Performance Assessment Basics: Five Fundamental Factors
We'd thought to put up the next readings collections focused on traditional businesses but with
INTC's results and GE's from last week, along with the resulting market gyrations, it seemed like a good idea to set that up with a deeper dive into evaluating business performance beyond the headlines. And trying to couple that with some observations on market behavior and investing.
The bottomlines are that GE is actually doing much better than its' hammering, deserved in the short-term but a buying opportunity in the long. INTC is also doing some wonderful things, though not as outstanding as the headlines, and both are long-term investment opportunities. And for largely similar reasons. Both have undergone massive transformations over the last several years, both have broadened and modernized their product portfolios to match the 21st C and both are running very tight, forward-looking but current-controlled enterprises. We'll pick on each one a little more detail in a follow-on post but we need some machinery first.
We've talked before about our approach and Warren Buffett's to understanding a business, and it might be worthwhile to review that (Masterclass: Buffett on Investing and Business Analysis), but two guidelines Warren came out with that motivate this whole exercise. Understand the business you're investing in - what he doesn't mention is that he spent decades at it, not just sticking to ice cream. And focus - if you're going down this path focus on 7-10 investments but constantly track and monitor a pool of selected targets of 20-30. GE and INTC are perfect examples because, among other reasons, if you get familiar with them you get a baseline for understanding a broad swath of industries. And when Warren says understand a business he means this kind of in-depth investigation.
Understanding the business means digging into five major factors and their relationships with each other and the company as whole, laid out in the graphic and discussed in detail below. If you'd like some more discussion keep on....
Five Factors of Performance
1. Fundamental Value Proposition - the first thing you need to understand is what does a company do. Oddly that's a lot less trite than you think because the answer leads to the business model and strategy, i.e. how they make money now and in the future. A good example of someone who lost sight of their business model was Dell where they stuck with their old model and can't find a new one. An example of a company who may have self-arrested in time is Starbuck's. Which can be contrased with both WMT and Home Depot both of whom had mature, saturated and aged business models that they're still struggling to adapt to the new world. On the other side of the coin P&G and MickeyD's are perfect examples of companies that self-arrested, re-thought their fundamentals and re-built their companies in flight. Which shows you good strategy is one thing but execution another.
2. Marketing, Sales and Service - a good place to start is what anyone can see by inspection which is how do companies treat their customers. Oddly enough we've known for over 20 years, and by known we mean had data and profit figures to prove it, not just good business judgement and intuition, that good service is not just a cost. It helps grow revenues and profits. Whether your someone involved in investing or running a company this is a test point, for one thing it's an area where some of the fastest short-term benefits show up. It's also where problems with the business model and execution do as well. If you go into a retail store and the displays are sloppy, the prices terrible and the floors are dirty you've found out a lot about that company. One of the first signs that Dell was in deep trouble was when they cut service costs, cut corners and outsource to India. Nothing against Indian outsourcers per se but the company was built on a value proposition that said we'll take care of the customer. When service started going down, extras got charged for you had a 2-3 year heads-up on looming major problems. A more recent example - the Ritz-Carlton is running a series of on-line ads suggesting a bridegroom has one last chance to cheat on his girlfriend. That's just wrong in so many ways let alone for a company supposedly based on service, customer-focus and value. That it got out the door is appalling on multiple levels.
3. Operations (Logistics, Procurement, Manufacturing,Product Development etc.) - in some ways this is the beating heart of the company. For auto companies at the end of the day they can run all the great ads they want but what kind of a car did they build. Two perfect examples of the same kind of execution breakdown are Chrysler and AMD. AMD came up with some great new chips while INTC took it's eye off fundamental changes in the market so AMD was able to kick butt and take names for a couple of years. But it turned out they couldn't sustain it. Similarly Chrysler culture for decades has lurched from hit-to-hit but had poor manufacturing and operations. Another perfect example is Motorola which rode the Razr high but didn't have either the manufacturing execution or product development processes necessary to create sustained performance. One can envision applying this to the entire Finance Industry - great strategic concepts combined with terrible risk management and operational execution. Oops and ouch. Bright ideas don't count if you can't deliver them.
4. Management Systems (Budgets, Operating Plans, Controls, HR, Leadership) - this is kinda of a catchall but it's the skeleton and sinew that everything else is hung around to form the body of the enterprise. I can't tell you how many companies don't have any budgeting systems let alone effective ones. Years ago I sat thru a presentation on SOX the first 3rd of which was common business sense and the last 2/3 of which was legislative and regulatory rules for enforcing what should have been common business practice. The story goes that each Citi manager has so many conflicting institutional goals, measures and conflicting instructions that they just ignore 80% of them. If you wonder why Citi blew off both feet at the knees in front of our eye and has never made the supermarket function there you go. If you really want to know whether a company can hang all together and make the parts integrate and serve the whole this is where you can test. And there's actually a pretty good forward looking indicator. Look at the Investor Relations pitches - Intel and GE's are particularly good. For clarity and structure IBM's is superb except that it's focused on financial engineering and not on growing the business.
5. Pauschian Head Fake - did you notice in the chart that there are only four boxes and we talked about Five Factors ? Well if we didn't get too clever and you clicked thru on the repeated graphic it took you to a PPT slideshow version that filled in the middle with the head fake. At the end of the day this is all about making the pieces work together. And especially on realizing in this brave new world that just maintaining history won't cut it.