A finance view of company growth

24 06 2014

The dominant finance view of growth is very much focused on shareholder value and for private companies it could be translated to value to the owners. Brealey et al (Brealey et al., 2001) state that, for large companies, where separation of management and ownership is a necessity, management’s objective is to maximise the value of the firm to its stakeholders and that management teams that deviate too far from this rule are likely to be replaced.

The management of a firm should take advantage of the growth opportunities of all positive net present value (NPV) projects in the company in order to maximise the earnings’ growth rate. The latter is expected to be, at worst, equal to the industry’s growth rate. During the financial planning process, corporate staff might require from divisions the development of a best case, or aggressive growth plan, where aggressive capital investment and rapid growth of existing markets takes place; a normal growth plan in which the division grows with its market; and a retrenchment plan; where the firm’s markets contract. Financial planning in this context allows for exploration projects in markets where the company seeks to apply some of its existing strengths although there is no immediate positive NPV, but rather promising future investment opportunities (Brealey et al., 2001).

Should the company seek external, and especially equity financing for its projects, it should be in position to offer an attractive return to its shareholders. This is captured by the required rate of return, the discount rate compensating the share owners for the time value of money and risk (Fabozzi & Peterson, 2003) and is captured by metrics such as earnings per share (EPS). This shareholder view implies the expectation of continuous growth, year-on-year or even quarter-to-quarter, to make it a worthy investment. This kind of growth can be relevant for the sole or few owners of an SME. Considering these as investors, they too have an opportunity cost of investing in their own company or another in the same or another industry as part of an exit strategy.

However, EPS growth is criticised as a yardstick for company decisions as there is no empirical evidence linking an increased EPS with the value created by a transaction. This fallacy, as pointed out, is nevertheless equivocally accepted by stakeholders (bankers, executives, shareholders) as the de facto metric the markets use. As a result of focus on short-term EPS major companies often bypass value creating opportunities. In a survey of 400 CFOs, 80% would reduce discretionary spending on value creating activities such as marketing and R&D in order to meet short-term EPS targets. This emphasises the failure of assumptions such as that firms are infinitely rational and invest only in profit maximising projects (Coad, 2010).

Some of the publicly traded companies and especially large capitalisation technology companies in the US, manage to follow a slightly different route. Many investment pundits criticise the low valuation multiples in the technology sector where many companies trade at lower multiples relative to firms with similar characteristics in other sectors (Zenner et al., 2011). They argue that tech companies hold too much cash and have been slow to adopt financial policies that are consistent with their current, and lower, growth profile. This can be an effect of the tech bubble, which has led such companies to accumulate cash in order to mitigate risks. Another issue is that much of this cash is offshore and cannot be repatriated without incurring high taxation. This in part reflects the fact that business risk is materially higher than comparable consumer and industrial firms.

Nevertheless, technology companies present a different model of growth and earnings than consumer and industrial firms (Figure 1). The high P/E ratio of 44.1x, compared to S&P500 and shortly after the tech bubble, has dropped by 66% to 14.9%, a contraction which can be explained by the maturing of the sector. The risks, shortcoming in P/E and high net cash positions are also reflected on the dependence of valuation on long-term EPS growth. Looking at the 40 largest tech and 40 largest industrial/consumer firms, there is a pronounced correlation between valuation and growth for tech companies compared to industrial/consumer (Figure 2). It is also interesting that for tech industries there is a big difference between the valuations for 12%+ growth and 10-11.99% growth companies, which is not observed for industrial/consumer.

Figure 1: Earnings multiples over the past decade

Figure 2: Impact of growth on valuation

What this shows is that, despite all the criticism, investors put more money on companies that are likely to have higher long term growth in technology markets. Strangely, they put the same money on consumer and industrial firms, regardless of their expected growth.

So it seems that although technology companies do not favour shareholders’ value but put more wight on long term value, investors do not shy off (let alone market maturity). Does this approach make sense? Are technology firms correct in stashing cash piles for future development? Should technology SMEs focus on value for the owners or not?

2 Works Cited

[1] Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus, Fundamentals of Corporate Finance, 3rd ed.: The McGraw-Hill Companies, Inc., 2001.
[2] Frank J. Fabozzi and Pamela P. Peterson, Financial Management & Analysis, 3rd ed. Hoboken: John Wiley & Sons, Inc., 2003.
[3] Alex Coad, “Neoclassical vs revolutionary theories of financialconstraints: Critique and prospectus,” Structural ChangeandEconomicDynamics, vol. 21, pp. 206-218, 2010.
[4] Marc Zenner, James Rothschild, Tomer Berkovitz, and Alton Lo, “Beyond Growth: Valuation and Financial Policy in the Maturing Tech Sector,” J.P.Morgan, 2011.




Failure and entrepreneurship

13 06 2014

Failure is in the heart of businesses and in the back of the mind of everyone who has ever been involved in starting a new venture. Having started myself from scratch, with little understanding of what lies ahead and a lot of good will to make it work, I notoriously failed because I lacked some basic understanding of what makes a firm fail or succeed. It is not only the hard work: you at least need money, network or both. When you have none, things are tough.

As much as starting up is difficult, going on is sometimes even harder. The crisis in the EU has surfaced a lot of problems. Many good companies operating at low margins found themselves on the brink of bankruptcy and many crossed the line. Cash starvation, bad payment terms, debtor months instead of debtor days, have drawn a bleak operating environment. Many good entrepreneurs found out that, in the end, they cannot survive…

But is it cash alone that causes the firm to fail? Of course cash is the blood of the business and the only reason the company would fail – apart from a deliberate decision of the owner – but it is also the stigma of failure that pushes entrepreneurs, especially in the EU, to ignore the early warning signs and delay taking measures. The EU should consider this matter and allow interventions before it is too late. Further, we should allow entrepreneurs to try again and again.

Why SMEs fail

As is the case for all companies, SMEs would ultimately fail because they cannot generate attractive and adequate cash flows for the owners or investors. Failure in this sense does not necessarily mean bankruptcy, as it is possible to maintain a debt-free company that upon dissolution will have the cash to cover its liabilities. Nevertheless, bankruptcy has been and still is a serious problem in the EU especially during the financial and debt crisis. But before reaching the point of bankruptcy or dissolution, there must be significant reasons that led the organisation to such a dire situation such as:

  1. Lack of adequate cash flows
    1. Ineffective financing and undercapitalisation
    2. Inadequate market for the products
  2. Inefficient management
    1. Lack of strategy
    2. Poor management team and structure
    3. Lack of operational capabilities
    4. Ineffective marketing and sales
  3. Inefficiency of owner(s)
    1. Vanity, arrogance
    2. Fear of entrepreneurial risk
    3. Ignorance, incompetence, lack of professionalism

This is not an exhaustive list and certainly one could argue that depending on the point of view, some of these factors are correlated. However, the point is to show that factors leading to a problematic company would relate to the financial and market environment, the lack of resources and capabilities and especially for SMEs the personality and competence of the owners.

The lack of adequate cash flows due to market conditions and lack of access to financing have been cited as the two most pressing problems on SMEs (European Commission, 2011). Access to finance is a key determinant for business start-up, development and growth for SMEs. These have very different needs and face different challenges with regard to financing compared to large enterprises. The latter have ready access to equity capital markets, which are not accessible to the vast majority of small businesses according to the EC. This lack makes SMEs more reliant on bank lending and similar financial products. In order to foster a functioning finance market for SMEs that takes into account their needs and considering the importance of SMEs within the overall economy, over the past two decades the EC has aimed to develop a comprehensive range of financial policies and instruments to support them with the most appropriate sources and types of financing at each stage of their life.

In the EU though, bankruptcy is severely stigmatised and entrepreneurs are not offered a second chance. The Small Business Act (European Commission, 2008) reported that 15% of all company closures are bankruptcies and some 700,000 SMEs are affected on average each year. Further it is reported that 50% of businesses do not survive the first five years of their life and the economic crisis has only increased the vulnerability of start-up companies (European Commission, 2007). In 2009, bankruptcies in the Euro zone grew by 46% and continued to grow another 5% in 2010 (European Commission, 2011). As 2.8 million jobs are involved on annual basis and bankruptcy leaves debts unpaid and destroys capital, honest entrepreneurs should quickly get a second chance (Wymenga et al., 2011).

Enhancing the survival rate of businesses and encouraging entrepreneurs in financial distress to take action early on is crucial to ensuring the stability of the economy (European Commission, 2011). Therefore preventing SMEs from falling into bankruptcy through advice and negotiation assistance is important to keep businesses afloat. Entrepreneurs faced with financial difficulties are reluctant to seek assistance at an early stage due to self-reliance, reinforced by the fear of losing control over their businesses and inability to admit defeat (European Commission, 2011). Also quick bankruptcy procedures in order to receive a second chance are pivotal to the mitigation of the bankruptcy consequences.

Although only 4-6% of bankruptcies are fraudulent, public opinion in the EU makes a strong link between business failure and fraud. There is a contrast between this and the fact that 81% believes that people that started their own businesses and failed should be given a second chance (European Commission, 2009) (Figure 7). This again should be contrasted to the 46% that believes that one should not start a business if there is a risk it might fail.

These perceptions of failure lead entrepreneurs in distress to not seek early enough advice and financial support in order to enable a recovery strategy. They also make people afraid of the consequences of a (likely) failure of a start-up due to the stigmatisation. This view on failure is in stark contrast to the view in the US where failure is often seen as a valuable lesson. Apart from creating a favourable environment for entrepreneurship, the EU should also try to make sure the existing stock of entrepreneurs can stay in the game.

Barriers to entrepreneurship

Figure 7: Barriers to entrepreneurship (European Commission, 2009).

 

As a bottom line, Europeans need to accept and embrace risk. We need to move away from the idea that a failed entrepreneur is worthless and incompetent. In times of crises, it is this fear that reinforces failure.

Works Cited

[1] European Commission, “SMEs Access To Finance,” European Commision, Analytical Report 2011.
[2] European Commission, “”Think Small First” a “Small Business Act” for Europe,” Brussels, Communication 2008.
[3] European Commission, “Overcoming the stigma of business failure – for a second chance policy,” Brussels, Communication 2007.
[4] European Commission, “A Second Chance for Entrepreneurs,” Brussels, 2011.
[5] Paul Wymenga, Viera Spanikova, James Derbyshire, and A. Barker, “Are EU SMEs recovering from the crisis? Annual Report on EU SMEs 2010/2011,” ECORYS, 2011.
[6] European Commission, “Review of the “Small Business Act” for Europe,” Brussels, Communication 2011.
[7] European Commission, “Entrepreneurship in the EU and Beyond,” Flash Eurobarometer 2009.

 

 

 

 





BMW’s Car of The Future: find the differences

28 08 2013

This is the “BMW’s Car of The Future”

This is a Chinese flashing roller shoe with LEDs.

Find the differences.

I can see all the so-called in Greece “kangaroo people” (although it is a Universal Constant) drooling over such designs and the nouveau riche queuing outside the dealers, but for goodness sake, is it possible to bring back some design style in cars? Why do we have to live the ’80s fiction over and over again?





presenting for the jury

11 03 2013

presenting for the jury.





What does it take to nearshore SW development to Greece?

22 08 2012

I asked this question to the Greek IT network on LinkedIn

I was wondering what is stopping Greek SW developers from getting organised and offering nearshoring services to European companies.I am looking for people for our Indian office and the salaries are comparable to what I expect to find in Greece and certainly higher than Romania, Bulgaria or Serbia.From my experience, I would say Geek developers don’t get the chance to work on full scale projects through the whole lifecycle. So I suspect there is a lag in professionalism, at least for the freelancers.I had the opportunity to work on my own project end-to-end from development to sales and I’d say if you’ve never gone from product to client it’s difficult to grasp the whole thing.

I then asked the respondents to fill up a survey that would show us what are those factors that are limiting the nearshore activity in Greece and here are the results from the 30some responses (until 16/08/2012):

 

And the big one:

Three factors have similar percentage (~50%) and these are lack of confidence, short term strategies and stability in the country.

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Δημόσιο και κέρδος δεν συμβαδίζουν

13 06 2012

Πάμε ξανά.

Εβλεπα σήμερα στο ΣΚΑΙ τον συμπαθέστατο και γλυκομίλητο Γιάννη Μπαλάφα. Διαφωνώ σχεδόν με όλες τις θέσεις που εξέφρασε. Θα σταθώ όμως σε μια βασική ασυνέπεια και αντικρουόμενη σκέψη της αριστεράς. Αναρωτήθηκε ο κος Μπαλάφας γιατί δεν μπορεί ο κρατικός λειτουργός να διοικεί μια κερδοφόρα εταιρεία όταν μπορεί ο ιδιώτης.

Sifnos_2012_327

Εκεί εμένα μου ανάβουν τα λαμπάκια και το έχω ξαναπεί αλλά είναι αδύνατο να περάσει αυτό το μήνυμα στους αριστερούς. Δεν είναι δυνατό να λές αυτά τα πράγματα και να θεωρείς ότι είσαι αριστερός. Γιατι; Είναι απλό:

  1. Ο κρατικός λειτουργός πρέπει να νοιάζεται πρωτίστως για το καλό των πολιτών και να διοικεί ώστε οι κρατικές υπηρεσίες που προσφέρονται στον πολίτη να είναι υψηλής ποιότητας σσε κόστος που αντέχει το κράτος. Αλλά πρώτα πρέπει να βάζει τον πολίτη. Δεν μπορεί να έχει μέλημά του το κέρδος.
  2. Ο επιχειρηματίας έχει μέλημά του το κέρδος, αν δεχτούμε ότι ακολουθούμε ένα καπιταλιστικό σύστημα.
  3. Σε συνθήκες ελεύυερης αγοράς, η κερδοφορία μιας εταιρείας επιβάλλεται να είναι μηδέν (0) άντε λίγο πάνω από αυτό.
  4. Για να έχει κερδοφορία η επιχείρηση εκμεταλλεύεται ατέλειες της αγοράς που συνήθως οδηγούν σε ανταγωνιστικά πλεονεκτήματα ή ολιγο/μονοπώλεια τις οποίες είτε δημιουργεί η ίδια είτε προσφέρονται σε αυτή από το κράτος (π.χ. ΔΕΗ). Με τον τρόπο αυτό η εταιρεία έχει υπερκέρδη χρεώνοντας περισσότερο από ότι σε συνθήκες ελεύθερης αγοράς.
  5. Το κράτος (όταν δεν χρηματίζονται οι υπάλληλοι) ρυθμίζει την αγορά, ελέγχει τη νομιμότητα του επιχειρείν και φορολογεί τα υπερκέρδη (και όχι τον τζίρο, αυτός φορολογείται αλλιώς) προς όφελος των πολιτών.
  6. Αν η εταιρεία του δημοσίου έχει κέρδη, με βάση το παραπάνω σκεπτικό, δημιουργεί αγορές με ατέλειες εις βάρος των πολιτών της.

Αρα η παραδοχή (1) δεν ισχύει.

Είναι λοιπόν εντελώς αντιφατική η θέση ότι η κοινωνική πολιτική συμβιβάζεται με το κέρδος. Η ΔΕΗ είναι χαρακτηριστική περίπτωση: είναι ένα κρατικό μονοπώλειο εισηγμένο στο χρηματιστήριο. Δηλαδή, είναι μια εταιρεία που ανήκε στους Ελληνες, μετοχοποιήθηκε ένα μέρος της, χωρίς να ερωτηθούν οι ιδιοκτήτες, και δόθηκε σε “επενδυτές”. Η επένδυση έχει την έννοια του ρίσκου. Οι “επενδυτές” της ΔΕΗ δεν παίρνουν κανένα ρίσκο γιατί έβαλαν τα λεφτά τους σε ένα κρατικό μονοπώλιο βασικής παροχής που ακόμα και η Ελλάδα να καταρρεύσει, η ΔΕΗ θα υπάρχει. Το μονοπώλιο αυτό το δώσαμε οι Ελληνες χαριστικά, και τώρα η ΔΕΗ το εκμεταλλεύεται για να δημιουργεί κέρδη (προφανώς χρεώνοντάς μας άνω του κόστους) τα οποία δίνει μέρισμα στους μετόχους της, αντί να κάνει επιστροφές στους πελάτες. Και αυτά δεν είναι φιλελεύθερα μοντέλα. Είναι αριστερές στρεβλώσεις.





Δεξιά της Αριστεράς

14 05 2012

Ο ΣΥΡΙΖΑ του Τσίπρα δεν με απογοητεύει μόνο γιατί παίζει το παιχνίδι που έπαιζαν μέχρι τώρα τα δύο “μεγάλα” no more κόμματα. Το παιχνίδι αυτό το έχει μάθει καλά, είναι πρόστυχο και καταλήγει με βεβαιότητα σε απώλεια δημοκρατίας.
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Αυτό που με χαλάει περισσότερο, είναι ότι αμέσως αμολύθηκαν τα διάφορα μυστήρια πλάσματα τύπου Στρατούλης/Γλέζος/Λαφαζάνης να δημιουργήσουν τρομοκρατία με τις αβάσιμες ανοησίες τους περί τραπεζικών καταθέσεων και καταναγκαστικών (ναζιστικού τπυπου) δανείων. Πέραν του υφέρποντος φασισμού και ανοησίας, το επόμενο επίπεδο του δράματος είναι ότι αμέσως προσπαθούν να δημιουργήσουν “ταξικές” αντιπαραθέσεις. Ακόμα και στην περίπτωση που αυτές οι ηλιθιότητες γινόντουσαν πραγματικότητα, είναι βέβαιο ότι οι υμέτεροι, οι ΔΥ, οι αντιστασιακοί, οι συνταξιούχοι ΔΕΗτζίδες και κάθε καρυδιάς καρύδι θα εξαιρούνταν και το βάρος θα έπεφτε και πάλι σε αυτούς που το επωμίζονται τώρα και για τους οποίους οι διάφοροι συριζαίοι διαρριγνύουν τα ιμάτιά τους. Αυτές οι διχαστικές και φασιστικές ενέργειες δεν ταιριάζουν στην αριστερά, παρά μόνο σε πορωμένα “αιμοδιψή” ανδρείκελα που θέλουν “να πληρώσουν οι αστοί” που πληρώνουν ούτως ή άλλως σε μια κοινωνία που είναι κατεξοχήν αστική. Αντί να ενώνουν και να συμβιβάζονται βάζοντας στόχους για το μέλλον, διχαζουν και διαιρούν κοιτάζοντας το παρελθόν. Ελπίζω η ύβρις αυτή να τιμωρηθεί στις μάλλον σίγουρες επερχόμενες εκλογές.

Στο επόμενο επίπεδο, θεωρώ αδιανόητο το ότι μια εν δυνάμει αριστερή διακυβέρνηση ασχολείται με το μνημόνιο, εκμεταλλευόμενη τη ρητορική Σαμαρα-Βενιζέλου ότι τιμωρήθηκαν για τα τρια τελευταία χρόνια. Αυτή η οπτική όχι μόνο αγνοεί την καταστροφή του τόπου τα τελευταία τριάντα πέντε χρόνια. Επιπροσθέτως τραβάει τα βλέμμαα από το γεγονός ότι ο ΣΥΡΙΖΑ (όπως και όλα τα κόμματα) δεν έχει καμία πολιτική για τα φλέγοντα προβλήματα, της ανεργίας, των μεταναστών, του κατακερματισμού της κοινωνίας και της ανόδου του ναζισμού, της επιχειρηματικότητας, της παιδείας. Η ανοησία του θα διορίσω 100000 στο δημόσιο απλά δεν θα γίνει και σαφώς δεν αντιμετωπίζει την ανεργία.

Από την τυραννία του δικομματισμού δεν θέλω να περάσει η Ελλάδα στη δικτατορία του μονοκομματισμού. Πρέπει όλοι να υποχρεωθούν να συνεργαστούν, και πρέπει να ενδυναμωθούν τα μικρά κομματα ώστε να επικρατήσει η πολυφωνία και οι εξειδικευμένες λύσεις. Η συμπεριφορά του ΣΥΡΙΖΑ δείχνει περίτρανα ότι μόλις τα κοινοβουλευτικά κόμματα μυριστούν δύναμη ξεχνάνε της εναλλακτικές μορφές διακυβέρνησης που ευαγγελίζονταν. Καθώς και ότι οι άνθρωποι προτιμούν να είναι με τον δυνατό. Ασ μην ξεχνάμε ότι τον ΣΥΡΙΖΑ τον ανέβασαν στο βάθρο του νικητή των εκλογών της 6ης Μαΐου οι ίδιοι που ψήφιζαν ΠΑΣΟΚ και ΝΔ μέχρι τώρα…

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