After a roller coaster 2020, the new year is off to a solid start. Full year Gross Domestic Product (GDP), a measure of US economic growth, is presently estimated by the Federal Reserve Board to be 6.5%, revised from its 4.2% forecast in December. Just last month, economists at Goldman Sachs projected the US economy will conclude 2021 with a soaring fourth-quarter growth rate of 8%. The Bureau of Economic Analysis released first quarter GDP numbers on April 29 with a reported annualized rate of growth of 6.4%, confirming the consensus view.
The Fed continues with its mantra of “lower for longer” regarding interest rates, leaving the overnight funds rate at 0.25% at the conclusion of its meeting on April 28. The 10-year US Treasury benchmark is trading to yield 1.64% at the time of this writing. In addition, inflation remains near historic lows, and only recently have there been signs of an acceleration. However, as we’ve seen over the past 10 years, productivity gains have worked to keep inflation in check.
Despite near-record-high rates of unemployment in mid-2020, the labor market continues to improve with both average hourly wages and length of the workweek for hourly workers increasing. The US unemployment rate has recovered nicely and now sits at 6.0%. Weekly reported unemployment claims also continue to show improvement.
Global trade is so robust there are shortages of both container ships and shipping containers. A few years ago, the global shipping industry was bloated and oversupplied. The abrupt improvement in the global economy following the 2020 economic collapse has left many companies short of needed inventories due to an overburdened international supply chain and related delays in freight movement.
Overall, the US economy and measures of economic health are strong and/or improving. The notable outlier is the national debt, which has hit record levels on a continual basis after repeated fiscal stimulus. US national debt currently sits at an astounding $27.7 trillion. In time, we believe this will become a critical issue and one of greatest systemic, long-term threats to our nation given its ability to put a stranglehold on growth and prosperity.
We recently revisited the important topic of shareholder versus stakeholder primacy. Shareholder primacy is a shareholder-centric form of corporate governance that focuses on maximizing the value of a company for its shareholders. Stakeholders are both shareholders as well as others who may be involved with a company. Each is defined below.
Every company is capitalized through a combination of equity and debt (stocks/shares and bonds). Publicly traded companies typically allow their equity and debt to be freely traded in the public markets. An equity holder is a shareholder, with each share representing fractional ownership of a company. This equity capital bears the most risk and uncertainty of return. A debt holder is one who lends capital to a company under a contractual agreement. A debt holder has a very different investment proposition and agreement with a company, involving a promise of repayment in full on a specific future date while earning a predetermined rate of interest in the interim. A debt holder’s risk is very different from that of an equity shareholder, as are the prospective returns on invested capital.
Each party to a company’s capitalization has different motives and financial incentives. What they have in common is a desire for the company to succeed to ensure an optimal investment return. A debt holder’s investment has a known termination date, whereas an equity shareholder’s investment is perpetual in nature. On the other hand, a debt holder’s assurance is simply a return of principal along with periodic interest payments, whereas an equity shareholder has unlimited upside return potential (and the potential to lose all of the capital invested).
Stakeholders include equity and debt investors as well as other people or entities that engage with a company in a variety of fashions. This includes employees, customers, suppliers, communities, and governments. Many stakeholders have not committed capital to the company. Executives and directors are stakeholders but are often equity shareholders as well.
We believe a company has an inherent and indisputable interest in the well-being of its stakeholders, simply as a matter of good business practice. Employees, for example, have a choice as to where they work. Long-serving employees generally bring more value to a company by virtue of their experience and knowledge of the business. The employee/employer relationship is symbiotic by its very nature.
Of course, customers are critical to a company. A company needs to continuously update and improve its products or services to remain competitive and satisfy its customer base. Companies that fail to provide good products or services at competitive prices will eventually fail.
Suppliers of a company provide raw materials, services, facilities, and other considerations critical to the company’s products and services. Undoubtedly, the souring of supplier relationships is detrimental to a company’s success.
Communities prosper when a company succeeds. Higher community-level employment has myriad benefits. Companies also pay taxes that support local, state, and Federal Government services. Many companies provide volunteers and cash contributions to local non-profit organizations. Good companies and strong communities often go hand-in-hand.
Over the years, academics and practitioners have debated the merits of shareholder primacy and stakeholder primacy. At GVIC, we believe companies exist for many reasons, but we know companies can only exist in the private sector if they have investors – those who will provide capital to finance startup and ongoing operations. We believe all stakeholders have an inherently important relationship with a company, but the shareholder who provides capital is the primary and principal benefactor (and bears the most capital risk), and thus should be the primary concern of a company. When we commit capital for clients by making an investment in the equity of a company, we are first and foremost concerned with the return of investment. We consider many factors that relate to stakeholders and a company’s overall business practices, but our overriding concern is the company’s ability to consistently create value for its equity shareholders.
From Our Library
We recently began reading Valuation: Measuring and Managing the Value of Companies by McKinsey & Company. The book quickly delves into the notion of a company’s intrinsic value, differentiating a company’s real financial value from the value market participants assign to a company through its publicly traded common stock.
As an investor, you’ll need to learn the difference between financial markets and real markets and how they are related to each other. You’ll need to understand that good performance in one market does not necessarily mean good performance in another.
Companies should consider that performance in the stock market may differ from intrinsic value creation, generally as a result of changes in investor expectations.
The price of a company’s shares is based on what investors think those shares are worth. Whereas the intrinsic value is based on the future cash-flows or earnings power of the company. This means investors are paying for the performance they expect the company to achieve in the future. So, the return investors earn is driven not by the performance of the company, but rather by the performance relative to expectations.
A company may have excellent performance but fail to meet investor expectations (no matter how realistic) and consequently experience an underperforming share price.
Despite legions of students graduating with this knowledge, it appears that few investors on Wall Street understand these principles comprehensively. This is evidenced by the continued absurd valuations of many popular, high-flying companies in which the real intrinsic value and stock price are wildly disconnected. Determining a company’s intrinsic value is the most important part of security analysis, and buying at a discount from that intrinsic value is the most important part of investment management.
We recently added another research associate to our India office in Hyderabad. Ms. Ruchi Singhania joined our investment research and analysis team in early April. She is quickly becoming accustomed to our early morning research calls and especially enjoys participating in conference calls with company senior management. She previously worked with S&P Global Market Intelligence. Ruchi earned her Chartered Financial Analyst designation (CFA) in 2012. We are pleased to have her on the team and welcome her to our GVIC family.
We continue to work diligently to identify attractive investments in this unusually chaotic environment that emerged early last year and has shown few signs of returning to normal. One of our core principles at GVIC is to remain “calm, alert, and opportunistic.” We have had many opportunities to exercise this discipline over the past year – to the benefit of our clients, we identified some particularly attractive bargains (companies trading at a discount to intrinsic value) during those days when great uncertainty prevailed.
Thank you for trusting us to be prudent stewards of your capital, particularly through this challenging period.
Your Investment Research and Advisory Team
Global Value Investment Corp.
This document is published by Milwaukee Institutional Asset Management (MIAM), a division of Global Value Investment Corp. (GVIC). MIAM is the institutional investment advisory division of Global Value Investment Corp., providing investment advisory services to institutional investors including Registered Investment Advisors and Broker-Dealers. All statements or opinions contained herein are solely the responsibility of Milwaukee Institutional Asset Management. The material, information and facts contained in this report were based on publicly available information about the featured company and were obtained from sources believed to be reliable but are in no way guaranteed to be complete or accurate. This report is for informational purposes only and should not be used as a complete analysis of any company, industry or security discussed within the report. This report does not constitute an offer or solicitation to buy or sell any security, nor shall there be any sale of the security herein in any state or domicile in which said offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such state or domicile. An investment in any security referenced in this report may involve risks and uncertainties that could cause actual results to differ from the analysis provided herein, which may not be suitable for all investors. Past performance should not be taken as an indication or guarantee of future results. No judgment is hereby expressed or should be implied as to the suitability of any security described herein for any specific investor or any specific investment portfolio. Employees of GVIC may have positions in securities referenced in this report. ‘Intrinsic’ or ‘Appraised’ value refers to MIAM’s quantitative and qualitative assessment of the value of an enterprise. Market capitalization is a measure of the total dollar market value of all of a company’s outstanding shares. Market capitalization is calculated by multiplying a company’s shares outstanding by the current quoted share price. MIAM’s investment strategies generally invest in a smaller number of securities than some other strategies. The performance of these holdings may increase the variability of a strategy’s return. There is no assurance that dividend-paying stocks will reduce price variability. Value investments are subject to the risk that their intrinsic value may not be reflected in market prices. For purposes of distribution in the United States, this report is prepared for persons who can be defined as “Institutional Investors” under U.S. securities regulations. Any U.S. person receiving this report and wishing to affect a transaction in any security discussed herein must do so through a U.S. registered Broker-Dealer. Neither Global Value Investment Corp. nor Milwaukee Institutional Asset Management is a registered Broker-Dealer.
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