Value Investing using Economic Value Added (EVA)

Focus On The Short-Term Hurts Companies - Bill George

One of the important qualities of ValueAligned companies is that its management team and its processes are organized around maximizing "economic value", called "intrinsic value" by Warren Buffett, not some vague notion of maximizing "shareholder value", which almost always degenerates into short-term management of accounting earnings, or "making" the number.  The sad result of this is that public companies rarely overcome what the Aspen Institute calls "short-termism".

The statement, “Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management,”identifies three leverage points for encouraging a renewed focus on long-term value creation and for addressing one part of market short-termism, shareholder short-termism: 

1. Market incentives:  encourage more patient capital through tax policy

2. Alignment: better align the interests of financial intermediaries and their ultimate investors

3. Transparency: strengthen investor disclosures

We would also add better "alignment" between corporate managers and shareholders - whether financial intermediary or not.  Of course, we prefer to eliminate financial intermediaries like mutual funds and directly to own the shares of great companies.  

The best way we have seen to signal to investors that a company is well-aligned is for top management and other employees, all the way down to the shop floor, to have implicit incentives within the management systems and explicit incentives within the reward and compensation systems, to maximize economic value.  That's what Value-Based Management (VBM) is all about.

On his blogand in the WSJ, Bill George the former CEO of Medtronic (MDT), makes his plea for managers to do the "right" thing and reject short-termism: 

This crisis wasn't caused by subprime mortgages; it was caused by subprime leadership. Its root cause is leaders who practice short-termism. The culture of short-termism—investing for short-term gains at the expense of long-term accumulation—has taken hold on Wall Street. Managerial capitalism has replaced financial capitalism as holding periods for stocks dropped from eight years in the 1960s to as low as six months today.

George goes on to remind investors that if they do not demand economic value creation from their companies they own then it isn't likely that much will change anytime soon.

Warren Buffett once said that the best holding period is "forever." That philosophy earned him $40 billion and the reputation as America's best investor. Unfortunately, long-term value investing is decidedly out of favor these days. Instead, investors pursuing short-term returns pressure corporate leaders to meet quarterly expectations rather than creating long-term sustainability and growth.

Many corporate leaders fell prey to playing this short-term game. They bought into the widely-believed myths that a company's stock price represents its true economic value and that success can be measured by comparing quarterly earnings to security analysts' expectations.

They hyped their stock prices with short-term actions or made value-destroying acquisitions that crimped their long-term competitiveness, often putting their entire business at risk. Many of their firms, like General Motors, AIG and Citigroup, are barely surviving now.

It is the very idea that maximizing stock price in the market at any given moment is what managing for value is all about that has given Value-Based Management (VBM) a bad name.  The corporate objective function in a well functioning capital market ought to be singular, but ought not to be share price.  It ought to be "intrinsic or economic value" - which can mathematically tied directly to "economic profit dollars per share".

BERK

VAT: Like Giving Whiskey and the Car Keys to a Group of Teenage Boys

This Center for Freedom and Prosperity Foundation video explains why a value-added tax would be a dangerous money machine for big government. The evidence from Europe also shows that VATs actually lead to higher income taxes. www.freedomandprosperity.org

 

 

New VAT is good for Washington politicians but really bad for America - VAT looks benign on the surface but in Europe when the VAT taxes went in all the other taxes went up too.   Why? Federal governments, especially the ones in really big jurisdictions, will not and probably cannot restrain spending - the only way to constrain spending is to starve the beast.  Notice Ms. Pelosi and Co's "innovation" - of new collection schemes that is.

BERK

HT: Carpe Diem

 

 

The New Atlantis » Diagnosis »Baucus Bill Is A 70 Percent Tax on Work

The New Atlantis » Diagnosis » A 70 Percent Tax on Work Shared via AddThis

President Obama said the other day that the debate on health care has gone on long enough, and now is the time to pass something.  Here's one unintended consequence that will be overlooked by the media and those drumbeating for "something" to get done - low wage earners' trapped by Obamacare in low wage jobs as work incentives are destroyed.

Remember that most of the economists in the administration had to check their common sense and their knowledge of "what works" at the door on the way in.  To the man and women they refuse to acknowledge the importance of marginal tax rates as an incentive for work because doing so would have to admit that their boss' wealth distribution efforts are severely damaging to future economic growth. 

James C. Capretta of National Review Online's Health Blog shows how the current health bills are bound to destroy work incentives for the nation's low income earners.  This will hurt income mobility and retard economic growth.

But does Congress, let alone the public, really understand what these bills would mean for the health sector and the wider U.S. economy? In 1994, the Congressional Budget Office (CBO) issued a lengthy assessment of the Clinton administration’s proposal, covering everything from its distributional consequences to the budgetary treatment of its various moving parts. The public should get the same kind of thorough review of what Obamacare would mean before Congress takes any further steps toward passage.

For instance, there hasn’t yet been a thorough analysis of what the bills moving in the House and Senate would mean for work incentives among low-wage families. A cursory review indicates that Obamacare would impose a massive new implicit tax on low-wage households, effectively penalizing the family that tries to do the right thing by working their way into the middle class.

According to CBO, family coverage in 2016 is likely to cost about $14,400 under the so-called “silver option” in the health-care reform plan sponsored by Senate Finance Committee Chairman Max Baucus. In the Baucus plan, a family of four at the poverty line (about $24,000 in 2016) would have pay to about $1,400 toward coverage, with the federal government paying the other $13,000 on their behalf. In addition, the government would also provide $3,500 to reduce the family’s deductible and co-payment costs for health services. Thus, the new entitlement provided by the Baucus bill would be worth a whopping $16,500 for a family at the poverty line.

As incomes rise, however, the Baucus bill cuts the value of the entitlement. A family with an income at twice the poverty line, or $48,000 in 2016, would get $9,072 in federal assistance for coverage — still a substantial sum. But its $7,400 less than the family would get if they earned half as much. The Baucus plan thus imposes an implicit marginal tax rate of about 30 percent ($7,400/$24,000) on wages earned by families in this income range. 

And that would come on top of the high implicit taxes already built into current law. Low-wage families with children also get the Earned Income Tax Credit (EITC). The EITC boosts incomes for those with the very lowest wages, but it is also phased-out as incomes rise. Past a certain threshold (about $21,400 in 2016), the EITC is reduced by $0.21 for every additional $1 earned. Throw in the individual income tax rate (15 percent) and payroll taxes (7.65 percent), and the effective, implicit tax rate for workers between 100 and 200 percent of the federal poverty line would quickly approach 70 percent — not even counting food stamps and housing vouchers.

The more Obamacare is rushed through Congress, the more likely it is to produce highly regrettable unintended consequences. Surely even the Democrats in Congress can see how damaging it would be to send signals to low-wage breadwinners that it no longer makes sense to seek a higher-paying job.

This last sentence is comical - of course the Dems will refuse to notice how damaging their healthcare bill(s) are.  After all, the economic argument smacks of "more of the same" Bush policy that "got us into this mess"  Never do they get asked which mess and exactly how that happened.  So much for the hope that the President's economic appointees would sway the President from his growth desgtroying ideology.

BERK

Paying for healthcare will reduce tax receipts - taxes will go up even more.

Martin Feldstein - Obama's Health-Care Reform Plan Is Not the Answer - washingtonpost.com.

Although the president claims he can finance the enormous increase in costs by raising taxes only on high-income individuals, tax experts know that this won't work. Experience shows that raising the top income-tax rate from 35 percent today to more than 45 percent -- the effect of adding the proposed health surcharge to the increase resulting from letting the Bush tax cuts expire for high-income taxpayers -- would change the behavior of high-income individuals in ways that would shrink their taxable incomes and therefore produce less revenue. (my emphasis). The result would be larger deficits and higher taxes on the middle class. (again my emphasis) Because of the unprecedented deficits forecast for the next decade, this is definitely not a time to start a major new spending program.

Tax rates are not the same thing as tax dollars collected. Feldstein shows how the incentive effects of top rate tax increases erode the tax base - that is the level of dollars available to apply the higher rates to.  Not only will new entitlement spending explode the deficit directly, but trying to paying for it with higher tax rates will surely reduce the amount of dollars collected by the government. 

Berk

Tax Burden of Top 1% Now Exceeds That of Bottom 95% - or You Can't Eat Percentages!

The government pays for stuff with dollars.  It takes dollars from citizens through the income tax and transfers those dollars (after it goes through the government filter where billions are sucked out to pay for the bureaucrats, lobbyists and politicians plus their staffers).

You can't eat percentages.  Percentages are ratios. Tax rates are ratios and percentages.  Here's the news: When you raise tax rates - percentages- you do not always get more to transfer to those that do not have to create, risk, employ to earn, whatever dollars those ratios end up representing.

Here me now and here me LOUD!  Raising tax rates or lowering tax rates does not make a tax system more or less fair - more or less progressive.  Tax systems are for efficiently collecting revenue for the government.  Tax rate changes have perverse unintended consequences.

So why do I hear about tax cuts for the rich and how George Bush's tax cuts for the rich created the deficit that Obama inherited - Bull S*?$t. 

There were tax rate cuts but there were not any tax cuts.  Tax rate cuts do not mean that the wealthy pay less taxes. They only pay less if everything stays the same - and nothing ever stays the same.

Since the middle of 1987 after the Reagan "tax rate cuts for the rich"  - the rich have been paying - or sacrificing ever since.  The Tax Foundation - Tax Burden of Top 1% Now Exceeds That of Bottom 95%.

Nobody but nobody should be able to ever say again that the rich got the benefits while the poor suffered. On the contrary - the rich in total paid a greater share of total dollars to fund the other 95% of DOLLARS collected every year since 1987....

...the IRS data shows that in 2007—the most recent data available—the top 1 percent of taxpayers paid 40.4 percent of the total income taxes collected by the federal government. This is the highest percentage in modern history. By contrast, the top 1 percent paid 24.8 percent of the income tax burden in 1987, the year following the 1986 tax reform act.

Remarkably, the share of the tax burden borne by the top 1 percent now exceeds the share paid by the bottom 95 percent of taxpayers combined. In 2007, the bottom 95 percent paid 39.4 percent of the income tax burden. This is down from the 58 percent of the total income tax burden they paid twenty years ago.

To put this in perspective, the top 1 percent is comprised of just 1.4 million taxpayers and they pay a larger share of the income tax burden now than the bottom 134 million taxpayers combined.

1.4 million people pay more and more dollars - screw tax rates - than 134 million people - Is that fair?  Mind you I am not complaining - I am not in the top 1% but I know that I will only have a chance to become one of the 1% if there are incentives for everyone to win!  Soaking the rich, the fat, the skinny - is immoral, unfair and un-American.  AND IT DOES NOT WORK!

 HT:CARPE DIEM

I'm Berk and I am not taking it anymore! 

Big Bonuses and Risk Taking

My friend Marc Hodak writes here about Congress' attempt to eliminate perverse incentives at too big to fail firms.  Of course, Congress does not even know what they are trying to control.

He examines 7 questions that the compensation information firm Equilar finds that companies are asking in their recently filed proxies.  Marc is OK with six of the questions but one stands out as a "teachable moment" to use a recently popular phrase.  He writes:

“Do large maximum bonus opportunities promote risk taking?”

Of course they do.  Is that supposed to be a bad thing?  Entrepreneurs have unlimited bonus opportunities–thank goodness.

The question of a maximum bonus opportunity is simply the wrong question when talking about reward systems.  The question they should be asking is whether steep bonus opportunities are combined with zero bonus opportunities.  All the governance risk faced by a company is in the area where the participant would earn no bonuses unless they can get up into the green zone of bonus payouts with an all-or-nothing, double-down, longshot bet.

So, guess which of those questions most congressmen view as the most critical in determining “excessive compensation risk?”  Yep, the risk that business executives might get paid too much.

Why is any company public? - I often wonder. 

Also, my readers familiar with the incentives at hedge funds will understand that Marc is talking about the free "trader's call option".  When hedge fund managers are in the red zone - where they do not earn performance bonus-there is no penalty, no clawback.  Therefore, like Marc says, the manager has an incentive to take much more risk than "normal" to get a near-term large pay-off. 

There is no free lunch though.  Incentives become drastically misaligned in the red zone as the risk taking incentive is strong for the manager but not necessarily as big for the client.  These asymmetric (mis-aligned) incentives have always been my main criticism of the typical 2% and 20% of profits fee structure. 

It is also why many EVA companies have tried hard to implement bonus reserves where excess near term performance bonuses are held in reserve to make sure performance improvements are sustained in subsequent periods.  This way Boards more easily replicate ownership-like incenitves deep within the organization.  If there is risk of loss then managers can have large bonus opportunities.

BERK

A Letter From 6 Million Bosses Regarding the Spending Bill

I do not know exactly who I should attribute this too, but my brother just sent this to me via email which was forwarded from one of his business colleagues who did not write the letter but felt he could have.  My brother owns a bunch of fondue restaurants in the Washington D.C. area called The Melting Pot.  He is also partners with a few other owners in Long Island and Philadelphia.  We are extremely proud of him and my sister in law, who does at least half of all the work and worrying.

He has been at this for more than 15 years and only recently has he been able to enjoy the fruits of his equity capital. 

He is really mad about this anti small business bill about to be signed by the President.  He and his partners share the feelings of the guy or gal who wrote the following.

Dear Employee,

There have been some rumblings around the office about the future of this company, and more specifically, your job. As you know, the economy has changed for the worse and presents many challenges.

The economy doesn't pose a threat to your job. What does threaten your job however, is the changing political landscape in this country.

However, let me tell you some little tidbits of fact which might help you decide what is in your best interests. First, while it is easy to spew rhetoric that casts employers gainst employees, you have to understand that for every businessowner there is a back story. This back story is often neglected and
overshadowed by what you see and hear. Sure, you see me park my Mercedes outside. You've seen my big home at last year's Christmas party. I'm sure; all these flashy ico ns of luxury conjure up some idealized thoughts about my life.

However, what you don't see is the back story. I started this company 28 years ago. At that time, I lived in a 300 square foot studio apartment for 3 years. My entire living apartment was converted into an office so I could put forth 100% effort into building a company, which by the way, would eventually employ you.  My diet consisted of Ramen Pride noodles because every dollar I spent went back into this company. I drove a rusty Toyota Corolla with a defective transmission. I didn't have time to date. 20 Often times, I stayed home on weekends, while my friends went out drinking and partying. In fact, I was married to my business -- hard work, discipline, and sacrifice.

Meanwhile, my friends got jobs. They worked 40 hours a week and made a modest $50K a year and spent every dime they earned. They drove flashy cars and lived i n expensive homes and wore fancy designer clothes. Instead of hitting the Nordstrom's for the latest hot fashion item, I was trolling through the Goodwill store extracting any clothing item that didn't look like it was birthed in the 70's.

My friends refinanced their mortgages and lived a life of luxury. I, however, did not. I put my time, my money, and my life into a business with a vision that eventually, some day, I too, will be able to afford these luxurie s my friends supposedly had. 

So, while you physically arrive at the office at 9am, mentally check in at about noon, and then leave at 5pm, I don't. There is no "off" button for me. When you leave the office, you are done and you have a weekend all to yourself. I unfortunately do not have the freedom.

I eat, and breathe this company every minute of the day. There is no rest. There is no weekend. There is no happy hour. Every day this business is attached to my hip like a 1 year old special-needs child. You, of course, only see the fruits of that garden -- the nice house, the Mercedes, the vacations... You never realize the back story and the sacrifices I've made.

Now, the economy is falling apart and I, the guy that made all the right decisions and saved his money, have to bail-out all the people who didn't. The people that overspent their paychecks suddenly feel entitled to the same luxuries that I earned and sacrificed a decade of my life for.

Yes, business ownership has its benefits but the price I've paid is steep and not without wounds.

Unfortunately, the cost of running this business, and employing you, is starting to eclipse the threshold of marginal benefit and let me tell you why:

I am being taxed to death and the government thinks I don't pay enough. I have state taxes. Federal taxes. Property taxes. Sales and use taxes. Payrol l taxes. Workers compensation taxes. Unemployment taxes. Taxes on taxes. I have to hire a tax man to manage all these taxes and then guess what? I have to pay taxes for employing him.  Government mandates an d regulations and all the accounting that goes with it, now occupy most of my time. On Oct 15th, I wrote a check to the US Treasury for $288,000 for quarterly taxes. You know what my "stimulus" check was? Zero. Nada. Zilch.

The question I have is this: Who is stimulating the economy? Me, the guy who has provided 14 people good paying jobs and serves over 2,200,000 people per year with a flourishing business? Or, the single mother sitting at home pregnant with her fourth child waiting for her next welfare check? Obviously, government feels the latter is the economic stimulus of this country.

The fact is, if I deducted (Read: Stole) 50% of your paycheck you'd quit and you wouldn't work here. I mea n, why should you? That's nuts. Who wants to get rewarded only 50% of their hard wo rk? Well, I agree which is why your job is in jeopardy.

 Here is what many of you don't understand ... to stimulate the economy you need to stimulate what runs the economy. Had suddenly government mandated to me that I didn't need to pay taxes, guess what? Instead of depositing that $288,000 into the  Washington black-hole, I would have spent it, hired more employees, and generated substantial economic growth. My employees would have enjoyed the wealth of that tax cut in the form of promotions and better salaries. But you can forget it now.

When you have a comatose man on the verge of death, you don't defibrillate and shock his thumb thinking that will bring him back to life, do you? Or, do you defibrillate his heart? Business is at the heart of America and always has been. To restart it, you must stimulate it, not kill it. Suddenly, the power brokers in Washington believe the poor of  Americaare the essential drivers of the American economic engine. Nothing could be further from the truth and this is the type of change you can keep.

So where am I going with all this?   It's quite simple. If any new taxes are levied on me, or my company, my reaction will be swift and simple. I fire you. I fire your co-workers. You can then plead with the government to pay for your mortgage, your SUV, and your child's future. Frankly, it isn't my problem any more.

Then, I will close this company down, move to another country, and retire. You see, I'm done. I'm done with a country that penalizes the productive and gives to the unproductive. My motivation to work and to provide jobs will be destroyed, and with it, will be my citizenship.

If you lose your job, it won't be at the hands of the economy; it will be at the hands of a political hurricane that swept through this country, steam rolled the constitution, and will have changed its landscape forever. If that happens, you can find me sitting on a beach, retired, and with no employees to worry about ....

Signed,

Your Boss

I won't move to another country or renounce my citizenship, and I will not give up my career or my business without a fight - but everything else in the letter rings true.  Now multiply the effects described above by 25 million small businesses or at least by the 6 million with employees - there are only 17,000 large businesses in the US according to the SBA.

That's why no Republicans voted for the spending/welfare expansion bill in Congress today.  Our President is sadly mistaken.  Economies are not built from the ground up nor are they driven from the top down.

Businesses are created from the ground up, then they drive economies - the government should do nothing more than facilitate that opportunity, not try to produce "desired" outcomes.

BERK