July 2001
Coming to Terms
| "When ideas fail, words come in very handy." |
| -- Johann Wolfgang von Goethe |
HE INVESTMENT WORLD IS LIKE MOST OTHERS. All professions have their specific "business speak"; investment professionals do too. There's nothing wrong with that.
Like techies, investors use lots of acronyms (PEG, EBITDA, etc.). They have their own special uses of common terms ("bull" market, "confirmation", "correction", etc.) and even make up a few ("preannouncements", "pennying", etc.). There's nothing wrong with that, either.
Where we do have a problem is with the overuse of meaningless phrases -- you know the ones, the ones that sound impressive but when you think about them, really don't mean anything. These we could do without yet they continue to pop up and seemingly multiply every day.
As a public service, here's a list of popular worthless words and phrases. The sooner they pass into being passé, the better:
Visibility and Guidance -- Here's a two-for-one. You hear these everyday, usually together. Normally it's when companies are making excuses for not giving any indication of their coming quarter. They'll say something like, "Due to the lack of visibility, we can't give any guidance for the coming quarter."
What's that all about? Presumably they have no idea of their profitability so can't tell you what they think
| And why can't they give any "guidance"? If they can't who can? They are running the business aren't they? |
But even more importantly, what's this "visibility" stuff? Is managing the company similar to piloting a speedboat through pea-soup fog? If it is, then we'd suggest some management with better eyesight and failing that, investors should probably abandon ship.
And why can't they give any "guidance"? If they can't who can? They are running the business aren't they? How long can they do that if they don't have the slightest idea of profitability? Maybe they can't tell you to the penny what they'll earn, but can't they at least give you a range? If they can't, then it's time for them to get some alternative career guidance.
Going Forward -- This one pops up everywhere. You'll hear comments like, "Going forward, we expect the lack of visibility to prevent us from offering any guidance."
We've already addressed the "visibility" and "guidance" silliness, but what does the phrase "going forward" add to the sentence? Would it make sense to say, "In hindsight, I expect…," or, "Going backward, I think…,"? Of course not! Predictions are predictions, they're always in the future. Let's lose the redundant "going forward".
Accumulate -- Many brokerage and stock rating firms (including S&P) use a rating called "accumulate". They say things like, "Going forward, and despite the lack of visibility and guidance, we still rate the stock accumulate."
This rating usually falls between "buy" and "hold" so
| Essentially EBITDA is "earnings before all the bad stuff". |
Then again, in the bizarre parlance of Wall Street, "buy" usually means hold and "hold" usually means sell, so maybe "accumulate" means you should be selling slowly. Whatever it means, it's just another needless term we could easily do without.
EBITDA -- TV commentators think they sound cool when they talk about "EBITDA". They always look so smug when they say, "Going forward and despite the lack of visibility and guidance, based on EBITDA the stock is still rated accumulate." Didn't that sound cool?
Actually EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a viable concept. Essentially it's a reference to a company's cash earnings before adjustments for accounting factors. There are some industries where it can offer some insight into earnings, but it's still no substitute for profits and margins.
Essentially EBITDA is "earnings before all the bad stuff". The problem occurs when commentators start throwing it around as a meaningful metric for almost any company. It isn't and it never will be.
So here's hoping these terms quickly pass out of the investment vernacular. Unfortunately, there's a lack of visibility as to when this will occur. Until then we can only offer our guidance. Going forward, we'd rate this movement an accumulate. Of course, maybe EBITDA more than we can chew.
What investment terms are your pet peeves? Pass them on and we'll revisit this in a few months.
But we'd submit that capitalism is more akin to natural laws than those we legislate. Like gravity, you can defy capitalism for a short period of time, but it will always still be there. As they like to say about sports stars, you can only hope to control it, you can never stop it.
China and the Soviet Union spent most of the last century attempting to suppress capitalism in their economies. They never really succeeded as black markets continued to pop up with more vigor than the centrally controlled economy. What they did get was a lot of government, sluggish economies, and little innovation.
So if China and the Soviet Union couldn't control the free market, why should we think it would work in the Peoples' Republic of California?
On the face of it, this sounds like deregulation, but it was deregulation California-style. When 1998 rolled around, AB 1890 imposed rate caps on wholesale electricity and froze
So it's no surprise what happened next. By 2000 -- two years after "deregulation" -- the state's economy was completing its sixth year of expansion. In-state generation capacity had not risen and demand for electricity had climbed exponentially.
Power companies were not only unable to increase production; they couldn't even service the debt they took on when they were "deregulated". They could thank the price caps and smaller customer base for that. Capitalism's invisible hand had struck back.
Clearly the Soviet-style market planning wasn't working yet the California comrades continued to defy capitalism. Rather than allow prices to rise to their market levels, state officials offered the utilities little help. Instead they assailed the independent generators for overcharging and vowed to seek refunds.
The situation came to a head in January 2001 when utilities had no other
Commissar -- er, Governor -- Gray Davis' response was to call for nationwide rate caps, invoking "windfall profit" rhetoric of the Carter administration. Fortunately, President Bush had the presence of mind to reject this idea.
Had Gov. Davis had his way, his state's biggest export would have been bankrupt utilities. Thanks to the planning of the California politburo, Pacific Gas & Electric filed for bankruptcy protection on April 9. Gov. Davis reluctantly allowed utilities to raise rates.
As a result of the California turmoil, Nevada scrapped plans to deregulate its electric utilities. This isn't the lesson here. Deregulation -- real deregulation -- works by
The real lesson is that government -- no matter how well-intentioned -- should stay out of the business of fixing prices. As California discovered, short-term fixes had long-term consequences.
It's almost as if the invisible hand is giving California the finger.
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"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest…Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command…he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention." -- Adam Smith
CONOMIC TEXTBOOKS INVARIABLY DEFINE "capitalism" as an economic system characterized by private ownership of the factors of production, free competition, and individuals acting in their own self-interest. It is often contrasted with socialism, communism, or other economic systems. In this sense, a capitalistic economy is the result of choices like the choice of democracy as the form of government.
Pulling the Plug
Evidently somebody did. In 1996, Gov. Pete Wilson signed Assembly Bill 1890 calling for Californians to have both the right to choose their electricity supplier and a 10% rate cut in 1998. To stimulate competition, the state's three largest utilities were required to divest a portion of their power plants and transmission facilities. In return, they could issue up to $10 billion in bonds to finance the transition.
consumer rates until 2002. By requiring divestiture and imposing rate controls, the state wasn't fostering competition; it was attempting to tie Adam Smith's "invisible hand".
Power companies were not only unable to increase production; they couldn't even service the debt they took on when they were "deregulated".
If At First You Don't Succeed…
Blackouts started in the summer of 2000. With their reduced capacity, the state's major utilities couldn't produce enough power and couldn't afford to purchase it elsewhere. California's independent producers started closing down since there was no reason to generate power they would never be paid for. Out of state generators were accused of charging more than what was "just and reasonable".
alternative than to cut off power to thousands of Californians. State regulators quickly acted to prevent further cut-offs but now California's self-inflicted problem was infecting neighboring states that purchased their power from independent suppliers. California's demand had resulted in reduced supply and skyrocketing prices. If a viable solution was not found, Idaho and Washington's state utilities would soon be the same boat with California's.
Had Gov. Davis had his way, his state's biggest export would have been bankrupt utilities.
Handing It to Them
The problem still hasn't gone away. In fact it won't go away until California ceases efforts to control supply and demand. Like gravity, the forces of capitalism eventually reassert themselves.
removing artificial barriers affecting supply and demand. Had California really deregulated, there would have been no problem. Prices may have risen in the short-term, but demand would have fallen and electricity would have found its true equilibrium price.
The real lesson is that government -- no matter how well-intentioned -- should stay out of the business of fixing prices.
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