Ganesh Filters III: Analyzing Businesses Blueprints
The prior posts surveyed the general economic and market situation and the investment performance situation. Here we'd like to continue that theme and fortunately ran across several interesting sources and stories that reinforce the argument. Links and excerpts are continued below the line. A fascinating WSJ article finally extends the enterprise value argument by looking at current results vs future performance expectations. The graphic
example points at MickeyD's but please take note that it was strategic re-thinking and operational improvements that led to changes in future value, current valuations and stock improvements.In other words the way to translate our model of enterprise performance assessment is now explicitly linked to stock performance. But,we'd strongly emphasize, the key is the performance improvements, not pandering to short-term street expectations. Below are some equally fascinating links to analyst expectations which seem, in this light to be wildly mis-judged, to the liklihood of very large increases in corporate bankruptcies and, fresh today, two financial columns that outline strategies that conincide exactly with our overall outlook, sector analysis and individual performance analysis. We also provide linkages to applicable prior posts.
Just to explore this whole topic we ran an interesting experiment on LinkedIn by posting a question on expectations on enterprise performance. So far the response has been rather small - which may be a sampling problem. We'd also suggest that it's serious awareness problem. And, as today's headlines illustrates, early warnings are easy to ignore. The "surprise" downturn in Employment has been visible for months yet everyone is shocked, simply shocked :). Anyway if you can get to linked in check out the question for yourselves. Better yet leave your comments on your expectations here !
For another perspective we'll point to the performance of the SP500 over the last several years, especially PE Ratios (for why they're excellent indicators of eventual long-term performance try here or here. Anyway if you'll pop up the chart at left you'll a "stunning" climb in EPS coupled with a more than stunning compression of PE rations. Now you ask why might that be - could the market have figured out that earnings and profits are in fact not organic, are held up by buybacks and buyouts and not likely to be sustainable ? We'd argue that's a fair assessment and, willy-nilly, that any investment you're considering should be subject to the same value questions. How are they doing now and why ? And what are the likilhood of future improvements ?
Those are the questions that put you on the path to finding value investments that'll provide strong returns. And the heart of the discipline is seeing clearly what's coming, how performance is related and evaluating current strategic position and operational capbilities as well as future ones. Suitably adapted of course for sectors or other asset classes :).
Good luck and good hunting !
The Future Is Now Executives have become increasingly sophisticated at analyzing the value of current operations to help them manage the goal of increasing shareholder value. But they still need to supplement the tools used for value-based management with one that can analyze their company's future value. By the early 1990s, companies were increasingly zeroing in on whether business operations were adding value. Value-based management tools remain popular today, among them EVA, or economic value added, which takes after-tax operating profit and subtracts from it a charge for the capital employed to generate that profit. However, a variety of academics and consultants have pointed out the limited usefulness of EVA and other value-based performance measures, particularly given a propensity toward current-period and short-term, backward-looking performance evaluation. For example, EVA fails to quantify the increased value a company might realize in the future through, say, higher levels of investment in programs aimed at increasing brand loyalty, developing talent, generating patents or bolstering research-and-development capabilities. True value-based management requires executives to look both backward and forward. How important is future value to share prices in concrete terms? As an example, an analysis by AssetEconomics Inc. of the companies in the Russell 3000 Index as of May 2003 found that future-value expectations represented 59% of their overall enterprise value -- the market value of a company's equity plus the net value of its interest-bearing debt obligations. In 12 of 22 industry groups analyzed, future value made up more than half of enterprise value. In our research on a select set of major retailers, we saw a downward trend for future value in the industry as a whole. From 1998 to 2006, most of the retailers continued to invest heavily in new-store openings, fueling an increase in the companies' current value. Future value, however, didn't keep pace with the growth in current value. Best Buy Co. is an instructive exception to the industry trend. . Best Buy then launched its "customer centricity" strategy, which was designed to pinpoint the most profitable and fastest-growing customer segments in each store. A similar lesson can be found in McDonald's Corp.'s ability to renew investors' confidence in recent years. In the ensuing turnaround initiated by a new leadership team, increasing same-store revenue became the new focus of top management. Doing so meant renewing the brand through marketing and advertising. It also involved a radical change in the product assortment, with an expanded menu including salads, snack wraps and new sandwich and burger options. Video: The concept of future value
- WRFest 30Dec07(Business): Fragilities, Exposures & Soundness If it's not clear at this point we think the economy is slowing and seriously exposed to sudden & sharp disruptions as Housing and the Credit crisis worsen and it becomes more fragile. We also think that the Markets still haven't grasped this nor, definitely, is it reflected in pricing, earnings outlooks or valuations. Even on current course and speed with no major disruptions there's some serious re-thinking that needs to happen, at least IMHO. But if you start looking now and understand what's going on then there are going to be industries and enterprises that weather this storm, if not with style and grace. Finding them will be the trick and the trick to the trick starts with understanding the deeper structural fragilities that have been created by non-organic earnings and liquidity-driven buybacks. Well as is becoming a practice Paul Kasriel has already done the heavy lifting so we'll let his comments and charts speak for us. Here's the key point - on a macro level buybacks, real declines in profits and increased leverage indicate that business enterprises are very exposed to shocks if/when they come. In other words a hurricane will breach the dike and it'll take a well-founded company to manage the floods :). So pay careful attention to Paul's words and charts - think about 'em, 'cause they could be incredibly important.
- Corporate Earnings: A 2008 Bright Spot? After a disappointing 2007, profits are expected to rebound in the coming year. But there's a lot that could go wrong If you're looking for a prime example of the stress and strain on the economy from a tumultuous year, look at corporate profits. A year ago, analysts were expecting a great 2007. Earnings for the Standard & Poor's 500-stock index were expected to jump 14.5%, according to Reuters Estimates, after a similar performance in 2006. Boy, were the forecasters wrong. Reuters Estimates, which compiles the predictions of thousands of equity analysts, expects earnings to rise only 2.6% in 2007. That number could be reduced as financial firms prepare to report billions of dollars in writedowns from the year's credit crisis. By the time fourth-quarter earnings are released in the next month or so, Goldman Sachs (GS) predicts, 2007 earnings will rise just 0.7% from 2006 levels. However, despite the disappointing 2007, and despite the turmoil in the housing and financial markets and the fears of an economic slowdown, many analysts remain surprisingly optimistic about profits in 2008. S&P 500 earnings are expected to spike 15.7% in 2008, according to Reuters Estimates. A weak 2007 makes the year-over-year comparison that much easier.
Citi and J.P. Morgan Predict a Buffet of Defaults A wave of defaults from companies as diverse as the fare on a Buffet restaurant’s menu could be on the horizon. With credit flowing to practically any company in need of cash in recent years, the rate of defaults for U.S. high-yield companies fell to just 0.34% in December, according to a J.P. Morgan Chase analysis. The J.P. Morgan analyst, Peter Acciavatti, predicts that is about to rise drastically, to 4% by the end of 2009, and he isn’t alone. As BreakingViews points out today, Citigroup expects the default rate to surge to 5.5%, as easy credit becomes a distant memory. Those skeptics who say such predictions have time and again proved premature got a wakeup call Wednesday. That is when Tousa, the homebuilder, disclosed that it missed interest payments on $485 million in debt.
- Model behaviour OK, people have been predicting gloom for years. But that may be because their models failed to take account of looser covenants. Citi has a new model that predicts US high yield defaults hitting 5.5% by 2009 – even without a recession. Europe won't be that different.
Is '70s-style stagflation returning? Inflation is rising and the economy is decelerating, but those problems don't add up to that nasty combination of stagnant growth and out-of-control price increases. Yet.So how do you position a portfolio as we go into 2008? Remember that stagflation is possible but not certain. Investors who pay attention to the financial news out of the big banks should be able to keep their portfolios a step ahead of any shifts in the economy's direction. Fortunately, many of the investments you'd make to combat stagflation should work pretty well in 2008 even if all we get is a slowdown spread over a few quarters and a step up in inflation. Commodities and energy. Gold, of course. Growth stocks in sectors of the economy that will grow even if the economy slows. And any defensive growth stock with enough pricing power to raise its prices fast enough to stay ahead of inflation.
10 market predictions for a glum '08 It'll be a year of stock upheavals, especially in banking, but with great bargains along the way. For investors, the new year will be defined by a titanic struggle between governments' efforts to flood the world's faltering financial system with cash and banks' efforts to hoard it all for themselves. Commercial banks are stashing instead of using the cash infusions because leveraged mortgage bets gone bad are shrinking their capital bases faster than central banks and foreign investors can refill them. So what are the prospects for investors in this unhealthy environment? Here are the surprises that I see lying ahead:
Prior Postings
Another Trip to HD's Woodshed , Tesco in the US
An Ichan-like Inventory of Performances , Business Performance Readings
Strategic Outlook for US Industries , Tech Industry Outlook, Finance Industry Status, Retail Industry Performance
Review the Bidding: EPS Growth Analysis
Market Drivers (3): Buybacks and Market Drivers (2): Buyouts