Executive Writing

Nothing in the business world draws more ire than "high" executive pay. Ask a doctor what they think and they'll most likely declare: "I save lives. What do execs do?" Faro discussed management pay in a previous post and argued in favor of rational, shareholder-friendly payouts for top talent. Like a good exercise program, the advice is rarely heeded.

How executives get their jobs is worth pondering. In addition to talent (for most) and energy, much of the rung-climbing success is due to politicking and affability. Companies understandably gravitate to likable people. Though being a nice guy shouldn't be as big of a part of the equation. Clear communication and honesty should be near the top of the list.

You don't want a CEO who's just a consensus builder and good golfer. But that's how many do it. Too many, perhaps, come from smooth talking sales backgrounds. These are 'yes' people.

You have to wonder, why these 'yes' people want to be CEO of a big company. Is it the power, the money, the ego? The lifestyle and the lavish houses, however, are appealing. In an interview with Fortune, a famous rich guy named Warren said he'd rather be a paperboy than be the CEO of GE. Whether he meant this post- or pre-billionaire status is kind of irrelevant. People should place a high value on their time.

Well, what do CEOs do? They lead the strategy of the company. They motivate. They make sure all the pieces of the puzzle fit and that, ideally, the value of the firm increases over time. They attend meetings. They have secretaries who arrange their schedules. They golf. They attend fancy dinners. They hire and fire. They are scapegoats. They put in long hours (however productive they may be). They also should write the annual shareholders' letter. This seemingly easy task is, more often than not, plagued with ambiguity and buzzwords.

Below is the Fresh Del Monte 2007 letter to shareholders. Cleaning this up would be messy. The astute reader should be leery when only GAAP figures are mentioned, but also skeptical of language like "excluding", "other charges", "accretive" (though this term is not used below, it is very common when justifying a potential acquisition), etc. This doesn't mean the business is poor; the presentation is just bad. The poor writing also reflects unclear thinking. It doesn't have to be poetry, but it should be better than MBA-level "strategic" writing. But maybe strategic is what Wallstreet is looking for.

Areas of concern in the letter are in red. Faro's comments are bolded and in brackets.

__________

"Two thousand and seven was one of the best years in the history of Fresh Del Monte Produce. During this period, we benefited from the many improvements we made in all of our business lines, which restored Fresh Del Monte’s track record of creating enhanced shareholder value [I'd mention the 2007 stock performance of +125%. That's impressive.] To achieve this goal, we continued to streamline our fresh and fresh cut businesses, eliminating unprofitable products in our fresh-cut line, while maximizing production and driving efficiencies in our logistics networks. In addition, we improved banana contract pricing in North America, countering higher production and logistics costs. We expanded our global customer base, and we began to serve a number of new markets [I like numbers].

We also continued to leverage the power of the Del Monte® brand to create new inroads in fast-growing Middle East markets. Much of our success in these and other markets is due to enduring consumer confidence in our 115-year-old brand, which symbolizes quality, freshness and reliability. In addition, we aggressively repositioned our prepared food business by streamlining production and distribution [how? don't give away your secrets, but how].As a result of our solid operating achievements in 2007, we were able to deliver substantially improved performance across a range of financial metrics. Earnings per diluted share climbed to $3.22, compared with $0.10 per diluted share for the year ended 2006, excluding asset impairment, restructuring and other charges [i.e., exluding the bad stuff]. Net sales for the year increased to $3.4 billion, compared with $3.2 billion in 2006. Gross profit for the year rose to $364.9 million, compared with $189.4 million in the prior year. Net income for the year increased to $179.8 million, compared with a net loss of $142.2 million in 2006.

We are justifiably proud of our performance in 2007, particularly as the prior year had been one of the most difficult we had ever endured. In 2006, we faced a number of hurdles, including higher energy and production costs [you state it later in the 10k, why not mention impact of energy costs in $. What about foreign currency? That's on my mind too] . The fact that we were able to overcome the lingering effects of those factors in 2007 is a testament to the expertise and commitment of our management team and the dedication of our 35,000 employees around the world. It is also a powerful endorsement of our business model. Our mission is centered on increasing shareholder value [who's isn't]. To fulfill this mission, we set out each day focused on offering products and services that meet the needs of our customers and enable us to improve profitability. While this mission requires disciplined implementation, it also calls for flexibility and resilience—two inherent qualities that we demonstrated yet again in 2007, when in spite of continuing cost pressures, we delivered some of the strongest financial results in our history [examples would be great].

As we advance through 2008, we are optimistic about our future. Fresh Del Monte Produce continues to perform well around the world, in part because of our concerted efforts to improve our operating efficiencies and reduce costs. These efforts continue, and we remain vigilant about meeting the continuing challenges of fluctuating costs related to production, transportation, fuel and packaging. We also remain firmly committed to prudently growing the Company, improving our operations, expanding in new geographic areas and developing new products to meet consumer demand. As we steadily pursue these measures, we warmly thank all of our shareholders—including those of you who took a first-time stake in our Company in 2007—for your continued support."

__________

Source: http://library.corporate-ir.net/library/10/108/108461/items/285073/FDP07AR.pdf

Disclosure: none

The Problem with Being Active

This site was originally spinofftracker.blogspot.com. Spinoffs are still a great place to dig. Though I'm sure one of the rules of a successful blog is focus, this site meanders from the rare company analysis to random musings on markets and human nature. The principle reason is fear of activity. In most situations in life, the scorecard is based on how busy we look, not on how productive we are.

Society supports and rewards activity. Only in times past it was harder to fake. If you lived in the Great Rift Valley, it was impossible to pretend to hunt. Today we have IM and meetings to mask our slacking.

In the online financial world, sites that give advice, particularly stock advice, bore the reader with mundane lists and yesterday's news. They try to hard to be active. The Motley Fool is an example of a site with an occasional standout story or opinion piece. The rest is mediocre. (Important note: I did interview unsuccessfully--by some measures--with The Fool.) Their analysts try too hard to create the next big headline: "Why you need to buy these 5 stocks today", "3 mistakes Buffett made." Those headlines are not real. But most articles are overly hedged, obvious, or too promotional.

Hyperactivity is a great argument against subscribing to a stock newsletter. I'd guess that most newsletters are marketed to individuals not institutions. Institutions have research departments and sophisticated TPS reports.

A person, we'll call him Bill, is 45 years old and enjoys a modest income. Bill occasionally listens and cares about what Ben Bernanke says. He peruses the business section of the paper. He knows what LIBOR means, that the S&P is a market-weighted index, and that nobody really understands credit default swap exposure. He's ahead of the pack.

Most stock newsletters publish monthly picks of 1-2 stocks. You can imagine if Bill subscribes to just one letter, over the course of five years--the minimum time frame to establish a solid track record--that he'll have seen 60-120 recommendations. And surely he's not puting all his extra cash in one newsletter's picks. He'll pay 200-300 dollars per year for the letter and he'll cherry pick stocks he's familiar with. His performance will be very different from the letter's reported numbers.

Far superior to the newsletter model is money management. The idea of being a mere observer and learner and reaping the huge paydays is probably diverting many geniuses from cancer research and mentoring. That's not to say funds don't justify their "work" in some way. Nerds create algorithms, and fancy charts with Greek letters attempt to validate the lucrative 2 and 20 (2% of assets and 20% of returns) fees.

The ideal model is simpler. It would be a team of one or two. An ambitious unpaid intern could be of use in filtering and going through boring SEC filings. Office space would have to be free at the start, run out of an apartment or house. There'd be no company car, perks, or "strategic lunches." Portfolio turnover would be minimal, leverage nil, and picks rare (maybe 3-5 stocks in most years) but uncommonly good. 1.5% of hedge funds (loosely regulated investment firms) manage less than $100M. The fund would be small, have a one-time 100 basis point fee, and a performance fee of 20%, but only after profits of 5%. Size would be an advantage as the investment universe would be tilted toward $10-500M companies (too small for the big boys). The majority of the founder's net worth will be married to the fund.

Productivity, as measured by long-term returns, is the key. Bull shit activity is the curse of the modern corporation. A lot of big dumb problems can be avoided if we continually learn and work intelligently. Who cares if someone wears a nicer tie and walks faster than you.

Disclosure: see statement at bottom of screen.
Image: http://www.vtt.fi/kuvat/cluster1_tieto_ja_viestintatekniikka_elektroniikka/sw_testing_kuva_big.jpg

Life as a balance sheet

Albert Einstein famously referred to compound interest as the 8th wonder of the world. Double-entry book keeping arguably deserves a spot in the top 10.


Developed by Luca Pacioli, an Italian monk and mathematician, double-entry book keeping is the foundation of accounting. Pacioli established any transaction as a set of two transactions. If you're not yet bored, keep reading. This is a basic T-account, a favorite for accountants.

On the left of the T is the debit, on the right is the credit. Note: debit is not universally negative as many use it. A debit increases an asset; a debit decreases a liability and owners' equity. A = L + OE, to remember, think of the cold green gel that cools sunburned skin. Assets = Liabilities + Owners' Equity.

Assets are defined by SFAC 6 (Statement of Financial Accounting Concepts) as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." A liability is "probable future sacrifices of economic benefits arising from present obligations or a particular entity to transfer assets or to provide services to other entities in the future as a result of past transactions or events." This seems fun enough. An asset is usually good; a liability is usually bad. We'll spare the accounting details here.

Owners' equity, we'll just call it equity for our purposes, is the net of assets and liabilities. This is simple. The goal of companies is to consistently increase the equity piece of the pie, and the market value of the stock (again, we'll spare the accounting lesson of book value and market value details). Berkshire Hathaway has increased it's equity per share (book value per share) from single digits to tens of thousands. A compound annual growth rate north of 20%.

The personal finance jungle

Financial planning advice, outside estate and tax issues, is usually pretty bad. So though this is more qualitative in it's approach, Faro ventures to be one of the few to add valuable personal financial advice: treat your life as a balance sheet.

It goes something like this. And you can break this down however you'd like. Every period, be it a day or a month, has a series of debit and credit transactions. I'm getting into accounting terms; don't be too scared. Good sleep is a debit to assets--it has a positive future benefit. It also increases the equity in the long-term health account. Smoking would do just the opposite.

Time, and how it is spent, is a trickier one to estimate. Rest and fun are good, but in excess are a liability and decrease the equity in your quality of life account. Don't get lost with this.

How we spend our time becomes critical to our equity account. And anyone with competing interests--families, "careers", hobbies, reality TV schedules, and others--knows this. If in a day, you take out the uncontrollable factors, (sleep, work, etc) your time to have a material impact on your equity account is limited. It may be as few as 4-6 hours per day. So if you spend most of your time worrying about how cool your car is, what to watch on TV tonight, or planning the next credit-funded vacation, you'll discover your equity account is small.

The average American who watches four hours per day of television should feel this. The difficulty is in realizing and changing this. But treating your life as a balance sheet is a great way to open your eyes. It also helps establish the mindset for analyzing companies' decisions.

Useful Calls

Finance is prone to problems and complaints. There's too much regulation, then not enough. There's the politically valuable common man (the "working class") and there's Mr. Burns. Financial information is abundant; there's too much. Jim Cramer should annoy most sane people.

So when you open floodgates of financial media, you either have to ignore most noise, or only rarely but deeply pay attention. Faro prefers the former. Selecting what is newsworthy is hard given the prevalence of financial data: CPI, Case-Shiller, employment, level of the Dow vs eight days ago (who really cares?), oil, commodities, trade imbalances, inflation, etc.

These all have value. But meaningful short-term economic forecasting is extremely difficult. There is, however, a great source of data that come direct from companies (though you should be selective since most CEOs are salesman). Only pay close attention to companies whose business models you admire or that have a compelling special situation scenario--real "change" in the works.

This site is following three companies during this week's earnings calls: Borders, Costco and Tiffany & Co. All are household names and operate in the easy-to-understand worlds of books, food and electronics, and high-end jewelry.

All should add insight to investors on commodity costs, consumer behavior, and luxury consumers. Borders is in the news as a potential acquisition target for Barnes & Noble. A combination would have 30% of the book market. Costco brought in 1.3B in membership fees, curiously close ((1.2x) to its reported FY2007 profits. That's a fair trade-off for good food, a 90-day return policy, and tasty Saturday samples. Tiffany seems immune to the current economic woes. Drop in USD will be interesting in results, as will expansion plans.

Grab a pen, pay attention and ignore the buzzwords.

Wednesday: Borders

Thursday: Costco

Friday: Tiffany & Co.

Disclosure: None

Image: http://www.bradleygoughdiamonds.com/pictures/diamond.jpg

On Restaurants

Restaurants largely deserve their reputation as poor businesses. Any business with low barriers to entry will never make much more than its cost of capital*. It's capitalism 101. You don't need to read strategy guru Michael Porter to know that.

Long waits and good food don't equal a buy signal. The Cheesecake Factory, other than its bad name, is famous for it's dairy desserts and long waits. I wouldn't salivate over the stock, however. All capital expenditures, in excess of actual cash generated, are understandable plowed back into growing store count. But the incremental returns on capital are mediocre 13% / 8% (levered to unlevered).


Costs across restaurants are fairly consistent: about 1/3 of sales is food, 1/3 labor, 25-30% SG&A and other, and the other 5 cents flow to the bottom line.


Ticker ROE (ttm) ROE (w/o debt) Profit Margin


CAKE 13.0% 8.4% 4.51%
DRI 28.6% 12.6% 5.83%
EAT 24.7% 12.6% 4.71%
MCD 16.7% 10.0% 10.86%
RUTH 20.4% 9.1% 4.76%



Problems

• higher wages: minimum wages will jump 12% in some states this summer.
• low barriers to entry
• exposure to fluctuations of commodity costs while unable to pass on costs.
• consumer fundamentals: there were 524,286 eating and drinking places in the U.S. in 2006 -- a 45% increase from 1990, according to the National Restaurant Association. The U.S. population rose 20% during that period, according to census figures.**"
• People aren't eating out more frequently than 10-15 years ago.
• The solution: crimp on extras, cut hours, or offer specials.

The thought of a smaller burger patty brought by a disgruntled waiter annoys me.

In business, just like airline seats, the middle sucks. The low-cost fast food restaurant (e.g., McDonald's) or the high-end (Ruth's Chris) will be most likely to succeed in the long-term. A restaurant that can earn barely in excess of it's cost of capital is a wonderful restaurant, not a wonderful business.


Notes:
*return a firm would earn on an investment of similar risk
**Wall Street Journal
Image: http://www.shyiam.com/wp-content/uploads/2007/06/cheesecake.jpg

Hyping Stocks

Anyone who pretends to give stock tips should report transparent performance. Faro holds itself to that standard. Below is a brief update of all companies recommended on this site, with an unbiased view of how the three stocks have done. There's no massaging the numbers, no justifications or excuses; it's just the performance based on the adjusted closing price as of 5/9/08. All positions are still held in the Faro portfolio with no plans of selling. Additional shares of LOJN were purchased after the stock dropped 25%.

Nordstrom (JWN)
April same-store sales figures came in at -3.8%. That's a bigger decline than the '01-'02 downturn. There could be more shoes to drop. The Nordstrom name and franchise, however, is strong. JWN trades at a forward multiple of 12x earnings, 6.7x ebitda, .85x sales; it earns an enviable return on equity of 43%; Interest coverage ratio is 15x.

-10.8% vs. S&P -8.6%
Recommended: 10/27/07

Discover Financial Services (DFS)
In the current economic environment, few companies--outside mortgage originators, "greedy" banks, and brothels--get more flak than does DFS. Households continue to worry about expenses. Credit card issuers are often the scapegoats for America's vast financial illiteracy. A key indicator of the firm's business, the net charge-off rate, stood at 3.84% for fiscal 2007. Discover is priced at 11x forward earnings, 2x sales, and has 17.29 in cash per share.


39.3% vs. S&P 5.9%
Recommended: 1/20/08


LoJack (LOJN)
People keep stealing cars. Revenue for LoJack, however, fell 15%. The company faces a challenging near-term outlook as cash-strapped consumers delay big-ticket purchases. Car dealers are focused on clearing out sales lots and less on the added revenue from LoJack units.
Shares are at 10x forward earnings and .83x sales. The company earns a slight excess of its cost of capital: return on equity is about 14%.

-28.7% vs. S&P 1.7%
Recommended: 2/23/08


Is this site worth reading? You decide.

Image http://www.edmunds.com/pictures/VEHICLE/1993/Ford/7227/1993.ford.tempo.3624-396x249.jpg

Beyond The Klamath

If it were any other time of year, you'd wonder why 31,000+ went to Nebraska for a single event. This weekend, however, thousands converged on the surprisingly pleasant city of Omaha for the Berkshire Hathaway shareholders' meeting. Most came to hear from Warren. A handful came to protest. The protests did impact the mood.

The event continued. Despite efforts by the misguided few to protest the Klamath river hydroelectric dams of Pacificorp, a Berkshire-owned regulated utility. Capitalism and modernity never please all parties.

The trip to Omaha is a yearly journey thousands make in hopes of hearing the next piece of investment wisdom, thoughts on the economy, and political opinion. Many learn. Most of us, however, listen and forget. Advice, when truly needed, is seldom heeded. To paraphrase Munger's past comments on this, when people ask for advice, they often mean: spoon-feed me advice so I can be rich, only more quickly.

It is valuable time for friends and investment advisors to reflect on the past year and to consider their next capital allocation decisions.

The questions, however, were surprisingly poor given the financial hurdles of ownership and the intellectual make-up of the party-goers. Most of what was asked is found in past annual reports, books, or public comments. The true gems stemmed from the inspiration of the simple economic truths of Buffett's approach of analyzing people and businesses.

Below is a summary of a few points Buffett and Munger (Co-Chairman) made that I pondered both on Saturday, and on the return flight.

Noise

We ignore 99.9% of what we see in the market (stocks)

Communication

Communication--written and oral--is enormously valuable and under-taught.

What determines dividend policy

Whether you can earn more than $1 of market value per $1 of retained earnings.

Integrity

When we make a deal, there are no special clauses.....Whether Ben Bernanke runs off to Brazil with Paris Hilton, or if a nuclear bomb explodes over NYC, the deal will go through.

It's refreshing to hear such simple advice from a candid, smart, but imperfect man. Hopefully we listen. And hopefully we learn when, where, and to whom we protest.

Disclosure: none