Thursday, December 12, 2013

Value Wasters

Of course, Carl Icahn is featured in Time Magazine as the original wolf of Wall Street. He's prodding Apple, appropriately, to do something with all its cash. Cash is not to be hoarded.

It's been shown by Stearns Stewart that  the Economic Value Added (EVA) correlates well with enterprise value (aka stock value). EVA discounts net operating profits by the cost of capital expense on the capital (for many companies 20% of the equity). The more cash a firm has, the less EVA it has because net operating profits have to exceed the growth in cash. EVA goes down. Stock value should go down.

To counter this rationality in the stock market, Icahn and others are asking for dividends and stock buy-backs. Both strategies raise the stock value increasing shareholders' wealth. What else is a company going to do with its cash? There's no need to expand factories, invest in questionable new products/services or expand locations when demand is not increasing. Worse yet is swapping cash for inventory.

Why not increase wages for the people who make the business happen--the frontline workers? Cash goes down. And if consumer spending increases, demand increases. Wasn't that Henry Ford's revolutionary idea back in the day so that his workers could afford to buy what they were building? Shareholders aren't adding any value to the company. In most traded securities, it's an ownership swap, not anything like original investors that helped build the company. Shareholders don't need to be rewarded beyond a 'normal' and rational increase in share value when the company is actually adding value. Shareholders are taking a risk, but nothing like the risk that frontline workers take to keep their livelihood secure. Reward them for the successful effort, for the risk of sticking with your organization and making it a place where customers want to do business.

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