Quarterly Earnings Don't Matter
Plus -- the luggage-themed Melbourne cup
Live from Melbourne Cup…
Is the theme “luggage”??
Lots of frocks on display at Soul Bar…Karen Walker, Trelise Cooper etc must do a good trade for one day…
NZ
Spark out of the MSCI index end of month, Infratil goes in. SPK looks cheap but I think management couldn’t organise a piss up in a brewery…Selling the tower business…silly…
Vista — end of Potentia’s bid for board seats and fire power then. Nobody really ever took their campaign very seriously — but egg on face for Potentia…
Aus
Don Meji out at Dominos — after 22 yrs (!) the big man is out. I feel for him — obviously retail and food is struggling, so he’s exiting on a bit of a low note…over 22 yrs he has grown the Aussie franchisee like the clappers. But he leaves at a point where the business is at a question mark — too much expansion into Japan etc…
Chris Ellison out at MinRes…following a well documented tax scandal as reported in the AFR, etc. I don’t have much to say here other than he obviously built a very good business that has macro pressures (i.e. China is buying less).
Speaking of boys from Dunedin — Simon at DGL buying more of his own stock. I have written before that the stock is undervalued, even though it’s an average business. Continues to be undervalued.
URNM (Uranium) — trading very cheap here… AI data centres need power… you do the math…
Thought for the day (stealing this concept from our good friends at Craigs):
Buffett and Munger on the power of incentives (and the folly of budgets…)
…Companies do this all the time in the way they incent people. They should not have a system that encourages a focus on quarterly earnings. Our managers have no quarterly budgets – I don’t know what our numbers are going to be next quarter. I’m also careful not to communicate anything to the contrary via body language.
Insurance companies in particular can report pretty much any numbers that they want. With $44 billion of reserves, it would be easy to adjust the reserves to show whatever profit was desired.
Even if quarterly numbers weren’t tied to our managers’ compensation, if I went to Wall Street and promised X, the managers, who wouldn’t want to let me down, might play some games to achieve X.
Munger: What we don’t like in modern capitalism is the expectations game. It’s not the kissing cousin of evil; it’s the blood brother.
Buffett: People who predict precisely are either kidding themselves or others. We’ve seen people get their egos involved. And everyone in the organization knows what the CEO has promised in public.
It’s setting up a system that sets up financial or psychological pressure for people to do things they probably don’t want to do. It’s a terrible mistake.
It's relevant — earnings season is going on at the moment and as per, Wall St is glued to their screens like bipolar monkeys — red button for “miss” on earnings, green button for “beat” on 'em. They’re slamming that button down — it’s the casino and the degens are in.
Wall Street’s infatuation with “beats” and “misses” on earnings has always confused me. If you take a ten year period and how a company compounded earnings it does not matter if you rearrange the numbers. I.e, a company might compound earnings 5% in year one, 10% in year two, 2% in year three — well, you are going to have the same result as if you rearranged those any way, like a pack of tarot cards.
The same goes for quarterly earnings. What you’re really looking for is the long term earnings power of a company, and the quarterly results won’t tell you much as a result. This is why I am always suspicious of “data driven” managers who breathlessly monitor the weekly or even daily movements of their sales, revenue, etc etc. You risk being the horse chasing the carrot right in front of you and crashing into the bushes.
There is an added risk, too, because as our friend Warren pointed out above, you end up with managers who will do X and X in order to please the street (not the shareholders). For a long time Jack Welch was considered the greatest CEO in the world1 — under his leadership, General Electric never missed on earnings. EPS grew quarter by quarter with remarkable consistency. Of course — show me the incentive and I’ll show you the outcome. Well, mangers had a clear incentive to meeting earnings exceptions, so a lot of hocus pocus went on — aircraft parts would be sold from one GE division to another (i.e. from Korea to the US) — the revenue would be recognised as “new” revenue in each respective dept. You can do this with your friends at home, if you like — simply “sell” them a coffee for $5 and they can sell you back a piece of toast for $5 — congrats, you both have made revenue.
The dangers of this can’t be understated. Jack Welch’s management philosophy gave birth to many “mini Jacks” and permeated how many management schools taught people. Unfortunately, Welch wasn’t so much a management genius as an incentiviser of financial engineering — oh dear! It is perhaps no surprise that some of Welch’s protégées went on to lead Boeing.
Early in my career as an analyst I did a case study on IBM, which suffered a similar fate (even Buffett was seduced by the siren call of IBM). For years IBM starved its R&D budget while buying back shares and issuing dividends. The math is simple: if you reduce the number of shares on offer, the earnings per share number goes up (d’oh!). In itself this is no great feat — you do not have to be a particularly good manager in order to take a portion of your revenue and reduce your share count in order to increase EPS. It’s mere jiggery-pokery.
It goes back to the same thing I am always telling you — all we want to do is find good companies with good managers, that can grow underlying earnings in a sustainable manner. That’s it. I’ve no idea how badly, say, the luxury downturn will be — but I am sure that Arnault is an exceptional manager who has grown LVMH over decades, and worrying about a blip is irrational and monkey-brained (with apologies to the monkeys).
A small note on the folly of Jack Welch
Jack Welch is probably best remembered these days for his “rank and yank” philosophy. Welch would have managers rank their employees, and the bottom performers would be fired. This is stupid on many levels — an entire team might be high performers, but under this system, there “must” be a loser. It ends up making a team live in fear of the next cull. While it might make small men feel powerful, it’s basically a useless way to make your workforce dislike you. To put it another way, General Electric only now makes sense as a company, decades after Welch resigned, after it split into three different segments. This stuff matters and can be difficult to shake off — like shaking off fleas.
Burberry / Moncler
We talked earlier about how cheap of a stock Burberry is. I wrote:
Why is Burberry so cheap?
They made an error in who their audience is and therefore what image they project (i.e. they should’ve been talking about the “old money lifestyle” so beloved of aristocrats like the Churchills — hunting, horse riding, grouse, old and cold estates, etc).
They stuck with the wrong management and wrong designer for too long. Fatal.
They ran away from their roots — see, error one.
They over-expanded and the entire thing became commodified.
Why do I like it now?
It is very cheap
See point one
It has IP that is irreplaceable — and heritage — heritage is valuable
I think it is likely someone buys it at opportunistically low prices. There are plenty of vultures around (Mike Ashley1, etc).
Britpop mania is back in force. Oasis is back. Cigarettes are back. Kate Moss makeup is back. The Burberry check is back.
New management — Josh Schulman is ex-Michael Kors and Coach. He understands “premium” products that people who watch Married at First Sight can aspire to.
Did I mention it is cheap? It is so cheap. It is in the toilet cheap. It is nasty cheap (I’ve been a nasty Burberry, nasty).
This is a pretty loose tin pot thesis — but the thing with these things is — when something with actual value (i.e IP) is cheap enough, eventually something happens. Burberry’s been on a long decline. Time for a change. Burberry works when it does what it does best — quality outerwear.
Piece of evidence #1 of a turnaround — there is a new campaign out, which focuses on outerwear:
It focuses on the coat! That’s what we want! Coat please!
Piece of evidence #2 — this article from Astrid at Miss Tweed, which talks about Moncler mulling a bid for Burberry.
What’s the bottom line here? Cheap things, if they have value, don’t stay cheap forever…
A fun side-quest — go through old business books and see how many times Jack Welch is mentioned. Dude is treated like God.