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- Tuesday, January 06, 2009
Quality Matters
Posted July 10, 2008
California Public Employees' Retirement System (CalPERS), the giant California retirement plan that provides retirement and health benefits to approximately 1.5 million public employees, retirees and their families – and involving more than 2,500 employers &emdash; just decided to invest in tobacco stocks. Are they investing in tobacco stocks to help the industry? Maybe they are going to invest in newly formed tobacco companies to help some entrepreneurs get a start. Maybe they are just doing what governments do: Try to grow, try to regulate, look for reasons to exist, measure their success by revenues and people employed – not by outcome or any cost/outcome or cost/benefit matrix and not by looking at the virtues of what they created, grew or built. California will spend $79 million on smoking prevention and their citizens will spend millions more on smoking cessation and even millions more on cancer treatment.
All that activity adds to the GNP (gross national product) of the "nation" called California, which is a microcosm for any government. Governments need revenue, and that revenue is coming more and more from the capture of GNP – A contrived GNP without regard for sustainability or helpfulness to the people it serves. California now has an integrated plan of attack. It taxes cigarettes for revenues; it taxes those who sell cigarettes (more revenues); it taxes those companies, hospitals and doctors who treat cancer (even more revenues); it spends money to advertise against tobacco use (need for more government employees), which gets re-taxed; and, of course, it now supports the front end of this "bone-headed" circle of economic activity by investing in tobacco companies and receiving potential gains and dividend income. I am not trying to pick on California; I am trying to point out the irrationality of concentrating on GNP as a measure of success.
Ireland and Singapore
I wrote this month's newsletter while in Croatia, where one-third of its citizens smoke tobacco. Croatia is an emerging economy ravaged by war but blessed by natural beauty, climate and hard-working, industrious and happy people. My wife, Amy, and I flew from Dublin, where I met with strategists, economists and company CEOs/COOs. I love Ireland and have watched it grow from a country whose main export was people to a country that is similar to Singapore, the envy of the developing world. Our clients made millions in Irish and Singaporean investments during their transitions to the first world. Both countries had reasons to "fail" in their attempts to develop. They are not blessed by many natural resources. Singapore is hot, small and bordered by very unstable neighbors. Ireland is beautiful if you like rain, cold and being surrounded by cold water, but also enjoy viewing beautiful landscapes and seaside villages over a pint. What magic did those countries employ to turn poverty into prosperity? Simple … low taxes, moral fiber, stability, laws you could depend on, commitment and hard work, and common sense. Ireland taxes its corporations one-third that of the U.S. Imagine that!
For most industries low taxes give companies a great competitive advantage. Our government, unions, media and corporate leadership often like to blame our lack of competitiveness on "low wages," but it is much more complex. What type of jobs do countries want to support? What sort of businesses do countries feel are best for the long-term well-being of their citizens? Ireland and Singapore educated their citizens for global commerce and developed incentives for businesses. Croatia appears to be emphasizing tourism, which can be dangerous for a country to depend upon. Tourism is an industry that says to young people, "Don't worry about education, you'll be able to come straight out of school and be reasonably paid as a waitperson, taxi driver, store clerk, tour guide, hotel employee, etc."
Education and Leadership
On our first day in Croatia, Amy slipped on wet rocks along Dubrovnik's old port. She was graciously treated by well-educated doctors, nurses and technicians. X-rays were taken, and the doctor explained to us that she would need to have an operation to fix her broken bone upon our return home. All that for less than it costs for taxi fare to our apartment from the airport. So maybe Croatia will be the home of the emerging industry, "Medical Tourism."
Yes, I am looking for the next country like Ireland or Singapore to emerge and become a stable first-world society. Many countries have tried and failed in their quest toward sustainable development. Economists point to China, Russia, Brazil and India as easy "bets" in this complex development alchemy. All you need to look at is the history of China, Russia, Brazil and India to know the answer isn't that simple. To assume that the U.S. is not at risk for losing its economic "mojo" is as silly as telling our kids, "Don't worry about college. Don't develop your skills. You live in a rich country. You'll be fine." We all know that excellence takes work. Sustainable success requires forward-looking leadership. It requires allowing old systems to die and new ones to emerge.
In Dubrovnik, over 50 percent of its buildings were hit by bombs in a war that ended in 1995. They are currently busy with new construction and have focused their reconstruction efforts on utilizing energy efficiency and common-sense design as they try to retain the historic feel of the city. I spent considerable time learning about retrofitting, energy-efficient construction, insulation and overall modern construction methods from business folks who see energy efficiency and the wise use of resources as making logical, rational and good economic sense. As a result of these visits we have added to or held our previous positions while evaluating new investments for FIM Group portfolios that could benefit from the worldwide change in construction, infrastructure development, energy, environmental policies, tourism, logistics, health care (medical tourism), finance and commerce.
Eisenhower and Quality GNP
Like President Eisenhower, I think using GNP as the measure of an economy's success is severely flawed, illustrated by my initial point about tobacco. Common sense tells us that producing cigarettes has little social or long-term economic value. During my master's, my systems class professor felt compelled to repeat, "You get what you measure in a business," over and over again. Similarly, my human resources professor's first words were, "You get what you measure, so be careful what you measure." It's not all about GNP. It's about NP, or national product[ion], and its effectiveness in building and supporting a sustainable model of economic, individual, family, business, religious, institutional and social success. History shows that low taxes, education, efficient laws, common-sense principle-based regulations, and happy, hard-working, responsible citizens tend to attract capital and allow us to prosper with an economic model better than one based on skimming taxes from the GNP.
Interdependence and Independence
The point of all this is that taxes and social policies affect investing. As global investors we must place our clients' investment funds where we believe they will be most productive. We believe in the competitiveness of countries, we look across the globe for countries that consciously and in a straightforward manner attract businesses and corporations. Of course each country, in its Adam Smith way, has its great and not-so-great aspects. We like to look for quality NP &emdash; not just GNP &emdash; because our job as long-term investors is to find ways to capture profit and grow wealth from economic activity, not just skim off the top as government tax policies tend to do. Don't get me wrong, America is a very competitive country. We have great education, solid infrastructure, laws, an open society and so much more, all created by hard-working citizens. However, all you need to do is look at our current political climate, banking system, the decline of our dollar, oil prices, real estate, our complex tax system, and our deficits to understand the folly of "GNP at any cost" and to realize the logic of having a global view as an investor. Other global investors are investing in the United States. Much of the profits from the Middle Eastern oil companies are being recycled into U.S. companies. China has made significant investments in U.S. companies or purchased them outright.
This month is our country's birthday, and I am so proud to be an American citizen. In some countries I wouldn't be allowed to even write these words without facing serious consequences. In many of the countries I've traveled to over the years, I have been told "thank you" by an older person in Europe, for helping kick Hitler out and rebuilding and in Asia, for food aid, economic assistance, and sovereignty issues. It makes me proud that we have looked beyond our borders to help others, and others have helped us, too. We are independent … yet interdependent.
Great Investments and Great Prices
America is great because we chose to be great. Our economy to some looks to be in shambles. It is not! It is normal for an economy to have recessions. It is normal for stock markets to go up and down. It is part of a regular cycle for interest rates and bonds to move dramatically. Businesses fail and that is OK &emdash; weak companies will fail, strong companies will survive. When markets are weak like they are right now, it is time to be optimistic and excited about possibilities. We are buying great companies at great prices. We think it is rational to own companies like Gannett, New York Times, CBS, Time Warner, News Corp, Washingon Post, 1-800-FLOWERS, Pfizer Pharmaceuticals, Bristol-Myers Squibb, Newell Rubbermaid and others. We own the above mentioned companies in our various portfolios and are in awe of the bargain prices at which they currently sell. It is interesting that a great company like Time Warner (owner of AOL, Fortune Magazine, HBO, Turner and many other brands) is down over 75% from its all-time high in 1999 even though its profits have been stable, sales have grown over 40% and its earnings before taxes, depreciation and amortization (EBTDA) has nearly doubled.
History Lessons
We humans are predisposed to be afraid of what we don't understand and will place more weight on what we do know even if it is unbalanced, incomplete or even totally unfounded. Investors today know one thing &emdash; their investments have gone down. They place the weight of that fact, add a bit of "it is different this time" look at the banking and real estate uneasiness, forget history and sell &emdash; even though they said they were patient and in for the long haul. In my opinion, those who say, "This time is different" slept through history class. Thankfully we are scooping up investments at what we feel are great prices and are optimistic they will reward our clients. I know that we have great investments and believe that right now it is rational for investors to be patient &emdash; even excited &emdash; about the prospects of great profits when the cycle turns and we enter a robust or even modest economic period where we can collect our dividends and profit once again from our patience and foresight. My prayer is that our clients will be patient, have a great summer, and our citizens and elected officials will start to think about the quality of our GNP so we can keep our competitive edge and not have it go up in smoke … pun intended.
Blessings,
Paul
Dubrovnik, Croatia and Traverse City, Michigan
June 2008
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