Saturday, March 24, 2012

Saturday Short Term Thinking Rant

On the subject of ROE (return on equity)*...

*Stirred up thoughts as a result of my wanderings on some investment forums.

I've seen how public company employers and suppliers of mine have pushed ROE up in the interest of impressing Mr Market in their quarterly report.

It's often done at the long term expense of the company's competitive position. e.g. Manufacturing sector slows = idle plant capital equipment = unload capital equipment/capacity = increased ROE.

Then comes the market upswing... Duh-ohh.

During the slow down it was "damn the torpedos" and "nevermind the business sense of our short term action." "Sell that excess capacity!"

Nevermind the obvious industry or technology cycle. Nevermind your offshore competitors have anticipated the obvious and built idle capacity to cover the next 3 year up cycle.

Yup, you guessed it. Sure as spring, along comes the ramp up in demand and it's all a****les and elbows to make big new cap-ex plans and ramp up/debug "new" expanded capacity. It's "all forward full" and justify that recapitialization with a 3-6 month ROE payback to show Mr. Market what good little MBA's you are.

Nevermind being late to the new demand curve.
Nevermind missing the opportunity to get a pricing premium for having the standby capacity available early in the up cycle.

Huh? What'ch you talkin' 'bout Willis?
Ok, let's back up and fill in a bit of color...
When your customer pulls in orders early to meet their early demand the supplier can negotiate some nice spikes. There's a brief window of opportunity where your customer will take product "at any cost." Well, not at ANY cost but you get the idea...

There's also the special position opportunity movers are in to capture the followon business for the duration of the cycle.

OTOH, by coming late to the party the ROE-geniuses we talked about first have to price their product even lower still. They have to find a way to take away the demand captured by the early movers (who had kept capacity).
/rant off/

Perhaps ROE a more useful (or safe) number for an actual owner/operator to rely on. The private industrialists** I've known have freedom to look at ROE with some intellectual integrity as a consistently, internally, calculated benchmark. However, my impression is the private industrial types tend be much more interested in ROIC and FCF (Return on Invested Capital and Free Cash Flow).

**I see some parallels with the way Warren Buffet looks at cash generating companies.

fwiw, This is my impression of some large Asian offshore publicly companies I work with too. They may be pubilically traded but don't have the manic market visibility/reporting pressure on them for each qtr. Often they started as family businesses and still retain much of that investment culture that looks forward to positioning the enterprise for subsequent generations. They tend to be held by smaller groups with longer view of business more akin to private owners.

It's the difference, perhaps, between leadership and management by spreadsheet. Some of this stuff doesn't fit neatly into spreadsheet cells.

Things like Leadership, vision and intuition born of experience (or birth as a freak of nature business genius a la Jobs, Buffet) are hard to reduce to qty that factors into a spreadsheet.

Or maybe I'm just a grumpy over-the-hill... ;^)

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