bizzXceleration: Performance, Value and Profit

Business Performance

2008 "Worst Year" In Fortune 500 History It was 1955, the year Disneyland opened and Ray Kroc sold his first hamburger. Bill Gates and Steve Jobs were born that year. And it was in 1955 that Fortune magazine published the very first Fortune 500 list. It's an annual compilation of America's 500 largest companies, its changing roster reflecting the current economic climate. "Everything that happens in business in the United States shows up in one way or another in the 500," said Carol Loomis, Fortune's senior editor-at-large. "It's a mirror to the economy."  Since 1955, more than 2,000 companies have earned a spot on the list, but in 55 years only three have achieved the number one slot: General Motors, ExxonMobil and Wal-Mart. … And that brings us to a first-look at THIS year's list, which we're pleased to reveal this morning with thanks to our friends at Fortune Magazine. Read it ... and weep. From $645 billion in profits in 2007, profits dropped this year to just $98.9 billion - an 84.7 percent decline! Records were broken: Eleven of the top 25 largest corporate losses in list history took place last year. The biggest loser of them all: Insurance giant AIG. The company posted a $99.3 billion loss. But it's still on the list ("too big to fail" indeed!). It's ranked at number 245, down from number 13 just one year earlier.
Thirty-eight companies disappeared from the list altogether. Bear Stearns and Lehman Brothers may be no surprise, but it was also "last call" for brewer Anheuser Busch.

Talkin Profits: Economic Outlook, Earnings, Business Performance ? Now we're going to shift the focus back onto business performance but come at it top-down by starting with the macro-issues of profitability and asking what the economic outlook means for business performance and earnings outlooks. After the page-break you'll find some readings on those topics, general business conditions and some specific players (WMT, SBUX, Kraft, Whole Foods) that illustrate many of the points. Before we get into the meat however we'd like to share some of the morning's headlines which reinforce the arguments about a slowing economy and the deteriorating earnings outlooks. MUCH more importantly however these are the headlines from places like the WSJ and Bloomberg. Here's the first central question: what happens when it dawns on businesses and investors that the V-shaped recovery is history ? And that '09 is not looking much better ? Those headlines pretty well capture the arguments we've been making for some time, are based on similar analysis and point to a lot of other folks seeing the tipping point being crossed. And as Barry Ritholz points out in his post on the Deficient Market Hypothesis "you have an ....opportunity" ....if you make the right choices of course :) ! Speaking of which the next central question is what happens when the analysts figure out that their earnings outlooks need to go in the trash ? And the markets absorb those revisions ? How long will all that take to percolate ?

Profits, Earnings, PEs and Outlooks: Why You Should Reall....lly Care Fascinatingly the markets are up today, led by Financials of all things. Will wonders and delusions never cease ? This despite the fact that, other than WMT earnings, all the economic news was unremittingly bad: foreclosures are up 55%, new house prices dropped -7.3%, continuing jobless claims accelerated and new claims were unexpectedly high and consumer inflation jumped 0.8% MtM, a 17-year high ! None of that sounds like the outlook is sanguine in the sense of good. Anyway, as threatened, we're going to revisit the outlook and consequences for corporate earnings and what it means for the market. Tracking which posts get the most attention, equally strangely if not more so, the diagnosis of a schizoid market attracted more attention then the careful dissection of the profits outlook (Talkin Profits: Economic Outlook, Earnings, Business Performance ?) and what the rapidly deteriorating economic outlook means. To put a point on it if we are indeed crossing a tipping point and starting into a consumer-driven downturn, as is now being widely recognized, ignoring profits and the current market valuations is dangerous to your financial health. On the grounds that perhaps we haven't made it entirely clear why you really care we're going to build a longish post walking thru various aspects of profits, earnings, PE's and the outlook. Just as one example most of the downturn so far in the S&P is due to Financials. If the economy turns over, as we expect, none of that is priced in.

History Lesson Comments: Those two excerpts date from Aug08 and provide detailed breakdowns of corporate profitability and valuations analysis eight months ago, and echo postings from six to eight months before that. Any argument that this crisis was not foreseeable and foreseen, in some detail, with reasonable attention to the macro-environment is just plain wrong. The next point being that leadership has a responsibility to monitor that environment and adapt accordingly, before the crisis, not afterwards. Yet has largely failed miserably to do so. Which also implies that they will continue to badly lag the facts. A failure on both Drucker's and Wuzu's standards of leadership ! [Denial's Triumph: From Earnings to Business Performance (NOT) [UPDATES]]

Reactions and Reflections

America's Class Warfare Jeff Greenfield explored the roots and the history of anger in America. And how the class warfare argument has played out, and is playing out, in the face of our current economic crisis.

• Drawing The Battle Lines Of Class Warfare

The Rage of the Formerly Privileged Class In a witch hunt, the witches have feelings, too. As populist rage has erupted around the country, stoked by canny politicians, an opposite rage has built on Wall Street and other arenas where the wealthy hold sway. Its expression is more furtive and it’s often mixed with a kind of sublimated shame, but it can be every bit as vitriolic. “AIG pissed some people off, and now you’re gonna screw everyone on Wall Street?” rails a laid-off JPMorgan vice-president. (Despite the honesty of the conversation, many did not wish to be quoted by name.) “No offense to Middle America, but if someone went to Columbia or Wharton, [even if] their company is a fumbling, mismanaged bank, why should they all of a sudden be paid the same as the guy down the block who delivers restaurant supplies for Sysco out of a huge, shiny truck?” e-mails an irate Citigroup executive to a colleague. It is difficult to sympathize with these people, their comments laced with snobbery and petulance. But you can understand their shock: Their world has been turned on its head. After years of enjoying favorable tax rates, they are facing an administration that wants to redistribute their wealth. Their industry is being reordered—no one knows what Wall Street will look like in a few years. They are anxious, and their anxiety is making them mad. Wall Street people are not moral idiots (most of them, anyway)—it’s not as if they’ve never pondered the fairness of their enormous salaries. “One of my relatives is a doctor, we’re both well-educated, hardworking people. And he certainly didn’t make the amount of money I made,” a former Bear Stearns senior managing director tells me. “I would be the first person to tell you his value to society, to humanity, is far greater than anything that went on in the Bear Stearns building.” That said, he continues, “We’re in a hypercapitalistic society. No one complains when Julia Roberts pulls down $25 million per movie or A-Rod has a $300 million guarantee. We have ex-presidents who cash in on their presidencies. Our whole moral compass has shifted about what’s acceptable or not acceptable. Honestly, you can pick on Wall Street all you want, I don’t think it’s fair. It’s fair to say you ran your companies into the ground, your risk management is flawed—that is perfectly legitimate. You can lay criticism on GM or others. But I don’t think it’s fair to say Wall Street is paid too much.” Of course, it is precisely the flawed risk management that has brought Wall Street salaries under scrutiny. No one has ever been hurt—not financially, anyway—by a Julia Roberts movie. But with their jobs in jeopardy and their 401(k)s in the toilet thanks to a market in which banks took risks with great upside and seemingly little downside, the Minions of the Universe are looking at the Masters with a newly skeptical eye.

The Quiet Coup But I must tell you, to IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out. No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis. Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise. But these various policies—lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector. Policy changes that might have forestalled the crisis but would have limited the financial sector’s profits—such as Brooksley Born’s now-famous attempts to regulate credit-default swaps at the Commodity Futures Trading Commission, in 1998—were ignored or swept aside. The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations.

The Failure of #amazonfail In 1987, a teenage girl in suburban New York was discovered dazed and wrapped in a garbage bag, smeared with feces, with racial epithets scrawled on her torso. She had been attacked by half a dozen white men, then left in that state on the grounds of an apartment building. As the court case against her accused assailants proceeded, it became clear that she’d actually faked the attack, in order not to be punished for running away from home. Though the event initially triggered enormous moral outrage, evidence that it didn’t actually happen didn’t quell that outrage. Moral judgment is harder to reverse than other, less emotional forms; when an event precipitates the cleansing anger of righteousness, admitting you were mistaken feels dirty. As a result, there can be an enormous premium put on finding rationales for continuing to feel aggrieved, should the initial rationale disappear. Call it ‘conservation of outrage.’ A lot of us behaved like that this week, in our fury at Amazon. After an enormous number of books relating to lesbian, gay, bi-sexual, and transgendered (LGBT) themes lost their Amazon sales rank, and therefore their visibility in certain Amazon list and search functions, we participated in a public campaign, largely coordinated via the Twitter keyword #amazonfail (a form of labeling called a hashtag) because of a perceived injustice at the hands of that company, an injustice that didn’t actually occur.

Leaders, Leadership, Culture Changes

Corner Office: Think ‘We’ for Best Results Q. What are the most important leadership lessons you’ve learned through the years? The first time I ever really thought of myself as a leader was when I had a series of experiences in college, over a period of about 18 months, working on four different group projects. What I learned from that is that if you can get everyone to agree what the goal is, and to identify themselves with the successful achievement of that goal, then you’re pretty much there. One thing that helped move my thinking forward was that I noticed in my first job that there was something very definitional in who was included in somebody’s “we” and who was included in somebody’s “them.” I found generally that the more expansive the assumptions were within somebody’s idea of who is “we” — the larger the group that you had included in that “we” — the better off everybody was. I started to really do my best to make sure that my notion of “we” was very expansive and to promote that idea among other people. Q. What else? You’re constantly trying, whether you’re raising children or dealing with employees, to get them to take responsibility for their own issues. I’m not saying that in a maternalistic way, just in a way of trying to get people to take responsibility for themselves, to do the best that they can and to learn as much as they can. In both cases, you’re trying to make people more independent and bring them along. Q. From your days as a shareholder activist analyzing poor-performing companies, what did you learn about how not to lead? A. All of them had C.E.O.’s who took an enormous number of steps to make sure that no one would ever question them or second-guess them. At one of the companies we were involved in, we talked to a number of employees who all used the exact same phrase — that if you disagree with the boss, you get fired on the spot.

It Isn't Just a Myth, Power Turns People Into Assholes We have been talking a lot about leadership in my Stanford class on Organizational Behavior: An Evidence-based Approach.  Last week, we had a pretty detailed discussion about how and why putting people into powerful positions seems to turn them into selfish jerks. I am sure that there are some people who are genetically pre-disposed to be nasty and there are some people who -- perhaps as a result of emotional and/or physical abuse during childhood -- turn into assholes. But there is also strong evidence that, no matter what our "personality"  is, we all can turn into assholes under the wrong conditions. Asshole poisoning as a disease that you catch from others, and I talk a lot about that in the book. It is also something that happens -- with shocking speed and intensity -- when people are put in powerful positions. My colleague at the Stanford Business School Deborah Gurenfeld and her colleagues have been studying the effects of power on human beings for over years, and the findings are clear: power turns people into selfish and insensitive jerks, who act as if the the rules that the rest of us have to follow don't apply to them. Perhaps the  best quick summary of this research is an article San Francisco Chronicle last Fall called on power and its evil effects, The article summarizes this large body of research -- now hundreds of studies -- as follows: Research documents the following characteristics of people with power: They tend to be more oblivious to what others think, more likely to pursue the satisfaction of their own appetites, poorer judges of other people's reactions, more likely to hold stereotypes, overly optimistic and more likely to take risks. It quotes one of Gruenfeld's main conclusions: Disinhibition is the very root of power," said Stanford Professor Deborah Gruenfeld, a social psychologist who focuses on the study of power. "For most people, what we think of as 'power plays' aren't calculated and Machiavellian --  they happen at the subconscious level. Many of those internal regulators that hold most of us back from bold or bad behavior diminish or disappear. When people feel powerful, they stop trying to 'control themselves.'

• Another Badly Treated Nurse: How NOT to do a Layoff
• Scott Berkun: 10 Reasons that Managers Become Assholes

Are Markets Moral? A 2001 study on trust in forty-two countries, for example, asked people in their native language, “Generally speaking, would you say that most people can be trusted, or that you cannot be too careful in dealing with people?” The results were as diverse as they were striking. At the low end of the trust scale, only 3 percent of those surveyed in Brazil and 5 percent in Peru believe that their fellow citizens are trustworthy, compared to 65 percent of Norwegians and 60 percent of Swedes who trust one another. Falling in the middle of the scale were the United States, at 36 percent, and the United Kingdom, at 44 percent. The rankings remain essentially unchanged even when they are controlled for income. Trust is high in the countries of Scandinavia and East Asia but low in the countries of South America, Africa, and especially in the former Communist bloc. “The simple correlation between national rates of investment (gross investment per Gross Domestic Product) and trust is strongly positive,” Zak continues. “When trust is low, investment lags. The same positive correlation holds for GDP growth and trust.” Economic mechanics drive the relationship between trust and prosperity. “Trust facilitates transactions by reducing the number of contingencies that must be considered when ‘doing a deal.’ A deal sealed with a handshake between principals can only occur in a high-trust situation. Let the lawyers work out the details—we have a deal,” Zak offers. “Conversely, when trust is low, negotiations are protracted, and therefore more costly. When transaction costs are higher, fewer transactions occur and investment and economic growth are lower. Trust is among the most powerful stimulants for investment and economic growth that economists have discovered. In seeking to understand why some countries are poor and others are rich, it is, therefore, crucial to understand the foundation for interpersonal trust.”

Finance Industry Again

The Banks Are Fibbing (Jubak vidclip) Are bank profits for real? No, Jim Jubak says, because accounting tricks and gimmicks are responsible for many banks' sudden profits. All these do is delay the day of reckoning.

BofA Results Don't Calm Shareholders  Bank of America Corp. posted an unexpectedly high first-quarter profit of $4.2 billion, but the results didn't soothe investors or quiet the calls for a board shake-up, as concerns emerged about the bank's core operations and need for more capital. Another proxy advisory firm on Monday recommended that shareholders withhold their votes for the re-election of Chief Executive Kenneth Lewis as board chairman, citing the "potential conflict" of the dual roles. Egan-Jones Group Ltd. also suggested withholding votes for several other board members at the bank's annual meeting April 29 in Charlotte, N.C., including lead director Temple Sloan, joining three other advisory firms and two activist investors seeking new leadership."We think there should be significant change in Bank of America to get it back on track," said Egan-Jones managing director Sean Egan. The bank's net profit more than tripled from a year earlier, largely due to trading income from Merrill Lynch & Co., which the bank acquired January, and one-time gains. But core banking operations suffered as the bank set aside $13.3 billion for credit losses during the period, up from $8.5 billion in the fourth quarter, and nonperforming assets jumped to 2.65% from 0.9% in the prior year. Credit cards lost $1.7 billion and the mortgage-insurance division lost $498 million despite an uptick in mortgage refinancings. Profits even dropped by half in the bank's bread-and-butter deposits business. Unemployment is still likely to rise, according to the bank, putting more strain on the company's future performance. "Make no doubt about it," Mr. Lewis said, "credit is bad and will eventually get worse before it stabilizes and improves." Concerns about Bank of America's credit performance dragged down the overall stock market Monday and hurt stocks of other banks and credit-card issuers, spoiling a run-up in the financial sector that began earlier this month with first-quarter profits from J.P. Morgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. as well as robust expectations from Wells Fargo & Co. Bank of America closed down $2.58 a share, or 24%, to $8.02, contributing nearly 21 points of the Dow Jones Industrial Average's 289.60-point drop. The stock-market drop also reignited debate about the health of the U.S. banking industry and the fate of larger institutions like Citigroup and BofA, the nation's largest by assets.

• Fuzzy Math at Citigroup and Bank of America,   For BofA, a $4.2 Billion Profit Isn't a Fix
• Bank Profits Appear Out of Thin Air
• Citigroup's Shareholders Wonder When Treasury Ousts `Hall of Shame' Board
• Leading Economist Decries Power of Wall Street "Oligarchs"

Toxic Pay All along wall street, bankers are acting like amputees who can still feel their phantom limbs. Despite losing billions and getting bailed out by the government, many seem to think that nothing has changed. That deranged attitude explains why the bonus money has continued to flow despite the bailouts. And it explains why the public and Congress have revolted. Their anger is about more than money; it’s about the infuriating, though not surprising, posture from Wall Street. It’s only barely an oversimplification to say that banker pay caused the meltdown. Pay schemes were set up to massively reward bankers for short-term profits with little regard to the long-term performance of any deals that they constructed, trades they entered, loans they made, or mergers they advised on. In other words, there was little downside if deals went bad, as many of them did. So is there a better way? Credit ­Suisse, a Swiss bank that has weathered the credit crisis better than most, created an ingenious and gratifying solution to the problem of outsize pay for Wall Street failure. It decided late last year to pay out part of its bonuses in toxic assets. On Wall Street, the old saying is that you “eat what you kill.” In this case, Credit Suisse is making its employees eat their own garbage. What’s satisfying about Credit Suisse’s plan is that it shows that investment banks are capable of learning and bowing to outside pressure. The compensation problem is not going to correct itself. Sure, the Obama administration and Congress have implemented some constraints on the pay of bankers whose firms received government aid. But the administration’s plans were toothless, and Wall Street immediately set to work evading the congressional restrictions. Taxing bonuses at 90 percent is simply a bad idea. Ad hoc and emotional responses to outrages, however legitimate, usually fail. Britain’s Financial Services Authority is threatening to regulate pay in general. So should the U.S. government. It should mandate permanent, serious regulation of banker pay, and not just for firms receiving equity injections from the state. The government’s lending saved the financial system; it can require changes. That means restricting compensation—not just some portion but the entire package—in order to tie it to long-term performance, not just of the company but of each individual’s product. The way to do that is through changes to the tax structure, but ones that are carefully thought out. Without such changes, Wall Street bankers will continue to give them­selves what they think they deserve. And they never think they deserve less.