Built to Last - book review

Built to last is a nicely written (and read) book by Jim Collins and Jerry Porras that has greatly influenced the management and consulting thinking in the latter decades.

Personally I found it Storytelling at the level of 'time-telling', rather than 'clock-building'.

Because (IMO) the authors fail to address the special circumstances in which those significant events occured. The US economy has changed significantly in these decades, and 'any idea' could end in a great product/service ... which could lead to a great company (if indeed the owners/managers made use of the "best practices -which is the underlying story behind the book).

Nowadays (IMO), any entrepreneur really needs a big idea or good specific-knowledge of the field where he wants to break in, because otherwise the difference between his cost of capital and that of the competitors already established in the market is plainly too big.

Corolary: make use of the best practices. E.g.: align management and employees interests with that of the firm, ...

They recommend to 1) make Big Hairy Audacious Goals (BHAGs): long-term vision projects that are supposed to be so daring in its scope as to seem impossible for outsiders; 2) Evolutionary Progress: Try a lot of stuff and keep what works; and 3) Good-enough never is, driven self-Improvement.

Financial Mkts, where we are? and where we are going?

... only Bernanke knows

In an environment of (high to) low interest rates, growth companies (valuations) rise.

In an environment of (low to) high interest rates, growth companies decline.

In the current market situation, I think Bonds are poised to a significant fall in the med / long term. Thus, I like value companies more than growth companies.

Favourites among them: big franchise companies who have maintained a good operating margin through time (are price settlers), and have little debt: KO, JNJ, PG, MCD, MRK ...

VALUATION MODELS (PE / EVtoEBITDA / RIM)

PE is the most popular ratio. It is a measure of the price paid for a share relative to the annual net income earned by the firm per share.

It depends on:

- Growth (expected EPS g)

- Risk (Ke)

- Payout ratio (assuming constant growth, therefore ROE)

10y PE used by R. Schiller
Normalized PE used by J. Grantham: Calculate normalized earnings by multiplying a normalized profit margin (avg is 5.5%) by current P/S of the share / index. Apply the PE multiple (from 1900 to 2005, arithmetic avg 14, geometric avg 16)

Normalized PE for the SP500:

Calculate normalized earnings by multiplying a normalized profit margin by sales per share, assume 6% profit growth for the next 20 years – which is the long-term growth rate for earnings – apply a multiple of 15x – which is the long-term average PE of the market – then discount this 20-year expected S&P 500 target back to the present to calculate the expected capital gain. Then add the current dividend yield to get my total expected return. Currently, this model is forecasting a total return to equities over the next 20 years of 6.7%, well below the long-term average of 10%.

Enterprise Multiple (EV/EBITDA) looks at the cash flows before interest expenses.

It is very used by professionals (e.g. LBOs, MBOs, PE), because they could buy the outstanding equity and debt to change the leverage of the firm, and extract more value if possible.

It also leads to lower multiples' values (which is good, looks more attractive to buyers lol:)

RIM ...

would be the perfect valuation measure. Very appealing intellectually.

Takes into consideration the opportunity cost for the shareholders and examines whether the company created value up and above the broad market risk/return trade-off.

Current Valuation by Forward PE:

1. Calculate normalized earnings by multiplying a normalized profit margin by sales per share (P/S)
2. Assume 6% profit growth for the next 20 years – which is the long-term growth rate for earnings
3. Apply a multiple of 15x – which is the long-term average PE of the market
4. Discount this 20-year expected S&P 500 target back to the present to calculate the expected capital gain.
5. Add the current dividend yield to get the total expected return.

... currently, this model is forecasting a total return to equities over the next 20 years of 6.xx%, well below the long-term average of 10%. For how long Bernanke may sustain the house of cards (wealth effect among US consumers) ??

Angela Merkel warned that Germany could abandon the euro

"If this is the sort of club the euro is becoming, perhaps Germany should leave,"

Altough the Euro area would lose the corner stone, and the best example of how economic rigor leads to well-grounded and stable growth, I think it is one of the best ideas I have recently heard from any politician in Europe.

First of all, the current situation of Europe is unsustainable:

• With the current spreads, the PIiGS can not bear such a cost of the debt indefinitely,
• The longer it takes to change their current situation, the more they'll have dig in the whole, and
• The greater the economic differences between some leading countries (DE, NE, ...) and the tail of the animal (GR, IRE, PT, and SP)

With this scenario, my favorite solution is the so called 'United States of Europe', which would imply to go beyond the monetary union, to achieve a fiscal union (which Spain really needs to get rid of half of its political class).

The second solution is to go thorough some kind of disintegration in the Euro Club.

Much has been said about the countries that should leave the euro and the costs embedded.

'PIG'-countries are all small , that greatly benefit from a common currency, and would find expensive the logistics to leave the Euro.

On the other hand, Germany has the size to bear its own currency much better, and there are fewer advantages for them to be in the euro than to smaller countries (e.g.: benelux)

One solution could read like this:

PIIGS remain in the Euro, so that their liabilities do not appreciate due to the change in currency.

And the list of healthy countries, create their own currency and kick the can.

The banks will suffer equally because their liabilities will be denominated in a 'foreign currency' that will lose value, but ... the ECB can open a window of opportunity for them to exit.

The results are similar in both arrangements: an array of countries much more similar to each other than the current mix in the Eur. Because the third solution, to do nothing, to leave the differences between the core and the periphery to increase, provoking mutual nettle when default events occur is (IMO) the worse one.

Trichet made a good step forward calling for a fiscal union in the Euro the last month, but he needs to be piercing: no politian will be willilng to give up its 'kingdom', and action is needed asap.