Form over Substance

It has been a long time since the idea of wearing a suit was a focal point in front of a business community. Talk of a market top indicator, this was my revelation this past week, we are at a top. In the late 1990’s, young emerging entrepreneurs created a sartorial revolution and a new social fabric in the business world. I remember when in San Francisco during 1999, while serving as the Chief Financial Officer for a Holding Co, and meeting with management that was overseeing our San Francisco operations I was told we had to have a masseuse on staff, a ping pong table, a pool table, a Basketball backboard and net, all for creating the right environment for our internet wizards that were creating the next assured but not real billion dollar business. Interesting that none of them were even profitable, yet the promise of a new paradigm was the focus (though the term “cash burn” was part of the dialogue, it was all mitigated by the “promise”), as well as jeans, sandals, and a Zen environment being the right path to success. So how does this relate to my wardrobe and a market top indicator? I was to speak in front of a group of 200 or so Advertising industry participants in order to kick off a discussion around five new start-up companies that would provide the CEO of each the opportunity to present their businesses to the assembled audience. Just before I took the stage, a young, stylish beard wearing, jeans wearing, scarf adorning his neck executive asked if he could speak with me. I said yes. He asked me to lose my tie, to open my shirt, to relax so that the audience would relate to me. I was laughing, yet inside I was screaming. Once again, form over substance was emerging as the dominant theme, and as I later listened to the young company executives speak, I was not surprised to hear wonderful examples of data, impressions, recency, social accumulation, and not a word about profitability, about fundamental business concepts of return, of revenues and margins, etc. A chill ran up my spine as I overlayed this with the array of billion dollar valuations that exist today for companies that do not have correlated financial returns. Are we this blind? (please note that the young entrepreneurs have worked hard, have developed important business concepts, and will likely be folded into other companies which validate their efforts, but an element of basic business was never a part of the dialogue, and that troubles me, for in the end, our financial market decisions, our business decisions, should be based on returns of and on capital, and when that dialogue is absent, we are in an area of increasing risk). And couple this with the following: As low as interest rates are today, I did a comparison of returns for buying bonds and holding to maturity versus buying equities, and given the current environment, I was surprised to see that bonds are the better choice. My comparison began with the published Stock/Bond Yield Gap which is the spread between current bond interest and stock dividends. Bond yields exceed Stock yields by 1.96% currently, which is meaningfully below the historic mean spread of 3.95% by which bond yields have exceeded stock dividend yields over time. Comparing this to a calculated forward return from equities based on capital price appreciation resulted in Bonds returning 1.72% over equities in the aggregate. The equity return was projected based on the forward DCF return (11.17%), the cash flow growth projected today versus historic mean growth, the historic cash flow multiple as compared to the current cash flow multiple, the measure of risk in the market as represented by the VIX, and the price change needed to bring the mix of overvalued and undervalued equities into the historic average of approx.. 30% overvalued and 70% undervalued. Given all of the global uncertainty and the continued tapering by the Federal Reserve, which reminds me of the beginning of the 2000’s, when Greenspan began tightening in January once we were past the feared seizing up of the computer calendars as they flipped from 1999 to 2000, a tightening that was not reflected in equity prices until we entered April of 2000, and now as we enter April 2014, will we see history repeat itself, just like wardrobe and eyeballs seem to be more important than profits and true economic returns. Form over substance always ends when the King finally realizes he has no clothes. Are you dressed appropriately? http://seeinghighsandlows.blogspot.com/