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In an ode to Portlandia this week, Nick and Rick discuss food and in particular, the increase in food costs that have clearly outpaced wage growth this year. What does this mean to overall demand in the economy and is it a portend of broader inflation and interest rates? Listen to the discussion and determine for yourself what the implications are of the price of that free range, all natural chicken you just bought at the grocer.
In this weeks installment, we discuss the implications of the sequence of risk to returns and how they can translate to dramatically different results in the portfolio over time. Learn how restraint from the shiny object syndrome and a focus on undervalued equities can be the key differentiators to ensuring you are properly hedged for risk, in whichever sequence risk is encountered.
As recently as 10 million years ago, the Amazon river actually flowed east to west. At the base of the northern Andes, it formed a large lake that eventually flowed into the Caribbean Sea. Over time, it reversed course as the continent tilted and sediment built up. If the largest river on the planet can change directions - couldn’t the stock market?
While I am not a fan of reality TV, I have to confess my devotion to a couple of shows that have an entrepreneurial bent – ABC’s Shark Tank and CNBC’s The Profit. Reality drama aside however, both shows are a study in competency, business model execution, and commitment of the business owner or would-be-entrepreneur. What I have noticed from watching episodes of both shows is a common description Lemonis and the Sharks use to describe someone who is failing; they are someone who just doesn’t get it. At some point I adopted the use of this phrase and have used it to label a condition where the business owner or employee is clearly failing. But what does it really mean, to not get it? And more to the point, what if I’m the one not getting it?
In this week's chart review on margin debt in the NYSE and S&P, Nick discusses the implications of investor complacency in the equities markets and why this is something to pay attention to. We also refer to an earlier COTW discussion on the Perils of Prediction with regard to returns which is relevant to this week's discussion.
June has been a busy month in our household with two graduations to celebrate; our oldest from college and our youngest from high school. As much as my wife and I are excited for the future that lay ahead of them, it is not without apprehension.
I have laid awake at night wondering if they are adequately prepared to enter the workforce and be the self-sustaining, contributing members of society we hope they’ll be. Regardless, I found myself writing a top ten list the other day of what twenty-eight years in business and adult life has taught me, with the thought that it will be needed soon.
Rarely is our attention captured by a short term chart, however, in the following from Bloomberg it illustrates the significant appreciation in long term Treasury bonds since the beginning of the year. Not only was this unanticipated, but the opposite was the prediction from most experts. Validity of predictions aside, it does beg the question what should be done with positions that are long on bonds? Listen to the following discussion and hear what Pilot's Portfolio Manager, Nick Fisher, has to say.
If valuations actually matter anymore, and the U.S. is in fact overvalued - then what do we want to buy? This week we look at cyclically adjusted price-to-earnings ratios (CAPE) of other foreign markets and the returns that they generate. Fittingly, we also discuss the difference between risk, volatility, and the permanent loss of capital.
Cov-lite lending and commercial loans have grown quite a bit in the last couple of years. This week, we discuss what covenant light commercial loans are, how they are made, and how the risk is mitigated by lenders. All of this of course informs our risk vs. return assumptions and the evolution of our fixed income allocations.
Successful business owners and leaders recognize that leadership effectiveness directly impacts employee commitment, customer retention, organizational performance and ultimately, profitability. It's the "secret sauce" to fulfilling a vision. Join us for Part 3, Navigating Conflict and Fostering a Collaborative Culture!
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When it comes to business partnerships, finding and maintaining a productive partnership can be as challenging as a marriage. Perhaps even more so given that many business partnerships are nothing more than shotgun marriages; the result of a courtship based solely on the financial merits and not much more. I liken this to marrying someone based solely on how attractive you predict the children will be, without regard to whether the two of you will be able to stay together. The refrain, “Failure is life’s greatest teacher,” speaks directly to my experience and in this regard, I have earned a PhD, having suffered through two failed business partnerships before figuring out how to enter my most recent one with the best opportunity for success. Additionally, through my advisory work I have observed many partnerships in action, brought in to assist when the partnership is going off the rails. It is usually then when most partners begin to realize the complexities of the partnership, far beyond the dollar signs they had floating in their eyes when they first came together.
When I ask partners that are experiencing conflict and potentially on the brink of collapse, “what would you have done differently?” I almost always hear the same two responses; “I would have asked a lot more questions,” and, “I would have taken more time.” And this is the crux of the issue—most people do not take enough time to truly vet the potential partnership for issues that will derail it. This happens most often because there is the rush of a deal or market timing driving the urgency, and as partners in the midst of conflict will testify, no partnership, no matter how lucrative the opportunity may appear, is worth the pain and suffering caused from premature and ill-prepared agreements.
The reality is, attempting to repair a partnership that is deep in conflict and has not done the preparatory work to set it up for success is much like trying to unscramble the omelet. Not that it can’t be done, but on a scale of difficulty, it is much larger than I can do justice here and suffice to say, often the cure kills the patient. Rather, the best opportunity for success is if you are in the early stages of formation. Following are some key steps I recommend to ensure you enter the partnership with eyes wide open and prepared for the work it will take to achieve success:
Slow down – As I’ve already stated, there is no deal so important as to overcome the poor planning of a rushed deal.
Look for a reason to say no – This sounds contrary to what you’d want, but the mindset of no is necessary to force the hard questions and rationale of, “why the partnership?” Be clear about this and force yourself to write it down. Actually, there is a whole lot more here than I have the space to write, but suffice to say it is adequately covered in David Gage’s The Partnership Charter.
Clarify roles – One of the key issues I see is that partners don’t clarify their roles “in the business” as employees, versus “on the business” as partners. There is a key distinction and clarifying when and how these roles are defined can often be the difference maker between success and failure.
Go deep on values – If they even go through the effort of defining values at all, most people short the process. It is not enough to know that all agree that integrity is a value, for example. You need to go deep, defining what behaviors define integrity, so everyone is clear what it is, and what it is not.
Define how to exit – Most partner agreements avoid this step, however force the conversation around how to value the business, or in the least, who would do the valuation, and agree on what those steps would are ahead of time.
The reality is there is no guarantee, however as the saying also goes, success favors the prepared. With patience and effort you will avoid the proverbial Rodney King moment when you are exclaiming to everyone, “Can’t we all get along?”
You can find a chart that will tell you whatever you want it to: here are a couple that we will do very little with. Pascal is famous for the saying, "All of man’s misfortune comes from one thing, which is not knowing how to sit quietly in a room." And so while we are aware of some past trends, activity for activities sake is dangerous and stupid in our mind. We will wait for a bit of volatility. And be entertained along the way.
With the Fed meeting later this week and the prospect of continued tapering of asset purchases, it is a good time to revisit the theory behind Quantitative Easing. In this extended discussion, we look at the impact of QE, the hope of what it will induce, and how we are planning for the uncertainty. We refer back to our 2013 Q3 Commentary and the capital markets line in the proverbial quest of answering the question of "what do we want to own?"
We have written in last quarter’s report that we should expect lower annual market returns than what were achieved in the previous 4 years. The reason for this has less to do with a change in the vigor, (or lack thereof) with which our economy grows and more to do with the price paid for assets in today’s environment. To explain let’s first review the rationale of any capital allocation decision and finish with discussing the significance of volatility and the need for unconventional thinking. The basis of any capital allocation decision has not changed since Aesop’s truism in 600 B.C., “a bird in the hand is worth two in the bush.” Warren Buffett, in his letter to shareholders in 2000, added three questions to this enduring axiom: 1) How certain are you that there are indeed birds in the bush? 2) When will they emerge and how many will there be? 3) What is the risk-free interest rate [how would your bird in hand grow without taking any risk]? Of course, in Buffett’s example birds are dollars and a bush is any capital outlay or investment. If you can answer these three questions with certainty, than you will know the maximum value of the bush (investment) and the maximum number of birds (dollars) that should be offered for it.
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Of the many demands growth brings to a business, the aspect most owners are unprepared for is the demand on the financial infrastructure of the business to support the business growth. This is especially the case for entrepreneurs and small businesses where owners face multiple demands such as customer management, deploying strategic initiatives and dealing with an increasingly complex world of labor law and regulatory compliance. Feeling the pain of being pulled in too many directions, owners often attempt to address the financial demands by seeking to hire a CFO, believing that their problems will be solved.
We observe this frequently and it underscores how misguided many are as to what a CFO brings to the table. Often times, CFO’s are hired for the cache value; the perception of having a CFO in the business, rather than for the deeper knowledge of what it takes to leverage the value of a CFO, let alone afford one.
For an expert’s opinion on this, I asked Wayne Marschall, Vice President and Chief Financial Officer of The Stoller Group to weigh in on this topic. Not only has Wayne served in multiple executive leadership roles as a CFO for both large and small companies, Wayne is also serving as the 2014 Portland Chapter President for Financial Executives International (www.financialexecutives.org), a financial industry association focused on the professional development of financial executives.
“The inflection point for a business being able to leverage the value a CFO brings to the table is around $50 million [in revenues],” Marschall explained. “That is when a business begins to transition from a controller or bookkeeper mentality, which is primarily looking in the rear view mirror, to one that is forwardlooking and leverages the business intelligence in the strategy and planning. A CFO can bring the sophistication and nuance to these processes to scale the business in an effective way.”
Wayne’s points are well taken. Does it mean, however, that the services of a CFO are out of reach for small businesses that have not reached that inflection point? No. There are many qualified contract CFO’s that provide excellent guidance to small organizations on a contract basis. The clarification that we will make here is that often the CFO-for-hire is no more than an accountant turned contract CFO, providing just good accounting practices. While these services may be needed, they are not offering the value of a true CFO. In order to prepare the business for leveraging the value and investment of a CFO, (full time or contract) the following should be in place and are what Wayne refers to as the building blocks of an effective financial infrastructure:
1. Solid accounting processes – Accounting software and processes that generate financial reporting that has integrity and provides the owner with business intelligence, i.e. the ability to drill down at a line item level and identify what the specific expense, income or balance sheet item it is and what drove the number. Included in this is good history so that the numbers tell a story over time of what the business has been doing.
2. Competent talent – For a small growing business, this can often be the most challenging aspect of building a financial team. Legacy employees often do not have the skill sets necessary to meet the needs of a scaling business. Whether through training and development or new personnel; however it is accomplished, talent is required to drive the systems.
3. A planning and forecasting process – This is a key pivot point for the business in beginning to look forward in a proactive way rather than continuing to react and is the key difference between the activities of an accountant and a CFO. Further, ensuring the budgeting and business planning is aligned with the business strategy creates the efficiency in the systems needed such that the intelligence can be deployed nimbly. This along with sound business strategy creates a holistic business process that is a force to be reckoned with, no matter the market.
"The key question that needs to be asked,” Marschall reiterated, “is do I have the people, processes and tools to get me there?” The benefits of a CFO are best utilized when these building blocks are in place and functioning. Otherwise the business will not leverage the talents and expense of bringing a CFO to the table.
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