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The Only Financial Ratio That Truly Matters
When stock prices go all wonky, as they have in recent days, it pays to think a little about what really moves asset prices and determines long term business success. For ConvergEx's Nick Colas, the key driver has been – and always will be – return on capital. What investment analysts know as the DuPont model is now 100 years old, but its lessons and applications still drive innovation today. Want to know why Airbnb or Uber are successful?
They leverage existing assets to create higher returns – right out of the DuPont playbook. And consider that time is the scarcest and most valuable asset of all; every successful mobile app or social network tries to give you more choices about how to spend it. Optimizing return on capital – defined as maximizing any scarce resource - is always the compass that points to success.
Via ConvergEx's Nick Colas,
In 1920, General Motors had less than 12% of the U.S. car market; by the 1950s it held more than 50%. During World War II it was a critical part of the “Arsenal of Democracy”, and without it the war would have certainly lasted longer and cost many more lives. Even in the 1990s, when other carmakers struggled – Chrysler almost went bankrupt in 1991 – GM rolled along with an “A” credit rating and a +30% share of the U.S. automobile market. And while we all know the GM of today, it pays to remember that it was once the Apple/Google/Facebook of an earlier era.
That GM’s success lasted as long as it did is more the function of one man and one financial discipline than most people realize today. Alfred Sloan, who ran the company from 1923 to 1956 as Chief Executive Officer and then Chairman of the Board, was the epitome of the 20th century focused and dedicated manager. He centralized administrative functions and left everything else to operating heads. He regularly traveled the country, visiting 5-10 dealers a day to hear their concerns. He never shouted – his nickname was “Silent Sloan” – preferring to lead with quiet consensus building. He was on the wrong side of history as the industry unionized, to be sure, but afterwards he certainly ran a company that delivered a huge slice of the American dream to millions of workers and their families.
The core of the financial system he used to run the company actually came from outside, in the form of a former DuPont executive named Frank (F.) Donaldson Brown. The approach Brown took from his prior employer – and large GM shareholder – was to analyze all the activities of the company along two lines: the assets it took to run the business and the return on those assets in the form of income. We know this approach today, aptly enough, as the DuPont model and every aspiring stock analyst commits it to memory either in the classroom or from their CFA Level One textbook.
While the DuPont model may seem like an archaic approach, soiled in the grease of the manufacturing-oriented 20th century, it is just as relevant in today’s online “Virtual” economy. Consider a few examples:
The hottest venture-backed company at the moment is Uber, the online car service, with a recent $17 billion valuation. Its value proposition to drivers/car owners is an automated and location-optimizing dispatch service that promises more fares than standard human operators can deliver. The driver already has the car – a fixed asset – and Uber offers a better return on that investment than the traditional car service company may be able to provide. For the Uber user, the geolocating feature (in the Uber app) offers potentially shorter wait times and the facility to see how close your ride is to your location. Time is the user’s asset, and less time waiting means more time for everything else. In areas where driver licensing allows it, part time/non professional drivers can more efficiently choose which hours they wish to work, giving them better utilization of their vehicle/fixed asset and their time.
Airbnb, the house/apartment-sharing business, allows a homeowner or renter to use their capital to earn a return above the utility of simply providing shelter. What was once simply a spare bedroom becomes an income-generating property. F. Donaldson Brown and Alfred Sloan would have given that kind of project a big thumbs up at the old General Motors.
Less well known on this side of the Atlantic is the amusingly named BlaBlaCar, a U.K. company that offers ride sharing services. Want to go from London to Edinburgh for the Fringe Festival? Log on and see who is driving the same way on the same day and determine how much of a contribution you’ll need to make to share in expenses. Better asset utilization for the car owner (cheaper trip) and more affordable for the rider than public transport.
The DuPont model isn’t just for new business analysis – it also explains a lot of mergers and acquisitions/new business activity as well. A key here is an often-overlooked part of M&A analysis – how long can the acquirer really keep their business going in the face of new competition or opportunities? Advances in technology create a constant stream of disruptive threats to existing businesses, and sometimes it is better to buy your new competitor than try to fight it out with them. Unless you can develop something on your own… A few examples of popular M&A/business development themes:
Mobile. Consumers generally use smartphone-enabled technology for one simple reason: it is more time efficient than waiting until you are in front of a computer. Businesses like it because they can determine your location – just look on your own smartphone to see how many apps automatically update your location even when you aren’t using them. (Why does the Flashlight app on my iPhone need to know where I am?) In both cases “Time” is the asset in question, and mobile technology leverages that asset in a manner entirely consistent with what the DuPont model instructs: make the most of it. Always.
Money and Payments. Investors always want new and profitable places to invest their financial capital, and peer-to-peer lending is one growth area that addresses this market. These businesses match lenders with borrowers, based on credit scores and other factors, essentially allowing owners of capital to act as a bank and earn the interest on such loans. And bear the risk, of course…
- Vendors and merchants would prefer faster payments than the existing banking system affords – assets now are always preferable to assets later – and new payment systems offer the chance to get paid for that skinny latte in seconds rather than days. Alfred Sloan built the General Motors Acceptance Corporation into a lending juggernaut for precisely this reason – getting paid from the dealers immediately, and earning the interest from consumer loans – is a more efficient use of capital. And yes, he would have probably taken bitcoin for car purchases, but only because it is cheaper and faster than GMAC could ever be.
Buying customers and their attention. Some of the more head-scratching tech industry acquisitions of the past year or two (no names here, but you know who we mean) seem to revolve around buying businesses with a customer list and a popular technology. No profits, mind you, and none easily visible in the near future. But lots of users.
- I can’t help but think that the acquiring companies feel the heat of “Time as an asset” as they sign on the dotted line for their expensive purchases. It’s not the financial intrinsic value they are buying. Rather, they are buying the time it would take to compete with the business they are purchasing. Time better spent, apparently, doing other things. Especially fighting a competitor who beat them to the punch and bought the same asset.
Taken as a whole, these examples point to two conclusions. First, the nature of capital has changed from the days of Sloan and Brown and the GM of the 1930s-1950s. Valuable assets – time, for example – don’t appear on a balance sheet but that omission is irrelevant to modern business practices. Business owners still have to manage and optimize them just as they did when owning a tool and die machine was the starting point for a new venture. Second, the essential challenge of managing a successful enterprise has not actually changed all that much from when Alfred Sloan used to take his morning walk to work at the GM Building in New York. Manage what it scarce – physical capital, time, talent, opportunity, whatever – and make the most of it.
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-Stock and Flow.
-Time value of Money
-Profit=Revenue-Cost
Return on Capital (or flow derived from stock) is the only thing that matters.
Factory = stock
Output of the factory = flow
Both are needed.
Listen EKM1.
Could you imagine AirBnB-n-it and knuckles is your host? OMG, I would freak having him yap in my ear all night and trying to spoon on the couch because Ralph Spoilsport is outta town for the night.
Talk about an inefficient investment of time.
I like the Amazon Model of business. Lose money for 20 straight years, but become a multi-billionaire on bullshit inflated stock anyway. THAT is the only innovation left in the US.
Nothing new here...it's the old airline model "We're losing money on every flight, but we'll make it up on volume"
fwiw .. knuckles turned out to be a pretty great host
bonfire
burned some boxes, tables, chairs, tree limbs
roasted marshmallows
sang songs
neighbors came over, brought some beer
sparks drifting up to the sky
check it out sometime
Listen Bangalore,
That would be awesome. Definitely YouTube material.
Demand = everything
zero demand = zero capitalism
consumer with no disposable income [makes 10$ an hour] = can't drive demand.
My business, tiny as it is, requires customers with a disposable income available to pay for a nice get away weekend in tourist country. If nobody makes shit for wages in the big city, I got no customers.
I expect real capitalists with real big businesses have lost sight of this. Our society is demand driven, minus the wars and government waste. In the real economy the consumer with cash in hand in KING!
The thing about real capitalism is that it is virtuous. You only get paid if you serve your fellow man. Your product, labor, or capital serves a need that someone else has and they are willing to pay you for it.
The point of the article was that one of the things people are willing to pay for more than any other is if you save them time. Ask anybody today, their heads are spinning with work and struggles of life. Parents run ragged takin kids to school, sports, dance, etc and trying to get a few meals in without everyone glued to their damn phones while eating. Time is in short supply these days and people will give you their fortune in exchange for saving them time.
That is why you see less healthy diet choices in favor of quick easy fixes. The rise of the chains and death of mom and pops I would argue are the result as well. It is a waste of time to have your night out turn into a disaster so people don't take the chance on dinner at a mom and pop or spend the night at a local hotel. Instead they hit up Applebee's and stay at a Hampton Inn.
I'm not advocating any of this time saving by the way. I'm just explaining the phenomenon.
Perception of reality. Eyes on the phone, ignoring the real people in the room, while eating a meal is not a sign that people are connected to reality any longer. It shows they are disconnected. Too many disconnects and the system will break down.
And here we are today.
But how do we know what they are doing on their phones. Maybe they are posting comments on Zero Hedge for all we know.... nahhh... who am I kidding? People are on Face-book or texting.
Fuck your Prudential ads and, now, your Sean Eldridge ads. I hope those with AdBlocker realize who your sponsors are.
ads are tailored to what you search and visit, based on your invisible profile.
I can get all my ZH ads to become dating ads or financial ads, the choice is mine(yours) :D
The Prudential pop-up is ever-present. It comes up every time I click to a new screen. It wastes my time over and over and over again.
Advertisers are forgetting that Ads can have a negative impact.
One of my favorite ads were the Energizer bunny ads reminding everyone that they weren't invited to the "copper top" test party. It was such an easy thing. Didn't anyone at Duracell stop to think what would happen? Of course someone must have. So, what was the dynamic in play at the time?
Fuck cRapple IOS. Fuck Internet exploder, and especially fuck Google Chrome.
what a bunch of bullshit
Totally agree. For a number of reasons. Here's one:
Time is NOT a valuable commodity if interest approach ZERO. Any pile of shit can keep limping along, rolling debt at near-zero interest. The Federal Government comes to mind immediately, of course, but they are not the only example. Plenty of corporations (banks) fit the model as well. If nothing dies, nothing else can grow in its place.
Welcome to Japan.
Japan prospered because US Military was making sure goods move around. Yen is not reserve currency
Now it's different. The very reserve currency is under attack
NiDebt,
Time is always a valuable commodity. It cannot be recovered or stored.
What you're seeing is an illusion - the lag time between developing realities.
I remember being given an assignment in Dec 1988 by a lecturer to write about "Line" vs "Staff" in US corporates. I went to the library for the first time and found a book from the early 1960s or late 1950s that reviewed a survey of 'line' managers vs 'staff' managers in companies such as GM and IBM and Ford. Neither myself nor anyone else in the class knew what line vs staff meant. Line were guys who had risen up through the ranks mostly. Staff were the Ivy League types mostly (like today's C suite). All I remember is that the Line guys called the Staff guys 'college punks' and 'chair warmers' and 'slide rulers'. Obviously the line and staff guys had their differences, but the survey and discussion was truly engrossing, and I felt it was a more gentle, nobler time than today. I always visualise it as the madmen era where they were all probably constantly smoking and wearing those short-sleeved, white, IBM salesmen shirts.
loot company
get bailout
take bonus
borrow money
buy back shares
take stock option bonus
offshore profits
take bonus
offshore labor
take bonus
loot company
get bailout...
Good article....and true as long as we keep in mind that the overriding difference between then and now is that back in the 50's US companies actually MADE SOMETHING.
jam stocks higher on margin
take your 2 and 20
snort cocaine off hooker's ass
jam stocks higher on margin
take your 2 and 20
snort cocaine off hooker's ass
jam stocks higher on margin
take your 2 and 20
snort cocaine off hooker's ass...
All genocide, torture, destruction to nature have been done since Christopher Columbus in the name and glory of return on capital, Motherfucker!
reader2010,
Why not give some real thought to what capital is?
Monopoly money is not capital.
It might soon become apparent the economic efficiency of credit is beginning to collapse and the additional money poured into the system coupled with lower rates can no longer drive the economy forward. When this happens we are at the end game.
At some point the return on loaning money is simply not worth the risk! Why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? When this happens the only safe place to store wealth will be in "tangible assets" and the only lenders will be those who print the money that nobody wants.
The collapse of credit can pose major problems such as what we saw when many sellers were forced to demand payment up front before shipping goods in 2008. More on this subject below.
http://brucewilds.blogspot.com/2014/06/the-economic-efficiency-of-credit...
AdvancingTime,
I would say we are a step, or two past that. As the "money" in use becomes worth less, then you loan more. (i.e. NINJA loans)
Your statement assumes a stable value, or direct value, money. Not a printed cents off coupon one.
There's a double set of books in play. One is numbers. One is value.
In 1948, Henry Kissinger, a 23-year-old American intelligence officer, recruited Nazi expatriates to serve in top positions in American military, aerospace, and biological science and medicine. Twenty years later, he left Harvard’s esteemed faculty and resigned a lucrative position as Nelson Rockefeller’s foreign policy attache’ to become President Nixon’s closest advisor and director of the National Security Council. Seeking alternatives to tactical nuclear weapons to bolster America’s “diplomacy” abroad, the paranoid and egomaniacal Kissinger quickly ordered the Army’s Chief of Staff to requisition $10 million from Congress for the development and testing of EBOLA & AIDS-like viruses. Within ten years, the AIDS and Ebola epidemics erupted coincidentally in the regions of Africa ravaged by CIA military covert operations also ordered by Kissinger.
In 1984, Dr. Robert Gallo, of the National Cancer Institute, claimed credit for discovering the AIDS virus. He announced it most likely originated from a monkey virus which spontaneously mutated and naturally jumped species. Dr. Gallo was a biological weapons contractor for the CIA’s top secret “Project: MKNAOMI,” and was paid to produce and test EBOLA, AIDS-like viruses as early as 1970.
EBOLA – CIA Project Codename MKNAOMI & Hi-Tech AssassinationsFinancial Ratios do not matter in rigged markets. Indebted economies have lost all flexibility to sustain businesses on the paths of risk adjusted growth.
It is now a game to outsmart the Predators if you want to get involved.
Crap you mean business must offer value above the competion ? Not anymore they just cut costs and advertise marketing is the only thing that matters. No one has time to comparison shop they just go buy the lowest price or the closest store anymore. It's all the same stuff everywhere no one has different quality just presentation. High end clothes are Chinese crap was mart stuff is Chinese. Same quality different marketing.
Funny how no one mentioned Return OF Capital.
I'd argue that a "Negative ROI" is not a ROC.
Capital has not been preserved, but lost, given away or stolen. A true ROI in my view is when Capital is preserved and there is a Profit.
These days, between the Fed, the IRS and Wall St, talking about "ROI" is a Misdirection about the real problem: Loss of Absolute Capital, when your Investment/Capital is indexed to Real Money, not elastic fiat paper. The only way I see that math working out, is if it (every Input and Output) is indexed to Gold every step of the way.
Hmm . . . I thought we invented bailouts so that businesses no longer had to be competitive or create value.
Tyler, ZHers, while blogging here and listening to streaming online radio stations in several EU countries, I can tell you that they are talking about the Stress Test of EU banks today.
You may recall that ZH covered this days ago. :-)
Having said that, they are all downplaying the extent of damage if they were to "get into trouble". IOW, the PR Agents are doing their job.
E.g. Michael Kemmer, a speaker for the German Banks, cited the 8% Buffer that various shareholders and bond holders would have to cover, before account owners would be affected. He could not give a concrete answer what would happen if a bank's losses were much greater.
Further to above post...
per "Deutschland Funk" streaming radio...
They said that only one of Germany's 25 banks failed the Stress Test, but they claim to be taking Corrective Action.
No comment was made of a cascading or Domino effect, if a foreign bank triggered the bankslide.
They concede that the TBTF still exist, although it's thought that their demise is less likely after Reforms.
Apparently about 500 US small banks have been shut down or taken over by more profitable banks, there has been no such large scale consolidation in EU banks.
That's why you have a Wal Mart within spitting range of every american full of crap bought from China that doesn't work, has parts missing, or breaks within 15 minutes. Not to mention just try to get help in one of their hell holes. Leverage like hell and build as many as possible while ignoring the consumer. Online model will do the same thiing to them that they did to mom & pop operations. Good riddance wally world.
ROC matters, especially ROC>COC, in other news, water is wet
I read once that GM went around buying up streetcar lines in cities (the lines were privately owned), and tearing out the tracks to make way for cars (and eliminate a competitor). Does anyone know if this is true?
If so, Sloan maximized return for GM, while reducing it for society as a whole.
The question to ask is "how was the purchase of the tracks funded?". Was it funded with free money from banks ... equity purchases are funded by free money from banks, the money just has to be laundered first.
All US money is created out of debt.
Yes they did it in Pittsburgh and it was full of bribes to replace the trollies with GM busses as well.
Hang em high and neuter their children.
Sorry, it is a bullshit article for today's America. Money is free to the banks and government and so anywhere that they are involved in funding so called public businesses the capital is essentially free. There is no need for constraint, for good management, for fiscal responsibility. The banks and government will just create more money out of thin air and throw it where they want to throw it to benefit their power structure and their cronies.
Yes, we have a corrupt system, where people such as you promote the view that we were taught in business school ... but it is not reality. It is propaganda for the masses to try to make them believe that there are rules and things are fair ... with only a few bad actors.
Again, bullshit!
Buying time?
Time that WOULD have been put in to efforts to reach maximum users and catch their attention, who COULD be POTENTIAL customers for a FUTURE business model, which MIGHT yield decent ROC?