"

It seems to me that the general notion that "cream skimming" is bad always revolves around this question. Whether it involves private (Catholic) education, driving, or health, the real issue is how to distribute the real cost of high risk in society.

It seems to me that perhaps there is a better approach than the binary "all or none." Perhaps each person, or family, should be insured by society, i.e., government, at an agreed-upon level of "benefit," or claims, reflecting the probabilities that they will incur specific uncontrollable diseases. In addition to that, one may purchase, as available, private insurance. This at least acknowledges the reality of the occurrence of such diseases, and offers a minimal level of support for same.

There are, of course, a host of complications. How do we define these diseases? Which ones qualify? Does DNA testing mean there will be no effective private underwriting of such additional risk? Does it even go so far as to suggest that society may withhold coverage from individuals with unacceptably high probabilities, as predicted by DNA samples, of producing children with these diseases or conditions?

These are serious moral and economic questions for any society. How we choose to allocate our resources, in a world of competing national economies, is not a trivial question or topic.

Thus, the question with which this note opened, that of "cream skimming," is a much deeper one than it may initially appear. How we view the answer to this question suggests how we view answers to the deeper related questions of responsibility for situations which may be, for now, uncontrollable. It seems to me that exploring the answers to these questions is a good thing. Simply demonizing those who offer products and services from one vantage point is not.

Lance Armstrong's Troubling Endorsement

Last week I noticed an ad in the Wall Street Journal for a mutual fund complex, American Century Investments.

What was unusual, if I am not mistaken, is that the ad featured an endorsement by Lance Armstrong. A picture of the cycling great was the background for the text, which compared Lance's focus on winning to the presumed need of customers everywhere to focus on their financial performance.

If this is, indeed, an explicit endorsement by Armstrong, I confess to being dismayed.

First, who cares what a bicyclist thinks of a mutual fund complex? Armstrong is rather noted for employing a coterie of handlers to deal with the many complicated details of his operating empire. Why would anyone think he knows about equity or debt fund management?

Second, this is the first time I can recall seeing Armstrong endorse a non-athletic product which he, presumably, has not used. Or is not a tangible good. Isn't this insanely risky on his part?

It's one thing to oversee the design and production of, say, a bicycle, or an accessory, or whatever else Armstrong endores. Perhaps a car, I think? But the ongoing managment of a mutual fund complex?

Wow. Talk about financial risk!

Does this imply Armstrong's desperation, or naviete? And what of the perceived value of his endorsement, now that he's peddling money management to the masses?

I liked it better when he just rode his bicycle.

Inverted Curves

A very hot topic in financial circles for the past month has been the inversion of the Treasury yield curve. Currently, it is in a condition such that longer-term yields are lower than current yieleds.

At various times in the past, and I mean long past, such as up to 20 years ago, this has been coincident with the onset of recessions.

So, as you might imagine, quite a few financial media types are all over this story, to sell more ads and newspapers.

Here's a headline, though, to pour cold water on the hot topic. When asked about this, directly, during his recent Congressional testimony. He succinctly and directly replied that the inverted curve does not now portend economic recession.

How much clearer can you get? The chief monetary expert in the country, who has made it his research focus, does not believe that current conditions sustain the hypothesis that an inverted curve always portends recession.

This notwithstanding, the journalistic airheads on CNBC keep ranting about the inverted curve. All month long they have ignored Bernanke's comments, and sensationalized a host of minor analysts.

For the record, times have changed. I have found, in my own equity research, that the markets are qualitatively different now than prior to 1985 or so. It's easy to forget how scarce and expensive fundamental and technical information was in those days, compared to today. Computers were slower, less capable, not "online," and much more expensive. There is a sort of "one way" arrow of information effects over time. My own equity approach was less consistently successful in the era before the inexpensive and ubiquitous availability of performance data.

It pays to focus on credible sources, and ignore the lesser lights. I think Bernanke is viewing global economic expansion, and seeing the current yield curve inversion as evidence that the mediocre 70% of market participants are not processing market information correctly.

You Can't Judge a Book......?

Yesterday, I came home to find an unexpected bulky package in my mailbox.

For the second time in as many weeks, I had received an unsolicited book. Not exactly a typical occurrence, as I am neither a publisher, nor a reviewer of books.

However, these two particular books gave me pause, as they are exceptions to the old saying to which the title of this piece refers. Sometimes, there is enough information on a book's dust jacket to prioritize one's reading list. In this case, one volume went straight to the bottom of my list. The other is my current read.

The losing title was some combination of words like "innovation," "entrepreneurship," and, maybe, "American values," or "American economy." I really cannot recall. The author is the named donor of an entire center of study at a second- or third-tier US university. Are we surprised to learn that the center in question is focused on entrepreneurship? The gist is that without innovation, our entrepreneurship won't continue to drive our economy. Or maybe it was, 'without entrepreneurship, our economy won't be innovative.' Or was it, 'without an economy, innovators can't be entrepreneurs?' Well, you get the general sense of it.

Thanks- I was really losing sleep over these burning questions.

What sealed this book's fate was a quick look inside the cover, to see if the sender had inscribed a message. He is a classmate from graduate school, from whom I had not heard in years. No inscription. But in accidentally turning a page further, there was a page of acknowledgements, including one to the sitting CEO of GM, Rick Waggoner. That did it.

Does anyone really think Waggoner has demonstrated knowing anything about "innovation," "entrepreneurship," or running anything well during his tenure at the now-prostrate auto maker? Merely mentioning the guy on that page made me question the judgement of the author and co-author. Plus, the book's stated topics don't seem all that insightful. I would hazard to guess that our economy has out-performed most of the world's other economic systems due to its inherent risk-taking, risk-rewarding nature. Innovation and entrepreneurship would seem to be key elements of our economy on the face of it.

The other unexpected book I received recently, however, is a gem. My business partner, Steve, bought it for me on Amazon. Entitled, "Mean Markets and Lizard Brains," by Terry Burnham of Harvard. It is a rare breath of fresh air on a business-related topic from a school that is not noted, anymore, for empirical research. Burnham is a member of the second generation of academics doing work in behavioral finance, and this book is well worth reading. The title was rather obtuse, but compared to the other book, at least it wasn't uninteresting on its face.

So, maybe sometimes you can judge some things on face value, at least to rank order their worth.

I'll be writing more on Burnham's excellent book soon, as it provides some empirical foundations for why my own equity strategy has performed so consistently well over the last fifteen years.

Animal Spirits

It seems that last week, the equity markets decided to revalue energy company stocks upwards, while softening on technology issues.

At times like these, I am reminded of Ben Graham's famous depictions of the equity markets as person who, on some days will sell the same thing cheaply that, on other days, it will hold much more dear. With no apparent relationship between the two.

The wild ride of energy stocks so far this year bears this out. They were up significantly in January, and, then, as if a switch had been thrown, plummeting in the first ten trading days of this month. How can the long term outlook for the sector, and its various components, have been affected so much in so little time, absent any serious exogenous influences?

The answer is, as Graham observed, and Keynes, before him, "animal spirits." They seem to move investors and traders to value things in unsupportable and unsustainable ways in the short term. Thus the reason I hold stocks for several quarters. In market conditions such as these, who can possibly know that a daily value is "correct?"

Rather than attempt to trade frequently, attempting to anticipate volatile short-term price moves, I prefer to invest and hold, taking advantage of superior management and longer-term trends.