Posts tagged ‘Tim Cook’
Fink & Capitalism: Need 4 Kitchens in Your House?
Do you need four kitchens in your house? Apparently financial industry titan Larry Fink does. If Mr. Fink were a designer for millionaire homeowners, he would advise them to use their millions to build more kitchens in their house (reinvest) rather than distribute those monies to family members (dividends) or use that money to pay back an equity loan from mom and dad for the down payment (share buybacks). Essentially that is exactly what is happening in the stock market. Companies that are generating record profits and margins (millionaires) are increasingly choosing to pay out larger percentages of profits to stockholders (family members) in the form of rising dividends and share buybacks. Contrary to Mr. Fink’s belief, corporate America is actually doing plenty with room additions, landscaping, and roof replacements – I will describe more later.
As a consequence of corporate America’s increasingly shareholder friendly practices of returning cash, Fink believes this trend will stifle innovation and long-term growth in American companies. Here’s a snapshot of the supposed dividend/buyback problem Mr. Fink describes:
Source: Financial Times
Fink Mails Letter from Soapbox
For those of you who do not know who Larry Fink is, he is the successful Chairman and CEO of BlackRock Inc. (BLK), an investment manager which oversees about $4.65 trillion in investment assets. Mr. Fink ignited this recent financial controversy when he jumped on his soapbox by mailing letters to 500 CEOs lecturing them on the importance of long-term investing. What is Mr. Fink’s beef? Fink’s issues revolve around his belief that CEOs and corporations are too short-term oriented.
In his letter, Mr. Fink had this to say:
“This pressure [to meet short-term financial goals] originates from a number of sources—the proliferation of activist shareholders seeking immediate returns, the ever-increasing velocity of capital, a media landscape defined by the 24/7 news cycle and a shrinking attention span, and public policy that fails to encourage truly long-term investment.”
He goes on to bolster his argument with the following:
“More and more corporate leaders have responded with actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases, while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
What Mr. Fink does not say in his letter is that large, multinational S&P 500 corporations driving this six-year bull run are sitting on a record hoard of cash, exceeding $1.4 trillion (see chart below). In this light, it should come as no surprise that CEOs are forking over more cash to investors in the forms of dividends and share repurchases.
What’s more, despite Fink’s assertion that share buybacks and dividends are killing innovation, he also fails to mention in his letter that 2014 capital expenditures of $730 billion are also at a record level. That’s right, CAPEX has not been cut to the bone as he implies, but rather risen to all-time highs.
It’s true that generationally low (and declining) interest rates have accelerated the pace of dividends/repurchases, however dividend payout ratios (the percentage of profits distributed to shareholders) of about 32% remain firmly below the long-term payout ratio of approximately 54% (see chart below) – see also Dividend Floodgates Widen. I find it difficult to fault many companies doing something with the gargantuan piles of inflation-losing cash anchoring their balance sheets. Don’t cash-rich companies have a fiduciary duty to borrow reasonable amounts of near-0% debt today (see Bunny Rabbit Market) in exchange for share buybacks currently providing returns of about 5.5% (inverse of 18x P/E ratio) and likely yielding 7%+ returns five years from now?
Source: Financial Times
The “Short-Term” Poster Child – Apple
There is no arguing that excessive debt eventually can catch up to a company. Our multi-year expanding economy is eventually due for another recession in the coming years, and there will be hell to pay for irresponsible, overleveraged companies. With that said, let’s take a look at the poster child of “short-termism” according to Mr. Fink …Apple Inc. (AAPL).
Of the roughly $500 billion in buybacks spent by S&P 500 companies in 2014, Apple accounted for approximately $45 billion of that figure. On top of that, CEO Tim Cook and his board generously decided to return another $11 billion to shareholders in the form of dividends. Has this “short-term” return of capital stifled innovation from the company that has launched iPhone version 6, iPad, Apple Watch, Apple Pay, and is investing into exciting areas like Apple Television, Apple Car, and who knows what else?
To put these Apple numbers into perspective, consider that last year Apple spent over $6 billion on research and development (R&D); $10 billion on capital expenditures; and hired over 12,000 new full-time employees. This doesn’t exactly sound like the death of innovation to me. Even after doling out roughly -$28 billion in expenditures and -$56 billion in dividends/share repurchases, Apple was amazingly able to keep their net cash position flat at an eye-popping +$141 billion!
Mr. Fink abhors “activist shareholders seeking immediate returns” but rather than deriding them perhaps he should send the greedy, capitalist Carl Icahn a personal thank you letter. Since Icahn’s vocal plea for a large Apple share buyback, the shares have skyrocketed about +85%, catapulting BlackRock’s ownership value in Apple to over $19 billion.
With respect to these increasing outlays, Mr. Fink also notes:
“Returning excessive amounts of capital to investors—who will enjoy comparatively meager benefits from it in this environment—sends a discouraging message.”
This would be true if investors took the dividends and stuffed them under their mattress, but an important message Mr. Fink neglects to address as it relates to dividends and share buybacks is demographics. There are 76 million Baby Boomers born between 1946 – 1964 and a Boomer is turning age 65 every 8 seconds. With many bonds trading at near 0% yields (even negative yields) it is no wonder many income starving retirees are demanding many of these cash-rich corporations to share more of the growing spoils via rising dividends.
Capitalism Works
After looking at a few centuries of our country’s history, one of the main lessons we can learn is that capitalism works – especially over the long-run. With about 200 countries across the globe, there is a reason the U.S. is #1…we’re good at capitalism. As our economy has matured over the decades, it is true our priorities and challenges have changed. It is also true that other countries may be narrowing the gap with the U.S., due to certain advantages (e.g., demographics, lower entitlements, easier regulations, etc), but the U.S. will continue to evolve.
In many respects, capitalism is very much like Darwinism – corporations either adapt with the competition…or they die. I repeatedly hear from pessimists that the U.S. is in a secular state of decline, but if that’s the case, how come the U.S. continues to dominate and innovate in major industries like biotechnology, mobile technology, networking, internet, aviation, energy, media, and transportation? Quite simply, we are the best and most experienced practitioners of capitalism.
Certainly, capitalism will continue to cultivate cyclical periods of excess investment/leverage and insufficient regulation. But guess what? Investors, including the public, eventually lose their shirts and behaviors/regulations adjust. At least for a little while, until the next period of excess takes hold. If Apple, and other balance sheet healthy companies allocate capital irresponsibly, capital will flow towards more aggressive and innovative companies. BlackBerry Limited (BBRY) knows a little bit about the consequences of cutthroat competition and suboptimal capital allocation.
While I emphatically share Mr. Fink’s focus on long-term investing values (including his self-serving tax reform ideas), I vigorously disagree with his attacks on shareholder friendly actions and his characterization of rising dividends/buybacks as short-term in nature. In fact, increasing dividends and share buybacks can very much coexist as a long-term investment and capital allocation strategy.
The question of proper capital allocation should have more to do with the age of a company. It only makes sense that younger companies on average should reinvest more of their profits into growth and innovation. On the other hand, more mature S&P 500-like companies will be in a better position to distribute higher percentages of profits to shareholders – especially as cash levels continue to rise to record levels and leverage remains in check.
BlackRock’s Larry Fink may continue to urge CEOs to reinvest their growing cash hoards into superfluous corporate kitchens, but Sidoxia and other prudent capitalist investors will continue to exhort CEOs to opportunistically take advantage of near-free borrowing rates and responsibly share the accretive gains with shareholders. That’s a message Mr. Fink should include in a letter to CEOs – he can use BlackRock’s lofty, above-average dividend to cover the cost of postage.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including AAPL and iShares ETFs, but at the time of publishing, SCM had no direct position in BLK, BBRY or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
The Challenge of Defining Growth vs. Value
“A challenge only becomes an obstacle when you bow to it.”
― Ray Davis (Famous General in the Marines)
In the investing world, one major challenge is defining the differences between “growth” vs. “value”. Warren Buffett said it best when he described growth and value as two separate sides of the same coin. In general, low or declining growth will be valued less than a comparable company with faster growth. Often, most companies go through a life cycle just like a human would (see Equity Life Cycle). In other words, companies frequently start small, grow larger, mature, and then die. Of course, some companies never grow, or because of lack of funding or outsized losses, end up suffering an early death. It’s tough to generalize with companies, because some businesses are more cat-like than human. For example, Apple Inc. (AAPL) may not have had nine lives, but the stock has been left for dead several times during its lifespan, before managing to resurrect itself from value status to growth darling (with a little assistance from Steve Jobs). Whether Tim Cook can lead Apple back to the Promised Land of growth remains to be seen, but many investors still see value.
Fluctuating price and earnings trends over a company’s life cycle frequently create confusion surrounding the proper categorization of a stock as growth or value. The other frustrating aspect to this debate is the absence of a universally accepted definition of growth and value. A few specialty companies have chosen to address this challenge. Russell Investments in Seattle, Washington is a leader in the benchmark/index creation field. Russell tackles the definitional issue by creating quantitatively based definitions, tediously explained in a thrilling 44-page paper titled, “Construction and Methodology.” Here is an exhilarating excerpt:
“Russell Investments uses a ‘non-linear probability’ method to assign stocks to the growth and value style valuation indexes. Russell uses three variables in the determination of growth and value. On the value side, book-to-price is used, while on the growth side, the I/B/E/S long-term growth variable was replaced by two variables- I/B/E/S forecast medium-term growth (2 yr) and sales per share historical growth (5 yr).”
As I bite my tongue in sarcasm, I like to point out that these methodologies constantly change – Russell most recently changed their methodology in 2011. What’s more, there are numerous other indexing companies that define growth and value quite differently (e.g., Standard & Poor’s, Lipper, MSCI, etc.).
Like religious beliefs that are viewed quite differently and are prone to passionate arguments, so too can be the debates over growth vs. value categorization. I’ve been brainwashed by numerous great investors (see Investor Hall Fame), and underpinning my philosophy is the belief that price follows earnings (see It’s the Earnings Stupid). As a result, I am constantly on the lookout for attractively priced stocks that have strong growth prospects. If Russell or S&P looked under the hood of my client portfolios, I’m certain they would find a healthy mix of growth and value stocks, as they define it. If they looked in Warren Buffett’s portfolio, arguably similar conclusions could be made. Most observers call Buffett a value investor, but over Buffett’s career, he has owned some of the greatest growth stocks of all-time (e.g., Coca Cola (KO), American Express Co (AXP), and Procter & Gamble (PG)).
At the end of the day, expectations embedded in the value of share prices determine future appreciation or depreciation, depending on how actual results register relative to those expectations. If stock prices are too high (as measured by the P/E, Price/Free-Cash-Flow, or other valuation metrics), slowing growth can lead to sharp and painful price declines. On the flip side, cheap or reasonably priced stocks can experience significant price appreciation if earnings and cash flows sustainably improve or accelerate.
In my view, the greatest stock pickers think about investing like sports handicapping (see What Happens in Vegas, Stays in Las Vegas). The key isn’t buying fast growth (high P/E) or slow growth (low P/E) companies, but rather discovering which stocks are mispriced. Finding heavily shorted stocks that are poised for growth, or discovering unloved stocks with underappreciated potential are both ways to make money.
While defining growth vs. value is certainly difficult, the more important challenge is calibrating a company’s future growth expectations and determining the fair price to pay for a stock based on those prospects. Investing entails many difficulties, but categorizing investors or stocks as growth or value is a less important challenge than honing forecasting and valuation skills. Investing is challenging enough without worrying about superfluous growth vs. value definitions.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), and AAPL, but at the time of publishing SCM had no direct position in KO, AXP, PG, MHP, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
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