Value Investing using Economic Value Added (EVA)

The Power of Localism & the US Constitution

Tom’s excellent blogon the nightmare of ‘world government’ hits upon a very strong argument for localism. As Tom put it:

When all is said and done, there is one, final check upon a government’s ability to oppress its people. It is the mechanism used by Cubans when they tie empty oil drums to the chassis of old cars and try to paddle to Florida, or by North Koreans who manage to sneak all the way from the Yalu River to Bejing to try to slip into foreign embassies and beg for freedom. It is the ability to escape.

But this ‘exit option’ could be extended far beyond nation states. After all, even though it may be possible to move to a different, freer country, doing so is generally inconvenient. If we were to radically devolve power within nation states, however, that exit option would be very much enhanced. You could, in a sense, create a competitive ‘market’ in governments. And if you could change your government by moving from, say, Norfolk to Suffolk, you would have a far more genuine ‘choice’ about the policies you are subjected to than you could ever get at the ballot box.

The instinctive reaction of most English people to this suggestion would be incredulity. But look at Switzerland. Its 26 cantons exercise by far the greater part of that country’s political power, taking prime responsibility for health care, welfare, law enforcement and public education, as well as taxation. The most populous canton is Zurich, with some 1.2 million inhabitants, while the least populous (excluding the half-cantons, which band together) is Jura, with 70,000. And yet despite their small size, they seem to do rather well: the Swiss enjoy low taxes and excellent services.

via www.adamsmith.org

BERK: The freedom to escape is one of the most important freedoms that exists. And we expand freedom when authority is devolved into the local community. We see it in the United States when one state or city imposes high taxes or burdensome regulations on businesses - those businesses will flee to another state or another city. People move to where the jobs are, where after-tax income is high and the cost of living is low. 

We also see the dark side of this when Senators and Congressmen fight to get special favors for their states or their home towns in federal spending bills. (Witness the debacle of the buying of votes in the Senate to get the Super Majority to bring along the health care bill)

Without the ability to "escape" freedom is curtailed.  Remember how the Soviet Union had to keep people in, thereby preventing them from escaping tyrannical socialism.  What was the Communist Party afraid of?

The founding fathers were ingenious when they specifically reserved powers for the states not explicitly enumerated in the Constitution for the federal government. This in essence set up a competitive market in governments and policies. You can move from say New York City to Florida where there is no income tax and that puts pressure on New York to enact policies that stops the out-migration of citizens.

Herein lies the real problem with the federal government's most recent power grabs. The health care legislation before Congress would prevent competition because there is no exit for a citizen of any state - the laws and regulations would be national!

Of course, citizens could move to another nation-state, but that misses the point of the United States in the first place. We are one nation made up of local competing jurisdictions. That has served us very well for 220 years. In Europe, for instance, you can always move to another nation-state within the European Union, or come to the US. Don't like Sweden's tax rates? Move to Switzerland or Ireland or somewhere else. Germany got you down? Move to Monaco.

The health care legislation is reversing one of the US' greatest strengths by reversing the devolution of political power to the states and local governments.

CARPE DIEM: Yield Curve, Investor Optimism at Record High

WSJ -- A closely watched bond-market measure of investor optimism hit a record Monday, amid signs the U.S. economy's recovery is strengthening. That measure is the yield curve -- the difference between short-term and long-term interest rates on government bonds. That number is at its highest level ever, surpassing the record set in June, and signals that investors are expecting a stronger economic turnaround ahead.

The interest-rate development is good news for banks, which normally borrow at short-term rates and lend at long-term rates. The bigger the difference, all else being equal, the bigger their profit. Higher profits mean banks can refill their coffers, which have been drained by bad debts, and return to health.

The yield curve steepens when the Federal Reserve, which controls short-term interest rates, keeps them low to spur the economy. But at the same time investors, expecting growth to resume and with it the possibility of inflation, sell longer-term government bonds, which sends their prices down and their yields up. The difference between the yields, in this case on 2-year and 10-year notes, is the main gauge of the yield curve. On Monday, the difference reached 2.81 percentage points (see chart above). The gap between short- and long-term yields tends to stretch on the way out of economic trouble.

Before this year, the yield curve was last near these levels in 1992 and 2003. In both instances, the economy was pulling out of a recession, and staged a sustained recovery. However, on both occasions it took a year or more before the Federal Reserve decided the economy was strong enough to warrant interest rate increases. At this time last year, the gap was 1.27 percentage points. At the crisis onset, in June 2007, the yield curve was inverted: a phenomenon in which short-term yields are higher than long-term ones, a development which often augurs a recession.

via mjperry.blogspot.com

BERK: Hays Advisory uses a tactical asset allocation that measures the medium term relative attractiveness between cash and the stock market.  It is made of three legs (with a fourth leg, market tend, thrown in after the model failed to warn of the magnitude of last year's financial collapse): Valuation, Psychology and Monetary.

The "Monetary" leg is the most bullish it could be. One of the most important parts of the monetary leg is the yield curve depicted here.

To the extent that we have an economic recovery, it will come from monetary stimulus - the steepness of the yield curve and the unprecedented low level of short-term rates around the globe.  All the fiscal stimulus seems to have simply interfered with the monetary stimulus.

In China, They REALLY Hate the Rich - The Wealth Report - WSJ

In China, They REALLY Hate the Rich - The Wealth Report - WSJ.

Forget taxing bonuses or forcing the rich to pay for health care. When it comes to resenting the wealthy, China is far outpacing the U.S. and Briton.

Robert Frank reports on an article in the China Daily where expensive cars run a high risk of getting vandalized - the implication is that the destruction comes not for profit, but from resentment.  He says that a survey showed that 95% of the public in China resent the rich.  Most surveys in America seem to say that Americans admire the rich and that is because there is still (for the time being anyway) a sense that anyone in America can be wealthy.  Not so in China - only the connected get wealthy.  It's not even close to a meritocracy.  Get this, a study showed that:

... about 90% of China’s billionaires are the children of high-ranking officials.

Where is all this headed? No one is predicting another revolution quite yet. But unless China can start creating more truly free-market millionaires and billionaires, Chinese society will become increasingly unstable and unfriendly to wealth — local and foreign alike.

Do you think Al Gore getting rich from promoting "Global Warming" hysteria is similar? I do.  And I think we could be heading for a different kind of revolution in the United States.

Sears to Benefit from Cash-for-Appliance Programs

BERK:  Home appliances have suffered like home furnishings for the last three years as demand for everything in the house has cratered.  It is one of the reasons Sears Holdings' Sears stores have been suffering.  After all, Sears is the largest appliance seller in the US. Appliances have always been a source of traffic, interest and merchandising opportunities.

In our town in NJ we have had as long as I can remember - 40 years or so - a standalone Sears store.  It always seems to be on the verge of closing, especially since Target opened up on the other side of the highway a few years ago. 

When polled, very few people shop at the good old Sears, including my wife, our friends and neighbors.  It seems that the gurus and magicians who predict such things are correct - Sears is dead. Chairman Eddie Lampert was a good hedge fund manager but running a retailer for EVA and cash flow cripples its ability to compete.

This comment from a recent article is typical:

"Their strategy is not traditional," Mr. Dreher told Medill Reports. "They make little to no effort to communicate what that strategy is."

According to Medill, Sears saw sales decline 3.1 percent in 2006, 4.5 percent in 2007 and 11 percent last year. At the same time, the company has seen its margins remain in a holding pattern between 23.36 and 28.66 percent. These margin percentages are below comparable chains in the department store sector.

While Sears is trying some new things, there are signs that Mr. Dreher and others find worrying. He pointed to a lack of new designer lines in Sears' locations and online, a failure to invest in the business and the long empty CEO position at the company.

But wait! My wife came home the other day to say how surprised she was by the apparel selection at Sears.  She had no idea that the Lands End store within in a store was so good - and all those Levis!  She never would have been there had she not gone to look at buying a new dryer to replace our ancient broken model.

I think that with appliance demand kicking up  (see the NY Times article below about the Cash for Appliance Programs) - more and more people are going to notice Sears too.  Now how do I get her to shop at Kmart?

By JENNIFER SARANOW SCHULTZ

Amy Sancetta/Associated Press The State Energy Appliance Rebate Program may help some consumers get cash for old household appliances.

Now may be a good time to consider buying that new refrigerator, clothes washer or dishwasher.

Last summer, as part of the American Recovery and Reinvestment Act stimulus plan, the Department of Energy announced that up to $300 million in federal aid would be given to states to run rebate programs encouraging consumers to replace their old appliances with new energy-efficient ones.

Under the “State Energy Appliance Rebate Program,” otherwise known as Cash for Appliances, each state was allocated an amount based on its population. States were then supposed to determine qualifying products, set rebate amounts and submit their program plans to the Department of Energy for approval by Oct. 15, with the aim of starting the rebates by the end of this year and early next year.

In recent weeks, as the Department of Energy has approved many of the programs, details of the state offerings have started to emerge. By Tuesday, 51 of the 56 states and territories had won approval for their plans and received their money, according to a spokeswoman for the Department of Energy.

via bucks.blogs.nytimes.com

Disclosure: Rapidan Capital's clients own SHLD.

BERK

Driving Ongoing Profitability With EVA at Briggs and Stratton

John S. Shiely continues to expand a turnaround at Briggs & Stratton Corp. that was begun by integrating a business philosophy based on Economic Value Added (EVA). The essential principle of EVA analysis is that a company only makes economic profit if the company earns more than the cost of its capital. The results: EVA has helped the company achieve an impressive record of producing economic profits. Briggs & Stratton has made money every year since the late 1980s. For the fiscal year ending June 30 net income is predicted to grow 32%. Revenue is at record levels ($1.6 billion). Exports account for 25% of sales, and this U.S. producer expects to continue to undercut foreign competition even in some new market sectors.

IW: How do you define the EVA philosophy?

Shiely: EVA is both a measure of the true economic performance of a company and a strategy for creating shareholder wealth. EVA succeeds by changing corporate priorities and behavior throughout a company, right down to the shop floor. Properly implemented, EVA frees the measurement of corporate performance from the vagaries of accounting conventions and aligns the interests of managers with those of shareholders, ending the all too common conflicts of interest.

IW: What are the elements of EVA?

Shiely: An EVA program comprises three parts: a measurement system, an incentive system and a system of financial management. In measuring performance, for example, EVA's key ingredient is the recognition of a capital charge -- the cost of capital in a company, in a division, in a branch store or in a product. Research shows that companies using EVA outperform competitors of comparable market capitalization by an average 49% over a five-year period, as measured by total return to shareholders.

IW: How has EVA been applied to Briggs & Stratton?

Shiely: We began by returning our manufacturing focus to high volume business and began treating our people as owners. Back in 1989 we had to recover from a mistaken effort of trying to be all things to all people. For example, we began making a line of premium engines, but found that we couldn't make any money because the volume was too low. Step two of the recovery process was splitting the business into six divisions that serve as EVA centers. In addition to managing costs, the general managers of the divisions became responsible for managing their capital assets according to EVA principles. The third piece of the turnaround puzzle was the economic discipline, the full EVA program with EVA incentives, EVA training, using EVA metrics to measure new products, acquisitions and joint ventures. By 1992 the company was beginning to earn the cost of capital and that has continued for 10 of the past 11 years. That's quite an achievement because only between 30%-40% of companies earn the cost of capital in any given year.

IW: How does EVA impact capital equipment expenditures -- the plant floor investments?

Shiely: What we're trying to do is make our people owners by training them to view the world as owners do. We want them to learn to invest money in the business the way they do in their personal lives. The idea is to apply the same principles of economic analysis. That means that budgets are not a mandatory license to spend. For example the first year we put EVA in, we had a capital spending program of about $70 million and by requiring EVA justification, the analysis authorized only $47 million. A similar thing will happen this year with expenditures falling $10 million under budget. Under conventional [non-EVA] budget regimes, people will find a place to spend that money. Without EVA, that [spending] will tend to happen even if the capital investment isn't needed.

IW: How was the premium-priced engine project resolved?

Shiely: Mitsubishi now makes and brands this low volume engine line for us. If we had an EVA program when we decided to enter this premium market we could have avoided not only the $70 million we invested in production equipment, but also monthly losses of $1 million. That engine project should have been earning $10 million annually, but instead yearly losses were $12 million.

IW: What challenges confront managements who want to implement EVA?

Shiely: The challenges include unions who are not active in the value creation process and investors who focus on accounting earnings and ignore the higher correlation between economic profit and the value of the business. What unions ought to do is implement EVA incentive programs and get rich! Ideally all the corporate constituencies -- the customers, the employees, the communities where a company is located -- can help with the EVA value creation process.

BERK: Shiely is a great advocate for value based management and EVA.  He literally wrote the book! Check-out The EVA Challenge: Implementing Value-Added Change

 

Corporate Insiders' Selling Slows Down a Bit

Insiderscore.com monitors corporate insider - executives, institutions and the company - behavior concerning the buying and selling of their company's stock.  Excess supply, sales by corporate insiders and by companies looking to bolster their balance sheets have helped to keep the stock market in tight bound range.  Insiderscore.com just reported that much of that supply is stoll coming.

 

Insiders Remain Snug In Their Bear Dens

• S&P 500 Selling Slows, But Insiders Still Bearish
• Russell 2000 Sentiment Remains Bearish
• Transportation, Media Insiders Bear Teeth
• Weekly Scores for Consumer Goods, Healthcare Hit Quarterly Lows
• Basic Materials Sentiment Not What It Seems

(As of 12/16/09) Sentiment remained squarely in Bearish territory as our Weekly Score for the Entire Market inched lower. There was more significant movement in the Weekly Score for the Entire Market Excluding Financials, where the score actually improved, but most of that was due to a slowdown in selling amongst S&P 500 companies, not an increase in buying in any market segment. There's no disguising the fact that insiders across all sectors continue to exhibit a serious sell bias, something they've been doing for the better part of nine months now. Meanwhile, the insiders who have been buying have shown little in the way of conviction. With the quarter nearing an end and the holidays approaching the volume of transactions will lighten.

via www.insiderscore.com

CARPE DIEM: Capitalism Is the Driver of Real, Sustained Growth

There’s an old saying: “Everyone’s a capitalist on the way up and a socialist on the way down.” People want it all—to reap the benefits of free markets, but be protected against any downside. Capitalism won’t abide. And that’s a good thing. It’s a system of inherent checks and balances, which can be swift and brutal during the pruning process. In rough times, we seem willing to sacrifice free markets’ benefits for perceived security from this process. Still, if free markets were restricted, what would happen to those checks? Subprime problems #or Bernie Madoff’s# were not revealed by regulators, but by markets. Note, politicians are human, too.

Capitalism and free markets are not ever-stable. They work precisely because they compel folks to take risks and seek to create excess value out of existing capital, in whatever form that might be. They’re examples of constant change and innovation. Change isn’t always comfortable—and much of it will fail—but when it moves society in a more efficient direction, society certainly becomes more profitable.

During crises, the balance always tilts toward government and away from capitalism. This doesn’t mean capitalism is done. But such things are always said in times like these. Government “solutions” can only carry the economy so far—it’s up to capitalism to drive real, sustained growth. That is, it’s up to the people who make an economy, not its turgid overseers.

~Fisher Investments Editorial Staff (12/26/2008)

via mjperry.blogspot.com

Berk: Mark Perry over at the Carpe Diem Blog posted this note from Fisher Investments last year at this time to remind us all that we always go through periods where it "appears" government is the answer to the temporary social ills caused by the inherent riskiness of capitalism.

Capitalism, consisting of economic liberty and strong property rights- is the only way to generate sustained, real economic growth. We will soon learn that government stands in the way of this progress.

CARPE DIEM: Another V-Sign of Economic Recovery: ECRI

NEW YORK, Dec 18 (Reuters) - A weekly measure of future U.S. economic growth continued to rise, reaching levels hit in the summer of 2008, while its yearly growth rate climbed toward recent record levels, a research group said on Friday, saying this reaffirmed its forecasts of smooth recovery into 2010. The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index rose to 130.7 in the week ended Dec. 11 from an upwardly revised 130.2 the previous week (see chart

via mjperry.blogspot.com

BERK: It's cold in the East but this measure says the economy is just heating up.

This Is Not Health Care Reform; and Americans Know It

It has become obvious to any American following the debate that President Obama has adopted a get-a-deal-at-any-cost mentality that puts a higher priority on the political victory of passing any bill over the policy substance of what is actually in the bill and how it would effect the American people. As Dean told O’Donnell last night: “You can’t vote for a bill like this in good conscience. … It costs too much money. It isn’t health care reform. It isn’t even insurance reform.”

via blog.heritage.org

Berk: Even Howard Dean wants to kill the bill and start over. And Americans know the President has lost all credibility - the only reason the Democrats are going to pass this thing is because they have come this far already and hurt themselves. That's the problem. The President and his party in Congress are not thinking about the country; they are thinking about themselves and their political fortunes.

Conscious Capitalism? Making Money By Making a Difference?

Imagine that - recognizing that the freedom to create value through emergent associations among business constiutiencies - employees, suppliers,customers, communities, lenders and shareowners - just might be the most enlightened way for humans to manage scarce resources.  Now if the government and interest groups would also attend these conferences maybe they would see the wisdom in getting out of the way!

BERK