bizzXceleration: Performance, Value and Profit

Long-term Perspectives

Thornton Oglove on investing If you haven't heard of Oglove, who recently turned 75, that is understandable. He retired from the investment industry in 1990, but not without leaving his mark in the form of a book, "Quality of Earnings: The Investor's Guide to How Much Money a Company Is Really Making." On the current environment: "In my view, and I've been investing for 50 years, this is the worst credit crisis since the '30s. There's too much debt relative to equity." What about the current crop of earnings? "The market is influenced by earnings, and earnings have held up." What happens if you remove the benefit many multinational companies have received from the cheap dollar? "I would say you would have a very low quality of earnings," meaning much profit would be lost in translation against a stronger greenback. Speaking of which, what role should earnings quality play in the analysis of a company? "I think the balance sheet is 10 times more important these days. The less leverage a corporation has, the better off they are." What are some of your favorites? "I own the Swiss Helvetia closed-end fund, which is selling at a 13% discount. It owns Swiss stocks, but these are Swiss francs I'm invested in. I like Barrick Gold, but it took it 20 years to kick in. I like General Electric. These analysts are all down on Immelt because they want instant gratification every quarter. They are upset that the company missed, and they want the company to break itself up. That's insane. What do they know about managing GE? It still pays a good dividend, and a large portion of future appreciation will be these dividends."

Look to the margins when using the price/earnings ratio I love the price/earnings ratio, but like all investment tools, it is flawed. This is because it is only as good as the numbers that go into it. There is no debate about the "p" in the equation - price is quoted every second. But the "e", though readily available, is only as good as the best estimates. Many people describe the stock market as cheap. After all, at 18 times earnings, p/es are half of what they were eight years ago (those bubbly valuations are not coming back anytime soon) and only three points above their long-term average of 15. However, the "e" is temporarily inflated by all-time high (pre-tax) profit margins, which are at 11.5 per cent, or about 35 per cent higher than their multi-decade average of 8.5 per cent. Historically, every time profit margins have become overextended, they have reverted towards the mean (that is, declined). This is because capitalism works. One company's excess profits are another's potential opportunity - increased competition puts pressure on profit margins. This time round is no different. If profit margins fell and stopped when they reached the average level - an aggressive assumption as historically they have overshot and gone lower - the market's p/e would rise from 18 to 22. Don't abandon the p/e ratio, but adjust the earnings for high margins. Take a close look at the profit margins of the stocks in your portfolio and ask yourself if today's margins are sustainable. If you adjusted margins to the historical average, would the stock still look cheap?If you own a stock that belongs to the "stuff" or financial services groups, assume its high margins won't last.

$40 billion burning a hole in his pocket Berkshire Hathaway, the insurance focused conglomerate run by billionaire Warren Buffett, has been sitting on more than $40 billion in cash since 2004. When stock markets climbed and the housing market soared from the end of the dotcom bust in 2003 to the middle of last year, Buffett struggled to find attractive investments as he followed his own advice of being fearful when others are greedy and greedy when the market is running scared. Now, as thousands of Berkshire shareholders prepare for their annual pilgrimage this weekend to the company's headquarters in Omaha, Neb., some are hoping Buffett has the crisis he's been waiting so patiently for. Berkshire has already snapped up some securities that have been particularly hard-hit by the credit crunch. In February and March, the company built up a $4 billion position in auction-rate securities, Buffett told Fortune magazine in early April. Berkshire has also made big bets on high-yield, or junk bonds, which have suffered in recent months from the credit crunch. The company owns derivatives contracts that require it to pay up if certain junk bonds default. They expire from 2009 to 2013. The company collected $3.2 billion in premiums on these contracts last year and paid $472 million in losses, Buffett reported in Berkshire's latest annual report. Buffett: 'Why I go to work in the morning'

·         Buffett Plots $40 Billion Spree as Credit Crunch Hinders Competing Bidders Buffett spent $4.5 billion last month for a 60 percent stake in the Pritzker family's Marmon Holdings Inc. He committed $6.5 billion this week to help finance Mars Inc.'s takeover of Wm. Wrigley Jr., the world's biggest maker of chewing gum. The deal includes $2.1 billion for a minority holding in Chicago-based Wrigley that Berkshire will get at an unspecified discount. At the center of Buffett's European efforts is Angelo Moratti, scion of the founding family of Italian energy company Saras SpA. Moratti is organizing visits to Milan and Madrid. For the past seven years, Moratti traveled to Omaha at least four times a year to brief Buffett on companies and issues in Europe. Buffett has said in recent years that investments meeting his criteria and big enough to make a difference to Berkshire have become scarce, prompting him to look abroad. He said at last year's annual meeting that he would welcome a $40 billion to $60 billion deal. Buffett also has said he expects the dollar to depreciate, making earnings in other currencies more important.

• Wilbur Rosss World Tour Fresh from his around-the-world tour, Wilbur Ross grants CNBCs Maria Bartiromo an exclusive interview.

A Time to Mourn–or a Time to Mine?  Like the sample of the cut plastic, many “gems” can be unearthed across the world, especially in Asia and Europe, due to the current credit crisis. They are companies that have great growth potential when cut and polished and are fundamentally solid, but have been affected by the credit crunch. This presents opportunities for strategic acquirers to dig and buy the gems at a discount, especially now that the miners who had been most active in digging them out over the past four years—the private equity firms—are finding it increasingly difficult to finance their acquisitions with cheap bank loans. For example, in Europe, the valuations of private company sales to private equity has fallen by 14 percent in the third quarter of 2007 to a multiple of 15.3 times a company’s earnings. Meanwhile, the valuations of private company sales to corporates fell by just 2 percent to 13.4 times earnings. A decade of corporate restructuring, economic integration and international expansion in Europe has created a region with many hidden gems. The European gems are like rubies—the second hardest gemstone after diamonds—in that they have built up strong foundations over the years and are generally well-run. Asian firms, on the other hand, are keen to seek investment and technology partners to upgrade and expand abroad. In China, and to a certain extent in India, many companies are started and managed by young entrepreneurs. Not interested in selling their companies yet, they nonetheless pursue high-trajectory growth paths. In many instances, this means they are interested in accepting capital and technology transfers to aid expansions

Strategic Issues

Pay Gap Fuels Worker Woes The gap between top executive and employee compensation has never been greater. That's triggering lower morale and productivity on some corporate staffs, and making it more difficult to attract and keep talent, even in a slowing economy. Last year, payouts hit record highs despite efforts by corporate directors to put the brakes on perks such as overly generous signing bonuses and exit packages. According to the Congressional Research Service, the average pay for CEOs was more than 180 times average worker pay, up from a multiple of 90 in 1994. For many employees, the higher cost of gasoline, health care, education, food and other daily expenses has left them with the feeling that they are treading water. Hard-charging CEOs, who have spent decades climbing the ladder by putting in 80-hour workweeks, say they deserve to hit the jackpot when they gain the corner office. But ambitious employees have similar feelings, and figure their best chance to close the earnings gap is to keep zigzagging among companies and industries. "When executives talk about a talent shortage in their ranks, they're really talking about a commitment shortage," which stems partly from pay inequality, says Rakesh Khurana, an associate professor at Harvard Business School. "The greater the inequality, the less willing employees are to learn specific company ways of doing things that aren't going to be useful to their next employer." He says less than one-third of M.B.A. graduates from elite business schools are pursuing corporate management jobs, compared with two-thirds in 1970.

Help Wanted: Managers U.S. companies in China say recruiting talented managers for their local operations has become their biggest business challenge, a finding that highlights the continuing gap between the skills taught in China's universities and what businesses here are actually looking for. A joint survey by three American chambers of commerce in China showed "a continued worsening of human-resource challenges as companies expand," said J. Norwell Coquillard, chairman of the American Chamber of Commerce in Shanghai. Difficulty in finding, training and retaining managers was named as the top operational problem by 37% of the 324 companies responding, more than issues such as regulation, bureaucracy or piracy. U.S., European and other foreign business executives in China have grown increasingly worried about talent issues as they have expanded their local operations.

Importing Design Talent Mr. Ng's talent search is part of a push by Chinese apparel makers -- from yarn and textile manufacturers to those that stitch the garments -- to break into new territory: offering the world's biggest brands design expertise rather than simply following their instructions. By hiring in-house designers, the Chinese companies' thinking goes, they can turn around clothing collections faster, gain an edge in the fierce domestic competition and charge more for their services. At the same time, these companies are discovering the difficulties of nurturing creative talent. "It's not easy to work with designers," Mr. Ng said. No longer content with simply manufacturing low-cost goods for other companies, Chinese companies in a range of industries are trying to move up the value chain -- with varying degrees of success. Fashion brands have been making their goods in China for years, yet homegrown designers are in short supply. Design is still a new field for young Chinese, and local designers often struggle to grasp Western tastes. Now China's growing appetite for creative talent is making Western universities into feeder schools for textile manufacturers.

The Future of R&D: Leveraging Innovation Contrary to conventional thinking, R&D is a very manageable driver of corporate success. In large companies, of all of the things that are done, innovation tends to be managed with the least discipline of any function. "[Consulting firm] Booz Allen Hamilton reports that of all of the core functions of most companies, innovation had the most competitive value, but is managed with the least discipline," Maxwell observes, "and I agree with that. When I looked around the company [Parker Hannifin] and saw what was going on, it wasn't that people weren't innovating; rather, serendipity seemed to rule. Missing was the disciplined rigor of order and metrics common to the rest of our operations, like running a factory. In the manufacturing function we constantly measure our performance. Maxwell's approach with the Parker R&D program, called Winovation, puts a lot of things in place to create a corporate environment to enable and facilitate the innovation process. "That resulted, for the first time, in a standardized process by which we would evaluate projects and align them to our strategic growth objectives and track them in real time via the Web." The result: "For the first time Parker Hannifin could see itself. I could see every single project in the entire company and there was a rush of communication and collaboration among the divisions." Another outcome was the development of metrics that document the product development process. "What we're really measuring is our ability to grow -- top line growth and our bottom line profitability. Previously, without this real-time reporting of metrics, the situation was analogous to flying an airplane without gauges."

Larry Page on How to Change the World If you ask an economist what's driven economic growth, it's been major advances in things that mattered - the mechanization of farming, mass manufacturing, things like that. The problem is, our society is not organized around doing that. People are not working on things that could have that kind of influence. We forget that it really does matter that we don't have to carry our water; it's not that much fun to walk miles and miles to try to find water and then carry it back under human power. And our ability to generate clean, accessible water is based on basic technologies: Do we have energy? Can we make things? My argument is that people aren't thinking that way. Instead, it's sort of like "We are captives of the world, and whatever happens, happens." That's not the case at all. It really matters whether people are working on generating clean energy or improving transportation or making the Internet work better and all those things. And small groups of people can have a really huge impact. Many leaders of big organizations, I think, don't believe that change is possible. But if you look at history, things do change, and if your business is static, you're likely to have issues. Look at the auto industry: It took the Japanese to convince people you can have a reliable car. Then they started pushing the product cycles shorter and shorter. Instead of making a car in five years, they made them in one year or two years. That's a big change. What kind of background do you think is required to push these kinds of changes? I think you need an engineering education where you can evaluate the alternatives. For example, are fuel cells a reasonable way to go or not? For that, you need a pretty general engineering and scientific education, which is not traditionally what happens. That's not how I was trained. I was trained as a computer engineer. So I understand how to build computers, how to make software. I've learned on my own a lot of other things. If you look at the people who have high impact, they have pretty general knowledge. They don't have a really narrowly focused education.You also need some leadership skills. You don't want to be Tesla. He was one of the greatest inventors, but it's a sad, sad story. He couldn't commercialize anything, he could barely fund his own research. You'd want to be more like Edison. If you invent something, that doesn't necessarily help anybody. You've got to actually get it into the world; you've got to produce, make money doing it so you can fund it.

Companies

Big-box retailers undaunted by slow economy While a select few retailing giants -- namely home-improvement retailers -- have had to curtail expansion plans, others are continuing as if recession talk is nothing more than idle chatter. Companies like Target Corp., Costco Wholesale Corp. and Best Buy Co. are carrying on with expansion plans at virtually the same pace as in years past. For the most part, today's retail giants don't suffer in the same way that most retailers do when gasoline prices climb and pocketbooks get pinched. While they may make adjustments, they're big enough to absorb the shock, according to industry experts. "They really are looking through the economic time because their stores will open after the bad economic times have passed," said Jim McComb, president of retail consultancy McComb Group based in Minneapolis, home to Best Buy and Target headquarters. The biggest box of all, Wal-Mart Stores Inc., is curtailing its expansion efforts, although company executives insist that it's not recession-related. The world's biggest retailer is beginning to saturate the North American market, so now it's looking to grow more quickly overseas. Companies that seem to be clinging to good times are Best Buy, Costco and Target. Best Buy said that it could stand to build another 500 stores in its various markets, so it plans to open 130 to 160 of them over the next fiscal year. That's about the same pace at which Best Buy has grown over the past several years, according to company spokeswoman Sue Busch.

McDonald's Net Tops Estimates; Sales in U.S. Drop First Time in Five Years McDonald's Corp., the world's largest restaurant company, said first-quarter profit rose more than analysts estimated after record European revenue gains outweighed the first drop in U.S. comparable-store sales in five years.

Consumer slowdown scalds Starbucks The Starbucks (SBUX) turnaround is going to take some time. The Seattle-based coffee company warned Wednesday afternoon that it expects second-quarter earnings to fall short of Wall Street’s expectations due to “the sharp weakening in the U.S. consumer environment.” Shares of Starbucks, which have dropped 45% over the past year, dropped an additional 10% in late trading after a brief halt for the release of the bad news. “The current economic environment is the weakest in our company’s history, marked by lower home values, and rising costs for energy, food and other products that are directly impacting our customers,” said CEO Howard Schultz, who returned earlier this year to lead the company’s turnaround efforts after a spell of weak results under the departed Jim Donald.

Starbucks looks to international stores to fuel earnings Starbucks plans for more global growth after 2Q profit sinks 28 percent on US economic woes. Starbucks Corp. is dialing back expectations for its U.S. stores in light of economic uncertainty but has a three-year plan for snazzy new drinks and future profit growth fueled by aggressive international expansion. As expected, the company said Wednesday its fiscal second-quarter profit sank 28 percent as U.S. consumers responded to rising food and gas prices by making fewer latte runs. The coffee purveyor slashed 30 additional store openings from its already-scaled-back plan for 2008 and said it will open fewer than 400 stores per year in 2009 through 2011. International openings will increase at a far faster clip, though, with 975 this year and a projected 1,300 in 2011. Starbucks expects to have 21,500 stores worldwide by the end of fiscal 2011.Starbucks' financial goals for the coming years reflect worries about a protracted U.S. economic downturn and rely on international stores -- particularly ones run by licensed partners rather than Starbucks itself -- to drive profit.

American Air loses $3.3 million a day "While mergers may play a role in solving some of the fragmentation and capacity problems that plague the industry," he scribbled, "they are not the panacea for solving all the industry's problems and may create a few new ones." Then he looked at me, smiled, and said, "But that doesn't mean we aren't looking or don't have options." Then, as if it had been timed, we hit a patch of turbulence. That's a gentle word for what American's CEO has experienced of late. In the past month Arpey, 49, has dealt with picketing pilots calling for his resignation, FAA inspectors decertifying 300 aircraft, the merger of two large competitors, and $110-a-barrel oil that contributed to a $328 million loss for the first quarter. Since January, nearly every flight the airline has flown has lost money - analysts estimate it is losing $3.3 million a day. Of course, red ink in the airline industry is about as novel as weather delays or lost luggage. What has changed for executives like Arpey is that there is not much left to cut. Thanks to bankruptcies or restructuring, airlines like American long ago chopped the low-hanging fruit and added extra fees wherever they could: Pilots make less, planes fly more, and passengers now routinely shell out for once-complimentary items like onboard food and checked luggage. The problem is that no airplane was ever designed to make a profit with jet fuel at these prices, and no carrier has figured out a way to charge enough to make up the difference. Pity the airline CEO. He can't control his biggest costs. He can't really control the prices he charges. Already this year, record fuel prices have forced five carriers to file for bankruptcy. Analysts say more may be on the way - and some believe American is in danger. That's because as the only so-called legacy carrier to have avoided Chapter 11, American has significantly higher labor costs than many of its competitors and operates a largely aging fleet of gas-guzzling aircraft - two problems without easy fixes.

Time for big oil to explore places it would rather avoid Big oil was back in the spotlight this week and not just because petrol prices hit £5 a gallon on the forecourts. BP and Royal Dutch Shell both reported first-quarter results that smashed market forecasts and then enjoyed sharp share price gains. One broker calculated that it was the biggest quarterly earnings surprise from BP, with profits $1.4bn higher than expected. But long-term investors were unlikely to be jumping for joy. They have had to endure years of sluggish performance even though oil prices have experienced a record-breaking run. Rising costs and taxes, and limited access to new supplies help explain why BP and Shell have performed so badly and underperformed US peers ExxonMobil and Chevron. But other factors have been at work, such as the fatal accident at BP's Texas City oil refinery and the reserve misreporting scandal at Shell. Analysts estimate that underlying operating costs and capital expenditure across the oil industry are increasing 10 to 20 per cent a year. Taxes have also been rising. The Labour government has increased corporation tax on North Sea oil profits from 30 to 50 per cent in the past few years. Another way to look at rising costs and taxes is the impact on returns. Return on average capital employed at Shell was 24.5 per cent in the first quarter of 2008. That is only 10 percentage points higher than a decade ago. Yet in that time oil rose by $80 a barrel. Finding oil is also more difficult, and big western oil companies are forced to explore in places they would rather avoid. One of Shell's big projects is extracting oil from tar sands in Canada, and BP is drilling in ultra-deep waters in the Gulf of Mexico. In these large, complicated projects costs per barrel are high. Production at Shell has almost stood still in the past 15 years and BP's first-quarter figures showed production flat at 3.9m barrels of oil equivalent per day. A step change in output at both companies is not expected until 2011 when new but risky projects come on stream. Big oil is also facing lower returns in projects that are already running. Oil-rich nations no longer feel they have to call in one of the large integrated oil companies to exploit natural resources. They can buy expertise in large project management direct from oil-field services companies such as Schlumberger. This puts host governments in a very strong position to demand better terms from production-sharing contracts

How US Steel Leapt Off History's Scrap Pile - Old-line steel companies went bankrupt for good reason. For years, the industry was plagued by high labor costs and cheap steel imports. Industry executives were noted for begging the government for relief from foreign competition. U.S. Steel's stock price traces the sad story. In 1959, the high for the shares was $72.63. In the second quarter of 2006, the stock traded at $77.77. The shares -- along with U.S. Steel preferred shares -- were included in the Dow Jones Industrial Average in 1901 when the company was formed by financier J.P. Morgan and the steel magnates of the day. Ninety years later, when the company was called USX Corp., the stock was dropped from the Dow. The USX name was used after the company acquired the since split-off Marathon Oil Corp. How long will the bounce in old X continue? ``If the dollar goes up, the game is over,'' says analyst Bradford. Global demand has to cool off at some point too. Still, the steel industry looks better able to deal with slumping economies than it once was. Whatever the future, it's nice to see old X on top for a change.

Magic restored Under its new boss Disney has staged an impressive creative turnaround—and is making synergy work. Eventually the chef loses control of the restaurant, the frozen meals are tossed out and Remy's cooking helps it regain its reputation and inventive flair. Something similar appears to have happened at Disney. Four years ago it was in turmoil, with its then chief executive, Michael Eisner, under siege from shareholders who accused him of stifling the firm's creative culture. Today under Bob Iger, who took over as chief executive in 2005, Disney is enjoying a remarkable and profitable run of hit TV programmes and films. “Disney's creative momentum is so strong now that there's no comparison between it and other big media companies,” says Lawrence Haverty, a fund manager at Gabelli Asset Management. In the past Disney concentrated mainly on the very young, but in recent years it has found a new audience among “tweens”, or nine- to 14-year-olds. What accounts for this renaissance? Mr Iger's management style is said by many to have unlocked Disney's creativity. “There was already creativity inside Disney, but Bob removed the barriers to it,” says Peter Chernin, chief operating officer of News Corporation, a rival media group. “Michael Eisner was all about his own creativity,” says Stanley Gold, a former Disney board director who led a campaign to oust Mr Eisner in 2004, referring to the way in which the former boss meddled in the detail of Disney's parks and movies. In contrast, he says, “Bob pushes creative decisions to the people below him.” In addition, Mr Iger's acquisition of Pixar, a studio that insists on creative originality, has sent a signal to people inside and outside Disney. 

At Kodak, Some Old Things Are New Again Kodak is by no means thriving. Digital products are nowhere near filling the profit vacuum left by evaporating sales of film. Its work force is about a fifth of the size it was two decades ago, and it continues to lose money. Its share price remains depressed. But, finally, digital products are flowing from the labs. Kodak recently introduced a pocket-size television, which is selling in Japan for about $285. It has software that lets owners of multiplexes track what is showing on each screen. It has a tiny sensor small enough to fit into a cellphone, yet acute enough to capture images in low light. The company now has digital techniques that can remove scratches and otherwise enhance old movies. It has found more efficient ways to make O.L.E.D.’s — organic light-emitting diodes — for displays in cameras, cellphones and televisions. Paradoxically, many of the new products are based on work Kodak began, but abandoned, years ago. The precursor technology to Stream, for example, pushed ink through a single nozzle. Stream has thousands of holes and uses a method called air deflection to separate drops of ink and control the speed and order in which they are deposited on a page. Other digital technologies languished as well, said Bill Lloyd, the chief technology officer. “I’ve been here five years, and I’m still learning about all the things they already have,” he said. “It seems Kodak had developed antibodies against anything that might compete with film.” It took what many analysts say was a near-death experience to change that. Kodak, a film titan in the 20th century, entered the next one in danger of being mowed down by the digital juggernaut. Electronics companies like Sony were siphoning away the photography market, while giants like Hewlett-Packard and Xero had a lock on printers.