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Do Profits Matter?

By | Finance, Startups

This question is starting to be asked once again. In this recent NYT article, “A Hard Lesson in Silicon Valley: Profits Matter” they write, 

“Start-up investors are warning of a reckoning after the stumbles of some high-profile “unicorns.” Now turning a profit is in.”

Apparently high profile VC Fred Wilson at Union Square Ventures has begun to sound the alarm in a recent blog post titled “The Great Public Market Reckoning”. In it he argues that “the narrative that had driven start-up hype and valuations for the last decade was now falling apart.” One in which he was of course a part of. 

The article goes on to say,

“For the last decade, young tech companies were fuelled by a wave of venture capital-funded excess, which encouraged fast growth above all else. But now some investors and start-ups are beginning to rethink that mantra and instead invoke turning a profit and generating “positive unit economics” as their new priorities.”

But why do profits suddenly matter again? Well profits always matter when the enthusiasm and the thirst of investor greed suddenly begins to turn to caution. This change is once again being driven by the fact that the high-profile “unicorns” (the start-ups that were valued at $1 billion and above in the private markets) are not attracting the investor interest just as they reach the stock market. 

The truth is, in the long run profits always matter. If you are an early stage investor, or even a later stage investor in a money losing startup, your principle concern is your exit. Sure, your investment on paper may have increased exponentially as the valuations of these startups have hit dizzying levels, but in order to get paid you need to either attract additional financing through the private market or unload all your shares to the public market in the form of an IPO. 

At some point the valuations get to stupid levels, as we recently saw with WeWork. The investment community has begun to, once again, wake up to what is really valuable. A company with no profits, is not sustainable, and a company that is not sustainable eventually see their value drop to zero, as we are currently witnessing with WeWork. 

The Hutch ReportWeWork had been hoping to raise as much as $4 billion from its stock market IPO. In addition to the roughly $13 billion it has already raised from private investors. Another $6 billion in loans from big banks such as JP Morgan was predicated on the completion of a successful float. In preparation for the IPO WeWork was being valued at a ridiculous sum of $47 billion. WeWork formally withdrew the prospectus for its initial public offering, capping a botched fundraising effort that cost the top executive his job.

As we previously stated that if you have no access to the public market then you need to attract new loans or investments from the private market. Getting new financing is now critical for WeWork. The company lost $690 million in the first six months. Even with $2.5 billion in cash as of June 30 at the current burn rate, the company could run out of money by mid-2020, according to analysts. 

But haven’t we heard this all before? Yes, we have. We saw this clearly during the 1999 boom bust period of the internet. In fact, it is almost a carbon copy.

In a May 19, 1999, Wall Street Journal article entitled “Companies Chose to Rethink A Quaint Concept: Profits,” they asked the same question, “Profits matter. Or do they?” In it they write;

“James Borkowski always thought so, until he started listening to venture capitalists. “The attitude is almost antiprofit,” marvels Mr. Borkowski, executive vice president of Industrial Microwave Systems Inc. He says that his two-year-old company originally planned to become profitable in the year 2000. “But our financial advisers told us not to be profitable too quickly,” he says. So the company is projecting losses until 2001.”

“In this marketplace,” Mr. Borkowski says, “the more money you lose, the more valuable you are.”

Sound familiar? During the dot com crash, many online shopping companies, such as Pets.com, Webvan, eToys and Boo.com, eventually failed and shut down. 

Webvan went public in late 1999 on little more than hope. The stock doubled on its first day and the company quickly earned a $6 billion valuation, even though it had less than $5 million in revenue and cost over $27 to fulfill an order. The company flamed out quickly; going bankrupt in 2001. eToys and Pets.com likewise failed swiftly. Pets.com debuted on February 9 of 2000 and declared bankruptcy less than 300 days later. eToys took a bit longer to fail, going public in May of 1999 and declaring bankruptcy at the end of February in 2001.

Although the valuations are small in comparison to today, these were high profile examples of the time, of greed gone amok. 

So why did the Venture Capital world and corporate bankers not learn an lessons from this era? Well, actually they have been well aware of the lessons. They just made a conscious decision to disregard them and ride the wave while greed was still vibrant. 

Fred Wilson remembers the 1999 bust vividly. He knows first hand what it feels like when there is a fire and everybody is running for the exits at the same time. He apparently did learn some lessons as this time he prefers to be the one at the exit sounding the alarm.

The Hutch Report

The Game of Financial Market Predictions

By | Finance, Psychology

As humans have evolved, the ability to predict events days, months or years into the future has never been relevant to survival. Rather, our DNA has been equipped with the fight or flight response. It is our quick ability to react to the event once it has happened that keeps us safe. 

Speaking on a panel at the 2018 NeuroLeadership Summit, social cognitive neuroscientist Kevin Ochsner said, “Our brains evolved to manage the needs of the now and of the not-too-distant future—your immediate environment, and short-term goals for food, water, shelter, and child-rearing.”

Although the world has evolved, humans still carry the same neural architecture as our early ancestors, which means that our brains are still inept at predicting future events. The closest we get is our ability at using sensory data to foresee events in the immediate future, as in microseconds. This enables us to predict the trajectory of a fast-moving baseball which enables us to catch it. 

In his fascinating documentary series, “The Brain”, Stanford Neuroscientist Dr. David Eagleman explains how in practice predictability is impossible. He demonstrates this by dropping a single ping pong ball into a container of one hundred and fifty ping pong balls. It is possible to correctly identify where the ball will land but as it sets off a chain reaction of movement with the other balls the situation becomes more complex. He states, “Any error in the initial prediction, no matter how small, becomes magnified as balls collide and bounce off the sides and trigger other balls. Soon it becomes completely impossible to make any kind of prediction about how the balls will end up. The balls have no choice in the direction they move. They have no freedom to do it differently, and yet the system is completely impossible to predict.”

A human’s thoughts, feelings and decisions emerge from the innumerable interactions in the brain. In comparison to the activity of one hundred and fifty ping pong balls, the brain has billions of times more interaction every second and never stops during a lifetime. In addition, each individual’s brain is embedded in a world of other people’s brains. Dr. Eagleman goes on to say, “the neurons of every human on the planet fire, interact and influence each other creating a system of unimaginable complexity. This means that even though brains follow predictable rules, in practice, it will always be impossible to know exactly where any of us are going.”

Nassim Taleb developed a line of argument throughout his previous books, Fooled by Randomness, The Black Swan and Antifragile,  that the defining characteristic of future change is that it is impossible, and pointless, to try to predict it. Instead,  he argues, it is essential to make peace with uncertainty, randomness and volatility. Those who do not — who insist not only on trying to predict the future, but also on somehow trying to manage it — he disparagingly calls “fragilistas.”  

So if predictions are impossible, what makes such a large number of financial professionals believe they have the ability to identify, as in Dr. Eagleman’s demonstration, the correct outcome of the millions of interactions that are set off from the chain reaction of one event? 

The human brain values certainty in a very similar manner to how it values food, sex, and social connection. Certainty offers a perceived control over the environment that is in itself inherently rewarding, the brain treats uncertainty, and the inability to predict the future, as a source of deep discomfort.

This is essentially why viewers continue to tune into their favorite financial tv personalities, in the hopes that they will describe the future and give them a greater sense of certainty. The main certainty on behalf of the financial tv personalities is that regardless of their faulty predictions, they are protected by a number of disclaimers at the end of the show that viewers tend to disregard.

The Financial Times looked at the number of countries that the IMF expected to be in recession for every year since 1991 and compared it with the number of economies that turned out to have actually contracted. Over the last 27 years, the IMF predicted every October that an average of five economies will contract the following year. In practice, an average of 26 have contracted. The difficulty in getting forecasts right is not unique to the IMF. “All macroeconomic forecasters are poor at predicting downturns,” David Turner, head of the economics department at the OECD told the Financial Times.

The past is littered with a multitude of failed predictions over the years made by economists, financial analysts, TV financial personalities, or the Federal Reserve. 

Who can forget on March 11, 2008, Mad Money host Jim Cramer told a viewer who wrote into his show, “Bear Stearns was fine!” right before the stock absolutely collapsed. The stock was trading at $62 per share. Just 5 days later, the firm was picked up by JPMorgan Chase for $2 per share. Yet, Jim Cramer is still on CNBC shelling out predictions daily to a mass of viewers eager for some kind of certainty.  

In the past, there have been correct predictions. Although with no real timing accuracy, they can be considered a lucky guess, since none have been able to replicate the predictions that made them famous.

Elaine Garzarelli became a start with her prediction of the 1987 crash. Since then, her record was mixed. For instance, on July 23, 1996, she told clients that US stocks could fall 15% to 20% from peaks reached earlier that summer. The Dow Jones industrial average closed that day at 5,346.55, and had risen 45% by Nov 1997.

Elaine Garzarelli

Meredith Whitney catapulted to fame after her prescient October 2007 report on Citigroup Inc. and put this previously unknown analyst on the cover of Fortune magazine. Following shortly after her ascent to prediction stardom, she predicted an “as yet unrealised” meltdown in municipal bonds in a 2010 interview on “60 Minutes.” A short-lived hedge fund followed, but the fund lost money and closed in 2015 amid a legal dispute with its anchor investor.

The Hutch Report

Meredith Whitney

Paul Tudor Jones also called the 1987 crash, yet last year predicted that the US 10-year Treasury yield would rise to a “conservative” 3.75 percent by the end of 2018. The result? It closed the year at 2.43 percent and has since dropped to 1.73 percent. However, the ability to make predictions should not be confused with one’s ability to react and trade off of events. It is the trading ability of PTJ, his ability to react to situations, and trade accordingly that has made him wealthy.

The Hutch Report

Paul Tudor Jones 1987

Bob Johansen, author of Leaders Make the Future: Ten New Leadership Skills for an Uncertain World, states that the first step is to strive not for certainty, but for clarity. Given that the future is inherently unpredictable, we can never be certain about what the future will bring. 

If we really had the ability to forecast future events, there would be no such thing as an unforeseen crisis!

The Hutch Report

In a Negative Rate World, Cash is King

By | Economics

If you don’t understand how negative interest rates work yet then you should probably learn quickly.  The stock markets are, once again, close to an all time high and the economy is (depending on who you talk to) booming. However, the Federal Reserve has been signalling there could be the possibility of a rate cut, or in fact a few of them. But with yields already historically low, the Fed does not have much room to manoeuvre (before they hit zero), especially if they find themselves having to battle another recession. 

As we saw during the last crisis of 2008, many central banks reduced policy interest rates to zero to boost growth (It is interesting to read, some 9 years later, Ben Bernanke’s Washington Post Op-Ed on why the Fed did what they did). Since then, we have seen many of them take it a step further and implement a “negative” interest rate policy. 

The amount of negative-yielding government bonds outstanding through 2049 has risen by 20% this year alone. In fact, there is now more than $11 trillion in negative-yielding debt, which means that roughly 30% of developed countries’ sovereign debt yields less than zero. Roughly 6.7 Trillion of the total currently comes from Japan and 3.8 Trillion comes from Europe. Another 800 billion is credit related. 

So what exactly is a negative rate? Think of when you open up a deposit or savings account at your bank, the bank offers you interest for keeping your money with them. Over the years, this interest accumulates and your bank account grows. It is the fee the bank pays you for the opportunity to use your money (see Who Owns the Money in your Bank Account: Hint, it is not you). Equally, you can also purchase government bonds (you lend the government money) which in return will pay you interest over the life of the bond. In the case of negative interest rates, instead of receiving money on deposits, depositors must pay the bank a fee for the luxury of keeping their money there on deposit. That’s right, you deposit money in your bank account and the bank not only uses your money but they take a portion of it for themselves. 

The main reason central banks implement such a policy is to drive investors out of safe assets into risky assets with the intention of crowding out investors to try and jump start the economy. Results of low rates are a weaker currency which helps exporters of that country’s goods, which in turn helps power the economy. Switzerland was the first government to charge a negative interest rate. It implemented this policy between 1972 and 1978. The reason they adopted this strategy was to help stabilize the economy and to prevent its currency from rising too much from foreign investors buying its currency.

But why would anybody want to purchase bonds with a negative yield? As the Financial Times pointed out, “The idea of investing in bonds where you are guaranteed to lose money — if you hold them to maturity — has always seemed paradoxical. But it begins to make sense in a world where you are sure to lose even more money if you stick the cash in a bank.” Notice they said, “if you hold them to maturity”. If you purchase a negative yielding bond with the outlook that rates will continue to get even more negative, then the holder’s of the bonds can walk away with a gain as the price of the bond increases as yields continue to decrease. 

The Hutch ReportIn turn, why would you want to keep your money in a bank that not only does not promise you a return, they charge you a fee to keep your money there? The truth is you probably would not. When a central bank has a negative interest rate, it means that commercial banks have to pay a fee whenever they deposit money into the central bank’s reserves. The commercial bank then makes the decision to pass on those negative rates to the clients of the bank.

If they do not pass on these rates, the negative interest rates therefore result in a direct decline in interest margins for the bank, and result in a decrease in profitability. Competition between the banks and the option for clients to hold liquidity in cash do not allow for the negative interest rates to be passed on to individual clients. The bank essentially takes the hit. In addition, they know that there is a good chance that customers would flee in large numbers to the nearest bank offering a positive rate of return. So you would imagine that banks would never do it. Wrong!

When the SNB first initiated their negative rate policy, it didn’t take long before banks chose to pass the charge onto their customers. The Alternative Bank was the first Swiss retail bank to implement negative interest rates. It charged negative interest of 0.125% on up to 100,000 Swiss francs held in a private account and 0.75% for amounts in excess of 100,000 francs. PostFinance, the Swiss postal bank, was the second retail bank to implement a negative interest rate. The negative 1% annual interest rate applied to customers who hold more than 1 million francs of savings in PostFinance accounts. The Zürcher Kantonalbank (ZKB) introduced a  negative 0.75% annual interest rate for specific high-net-worth customers.

In 2017, UBS introduced fees on big euro deposits held by private clients at the Swiss bank. The move was in response to negative interest rates levied by the European Central Bank on cash deposits.

The IMF Blog pointed out that, “One option to break through the zero lower bound would be to phase out cash.” They go on to say that by doing so, “Central banks would have much more flexibility in policy as they could easily reduce the rate from 2 percent to negative 4 percent to counter a severe recession. The interest rate cut would automatically transmit to bank deposits, loans, and bonds.” Without cash, depositors would have to pay the negative interest rate to keep their money with the bank, making consumption and investment more attractive. This would jolt lending, boost demand, and stimulate the economy.

When cash is available, as is the case in many countries, cutting rates significantly into negative territory becomes much more difficult. Instead of paying negative interest, one can simply hold cash at zero interest. Cash is a free option on zero interest, and acts as an interest rate floor. 

The Hutch ReportIf negative interest rates are to become a long term reality whereby the banks are free to charge customers as they wish, cash will have to be removed from society. As long as cash still circulates in society, banks are at a disadvantage and will risk a run on the bank should they attempt to charge depositors negative rates. However, beware, because negative rates, first designed as a short-term jolt, have now become an addiction.

The Hutch Report

The Hutch Report

Focus on the Positive or Negative?

By | Psychology

Telling someone to focus on the negative may sound strange and counter to what we are used to hearing, particularly from a positive mindset self help industry that generates revenues of $10 Billion a year.  However, the statement does have some merit. The main distinction to make is the difference between focusing on the negative and “dwelling” on the negative. 

Our minds produce negative thoughts for good reason and are often necessary for our well-being and mental health. Negative thoughts are meant to alert us to the things that need attention. Focusing on these negative thoughts centers our attention on things that we need to adjust or change. 

The survival value of negative thoughts and emotions help explain why suppressing them is so fruitless and in fact can produce adverse effects. The act of suppressing thoughts and feelings can be bad for our physical health and cause stress. According to psychotherapist Tori Rodriguez, suppressing thoughts means we cannot accurately evaluate life’s experiences. If we don’t allow ourselves the lows, then the satisfaction from the highs becomes lessened and “attempting to suppress thoughts can backfire and even diminish our sense of contentment”.

So does this mean stop focusing so much on the positive? Not at all. We need to focus on the positives when it is the most useful thing to do, as we need to place our focus on the negative when necessary. Negative thinking isn’t superior to positive thinking, but neither is positive thinking the panacea for all your ills. Sometimes what’s required is a dose of reality. And it’s the negative thinkers, the ones who are perceived as meddlesome and troublesome and annoying, that often provide the cure. 

Negative thoughts are often a means of protection, reflection and learning. Julie Norem wrote in “The Power of Negative Thinking” that negative thinking has the ability to transform anxiety into action.” By imagining the worst-case scenario, defensive pessimists motivate themselves to prepare more and try harder.”

It is therefore very useful for us to focus on negative information you would never be able to learn from your mistakes. Concentrating on the process and not the outcome is one way to focus on the negative while avoiding dwelling on it. Remember that failure is necessary. Embrace the idea of failure as a learning barometer, focus on the negatives, make adjustments and you can move on.  

The Hutch Report

Expert-Tease

By | Education, Psychology

We seem to have an ever increasing amount of experts online which begs the question, “What classifies a person as an expert?” The Oxford Dictionary defines expert as “A person who is very knowledgeable about or skilful in a particular area.” However, the big challenge with this definition is quantifying “very knowledgable”. According to Psychology Today, “it turns out surprisingly difficult to provide a formal definition that everybody can agree with.  There are in fact many definitions, but most are unsatisfactory.” The lack of a reliable measure of expertise has enabled a large number of people to consider themselves experts in their chosen field. We call them “self-proclaimed” experts. 

In today’s digital economy there are literally hundreds of thousands of pieces of user-generated content published every minute. It is inexpensive and quick to create a video, write an article or produce a podcast. With the evolution of social media that number continues to grow exponentially. It is believed that 90% of the worlds data has been created in just the past 2 years.

With so much content and less time to filter through it all, people are overwhelmingly seeking out “experts” and high impact content to help them make purchase decisions, investment decisions, career choices, travel choices or even relationship decisions. The label of “expert” is powerful and weilds influence. In an  article in Forbes Magazine a study performed by Nielsen showed that expert content was 88% more effective in creating brand lift than a brands’ own content. It was also learned that expert content was the most influential at every point in the new buyer’s journey. However, more often than not, people are ignoring the fact that not everyone that writes articles, makes videos or produces podcasts is an expert.

The average content consumer has the challenge of determining what is real from fake, correct from false or simply what content can be trusted. They need to determine for themselves who is an expert versus who is just an online user creating content. But does that get determined at the site level or is there some sort of advanced criteria that you can run someone against to determine whether or not they are really credible in a particular area and moreover if they are an expert?

Financial television personalities such as Mad Money’s Jim Cramer provide investment advice on a daily basis. The efforts previously made to actually quantify the performance of his picks, here, and here, found that the results have been less than flattering. It is for this reason that most of these financial programs will flash a disclaimer at the end, which essentially removes them from liabilites that may arise from investors losing money following his expert recommendations.

“All opinions expressed by Jim Cramer on this website and on the show are solely Cramer’s opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL or their parent company or affiliates, and may have been previously disseminated by Cramer on television, radio, internet or another medium. You should not treat any opinion expressed by Cramer as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his opinion. Cramer’s opinions are based upon information he considers reliable, but neither CNBC nor its affiliates and/or subsidiaries warrant its completeness or accuracy, and it should not be relied upon as such. Cramer, CNBC, its affiliates and/or subsidiaries are not under any obligation to update or correct any information provided on this website. Cramer’s statements and opinions are subject to change without notice. No part of Cramer’s compensation from CNBC is related to the specific opinions he expresses.”

One explanation of our will to follow these experts is the Authority bias. Authority bias is the tendency to attribute greater accuracy to the opinion of an authority figure (unrelated to its content) and be more influenced by that opinion. This concept is considered one of the so-called social cognitive biases or collective cognitive biases. 

Our digitally driven world has led us to become less patient and lazy. Therefore the deference to authority can occur in an unconscious fashion as a kind of decision-making short cut. This is not to say don’t follow experts, just don’t be teased by the term expert. There are obvious domains where experts are not just the product of a society exercise in labeling (just try conducting a brain operation, teaching a class in Physics or compete in the Olympics). 

While there is no 100% foolproof way to tell between an expert and their “self-proclaimed” counterparts, there are some simple things readers can do if they are seeking to assure that their expert content really comes from an expert. Consider the source, check the facts,  and research the author.

The Hutch Report

The joy of earning billions…and paying no taxes!

By | Finance, Politics

Our previous article focused on the ways in which companies are moving away from generally accepted accounting principles (GAAP) and towards non-GAAP adjustments in order to manipulate their balance sheets in a way that suits them best. 

These new methods of clever accounting have far ranging effects as we have seen, in spite of new tax laws set up by the Trump administration, corporate tax avoidance remains rampant. 

According to a new report by the “Institute on Taxation and Economic Policy,” it was found that 60 profitable Fortune 500 companies managed to avoid all Federal Income Taxes in 2018. The companies that managed to avoid paying the taxes were not distinct to one segment of the economy but represented a wide range of segments. 

Included in the report were examples such as computer maker International Business Machines (IBM) which earned $500 million in U.S. income and received a federal income tax rebate of $342 million. The retail giant Amazon reported $11 billion of U.S. income and claimed a federal income tax rebate of $129 million. The streaming service Netflix paid no federal income tax on $856 million of U.S. income. Beer maker Molson Coors enjoyed $1.3 billion of U.S. income in 2018 and received a federal income tax rebate of $22.9 million. Automaker General Motors reported a negative tax rate on $4.3 billion of income.


60 Companies Avoiding All Federal Income Taxes in 2018

U.S. Income and Federal Tax figures in millions of dollars.
Company U.S. Income Federal Tax Effective Tax Rate Industry
Activision Blizzard
$447
$-228
-51%
Computers, office equip, software, data
AECOM Technology
$238
$-122
-51%
Engineering & construction
Alaska Air Group
$576
$-5
-1%
Transportation
Amazon.com
$10,835
$-129
-1%
Retail & wholesale trade
Ameren
$1,035
$-10
-1%
Utilities, gas and electric
American Electric Power
$1,943
$-32
-2%
Utilities, gas and electric
Aramark
$315
$-48
-15%
Miscellaneous services
Arrow Electronics
$167
$-12
-7%
Retail & wholesale trade
Arthur Gallagher
$322
Financial
Atmos Energy
$600
$-10
-2%
Utilities, gas and electric
Avis Budget Group
$78
$-7
-9%
Motor vehicles and parts
Celanese
$480
$-142
-30%
Chemicals
Chevron
$4,547
$-181
-4%
Oil, gas & pipelines
Cliffs Natural Resources
$565
$-1
0%
Oil, gas & pipelines
CMS Energy
$774
$-67
-9%
Utilities, gas and electric
Deere
$2,152
$-268
-12%
Industrial machinery
Delta Air Lines
$5,073
$-187
-4%
Transportation
Devon Energy
$1,297
$-14
-1%
Oil, gas & pipelines
Dominion Resources
$3,021
$-45
-1%
Utilities, gas and electric
DTE Energy
$1,215
$-17
-1%
Utilities, gas and electric
Duke Energy
$3,029
$-647
-21%
Utilities, gas and electric
Eli Lilly
$598
$-54
-9%
Pharmaceuticals & medical products
EOG Resources
$4,067
$-304
-7%
Oil, gas & pipelines
FirstEnergy
$1,495
$-16
-1%
Utilities, gas and electric
Gannett
$7
$-11
-164%
Publishing, printing
General Motors
$4,320
$-104
-2%
Motor vehicles and parts
Goodyear Tire & Rubber
$440
$-15
-3%
Motor vehicles and parts
Halliburton
$1,082
$-19
-2%
Oil, gas & pipelines
Honeywell International
$2,830
$-21
-1%
Industrial machinery
International Business Machines
$500
$-342
-68%
Computers, office equip, software, data
JetBlue Airways
$219
$-60
-27%
Transportation
Kinder Morgan
$1,784
$-22
-1%
Oil, gas & pipelines
MDU Resources
$314
$-16
-5%
Oil, gas & pipelines
MGM Resorts International
$648
$-12
-2%
Miscellaneous services
Molson Coors
$1,325
$-23
-2%
Food & beverages & tobacco
Netflix
$856
$-22
-3%
Retail & wholesale trade
Occidental Petroleum
$3,379
$-23
-1%
Oil, gas & pipelines
Owens Corning
$405
$-10
-2%
Miscellaneous manufacturing
Penske Automotive Group
$393
$-16
-4%
Motor vehicles and parts
Performance Food Group
$192
$-9
-4%
Retail & wholesale trade
Pioneer Natural Resources
$1,249
Oil, gas & pipelines
Pitney Bowes
$125
$-50
-40%
Computers, office equip, software, data
PPL
$1,110
$-19
-2%
Utilities, gas and electric
Principal Financial
$1,641
$-49
-3%
Financial
Prudential Financial
$1,440
$-346
-24%
Financial
Public Service Enterprise Group
$1,772
$-97
-5%
Utilities, gas and electric
PulteGroup
$1,340
$-44
-3%
Miscellaneous manufacturing
Realogy
$199
$-13
-7%
Miscellaneous services
Rockwell Collins
$719
$-16
-2%
Aerospace & defense
Ryder System
$350
$-23
-7%
Transportation
Salesforce.com
$800
Computers, office equip, software, data
SpartanNash
$40
$-2
-4%
Retail & wholesale trade
SPX
$66
$-5
-8%
Industrial machinery
Tech Data
$203
$-10
-5%
Retail & wholesale trade
TOTAL, THESE COMPANIES
$79,025
$-4
-5%
Trinity Industries
$138
$-19
-14%
Miscellaneous manufacturing
UGI
$550
$-3
0%
Utilities, gas and electric
United States Steel
$432
$-40
-9%
Metals & metal products
Whirlpool
$717
$-70
-10%
Electronics, electrical equipment
Wisconsin Energy
$1,139
$-218
-19%
Utilities, gas and electric
Xcel Energy
$1,434
$-34
-2%
Utilities, gas and electric
Source: Institute on Taxation and Economic Policy analysis of SEC filings 

The loop holes and tax breaks used by these companies are varied and range from accelerated depreciation, stock options, and energy tax subsidies to name just a few. 

One of the most egregious loopholes in the tax code, known as the stock option loophole, allows companies to deduct millions or billions from their taxable income for compensating executives in the form of stock options. Corporations can take these deductions even though granting stock options costs them nothing. 

In a report produced in 2016, Citizens for Tax Justice (CTJ) reviewed five years of corporate filings and found this loophole allowed companies to annually avoid an average $13 billion in taxes. It should also be highlighted that the average sum corporations are currently avoiding could be understated because not all corporations report information about stock options.

The ITEP report also pointed this out as they stated, “In many cases, the company’s disclosures don’t fully clarify which tax breaks were used.“ Therefore, analysis of the balance sheet does not always lead to the true picture of a companies financial health. 

“All data cited in this report come from the 10-K annual financial filings published by these companies. In many cases, the company’s disclosures don’t fully clarify which tax breaks were used. For example, Chevron’s annual report for 2018 discloses that unspecified “tax credits” reduced the company’s income taxes by $163 million.”

They go on to say that despite these companies managing to avoid paying their share of taxes, there is nothing illegal about what they are doing. They are simply taking advantage of legal tax breaks that have been provided to them in order for them to shelter a large portion of their earnings from Federal taxes. There are, however, a number of moral and ethical questions that can be raised. 

If these companies are to be reigned in the only true change will come from sustainable tax reform which only the government can accomplish. The big problem facing the government as an institution is as the years pass, the debt and deficits grow, the working population pays a larger and larger portion of taxes as the public’s confidence in elected officials continues to weaken. 

The Hutch Report

Mind the GAAP!

By | Finance, Markets

With the earnings season upon us we now go through the same dog and pony show. Companies report earnings, then the success of those earnings are based mainly on whether or not they beat consensus analyst’s estimates. Curiously enough, many often beat by one penny. What methods do they possibly use to beat by a penny per share? 

Prior to earnings, analysts tend to be busy estimating what earnings they think will be reported. Their estimates are based on guidance from the company itself, economic conditions and their own independent models and valuation techniques.

Companies prepare their accounting using generally accepted accounting principles, also referred to as GAAP. GAAP, are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting. GAAP are controlled by the Financial Accounting Standards Board (FASB), a non-governmental entity. The FASB creates specific guidelines that company accountants should follow when compiling and reporting information for financial statements or auditing purposes. GAAP is not law, and there is nothing illegal about violations of its rules unless those violations happen to coincide with other laws. Today, all 50 state governments prepare their financial reports according to GAAP. While a little less than half of them officially require local governments to adhere to GAAP.

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However, more and more, companies are finding that by following a standardized set of GAAP rules, their earnings often come out less than attractive. So, over the years corporate accountants have become more and more creative through the use of “non-GAAP” methods to improve their bottom lines. 

A study published by Audit Analytics noted that 96 percent of S&P 500 companies used non-GAAP measures in earnings releases during the fourth quarter of 2016. In addition, a study published by FactSet indicated that for the first quarter of 2017, 63 percent of the companies in the Dow Jones Industrial Average reported non-GAAP earnings per share and that, on average, the difference between the GAAP and non-GAAP earnings per share was approximately 54 percent. The most common adjustments were found to be restructuring charges, acquisition-related items, stock compensation costs, and, to a lesser extent, debt costs and legal costs. 

As companies battle to present themselves as profitable, non-GAAP measures are becoming the norm as the disparity between GAAP and non-GAAP results grows larger and larger. So if you think you are going to get the true story from a company’s statements or earnings reports, think again. 

Off-balance sheet financing is another method of non-GAAP financial engineering. A business tries to keep certain assets and liabilities off its balance sheet in order to present to the investment community a cleaner balance sheet than would otherwise be the case. It does so by engaging in transactions that are designed to shift the legal ownership of certain transactions to other entities. The transactions are designed to sidestep the reporting requirements of the applicable accounting framework, such as GAAP or IFRS. So, therefore, considered non-GAAP.

Off-balance sheet financing played an important role in the Lehman Brothers bankruptcy. Through the use of off-balance sheet entity ‘Repo 105’, Lehman was able to move $50 billion of debt off of their balance sheet, making them appear more financially stable before the end of the quarter. Since it was classified as a repurchase agreement, it was ‘bought back’ after the reporting period. When the debt was originally moved off-balance sheet, the bank recorded the debt as a ‘sale’ and booked the $50 billion as revenue. This type of accounting manipulation contributed to the largest bankruptcy in U.S. history, wiping out the life savings of thousands of employees of the bank. 

Adjusted EBITDA is another non-GAAP financial measure that has gained a lot of popularity. Speaking on Jim Grant’s Current Yield Podcast, Adam Cohen, founder of Covenant Review, stated, “Some version of adjusted EBITDA is quite common, but we are seeing things turn into absolute fantasy land.” He took a recent example using the company WeWork, currently valued at roughly $47 Billion, with a stated annualized revenue of $2.5 billion. Cohen explained that the WeWork 2017 income statement started with a net loss of $933 Million. Once they got themselves to adjusted EBITDA, they reduced that to a loss of $193 Million, however since they wanted to sell a bond yield, this wasn’t good enough, so they invented something called “adjusted EBITDA before growth investments” but that still wasn’t good enough, so they invented a third version called “Community adjusted EBITDA,” which at what point they achieved a positive $233 Million community adjusted EBITDA. That is a $1.1 Billion swing from net loss to profit, which is more than the amount of revenues they booked that year. 

As an update to this example, the Financial Times just reported on March 26th, 2019, “WeWork bond prices slipped on Tuesday after the provider of shared office space said that its losses had more than doubled from a year earlier, as the company ploughed money into a breakneck expansion that has captivated the real estate industry.”

So, as a word of caution to those investing in the next potential Lehman, as all these fairy tale companies go public, and as the earnings season takes off,  “MIND THE GAAP.”

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The Battle for Venezuela – Maduro vs. Guaido

By | Politics

Self-proclaimed President of Venezuela, Juan Guaido has now been stripped of his parliamentary immunity.  The National Constituent Assembly voted unanimously on Tuesday to approve a measure that strips Guaido of his immunity and authorizes the Supreme Court to criminally prosecute him for proclaiming himself the leader of the country. In addition, The court ruling cited Guaido’s violation of a ban on his travel outside Venezuela when he visited Argentina, Brazil, Colombia, Ecuador and Paraguay from late February to early March. For this he can also be prosecuted. 

This should start to make things very interesting since Guaido has been recognised as interim president by more than 50 countries, while Russia, Cuba and China are backing Maduro.  The Trump administration has threatened Caracas with a strong response in an event of his arrest. Just before the vote against Guaido was announced, US Republican Senator Marco Rubio accused the Venezuelan government of plotting a coup d’état and trying to “abduct” Guaido.

The situation in Venezuela has gone from bad to worst. In addition to the political battle, the country has been hit by a series of debilitating blackouts that have left millions without water. Maduro’s reaction has been to replace the country’s energy minister and institute power rationing in a bid to address the outages. Venezuela experienced three major blackouts in March, worsening already dire living and economic conditions in the country, and prompting authorities to take steps aimed at curbing the outages. Maduro and his government blamed “terrorists” for alleged attacks that have damaged the country’s main hydroelectric power plant, while providing no proof. 

At the heart of the battle for control of Venezuela are the oil reserves. Venezuela sits upon the world’s largest oil reserves. PdVSA is Maduro’s primary source of cash, Venezuela’s state-run energy company, PDVSA, kept oil exports near 1 million barrels per day in March despite U.S. sanctions and power outages that crippled its main export terminal, according to PDVSA documents and Refinitiv Eikon data.

The Hutch ReportAs long as the oil is flowing, Maduro is well financed. Therefore, U.S. President Donald Trump is considering imposing sanctions on companies from other countries that do business with Venezuela, according to White House national security adviser John Bolton. According to Treasury Secretary Steve Mnuchin, the measures will block $7 billion in assets and could result in more than $11 billion in lost assets over the next year.

However, that may be easier said than done as China is one of the largest buyers of the oil. That is likely to put additional pressure on the current US/China trade negotiations. Although as the amount of oil to China has decreased, the amount to India has increased. How India will react to a trade skirmish with the US is anybody’s guess.

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Drowning in Nestle

By | Economics, Health

Did you know that the human right to safe drinking water was first recognised by the UN General Assembly and the Human Rights Council as part of binding international law in 2010?

However, whenever something is so important that our lives depend on it, there are those that will exploit it for their own gain. Studies in Africa and Asia show that the poorest 20% of the population spend between 3 to 11% of their household income on water. 

Today there are thousands of bottled water companies worldwide but Nestlé is the biggest globally in terms of sales, followed by Coca-Cola, Danone, and PepsiCo, according to Euromonitor International.

Nestle Waters is the water division of Nestle. It owns nearly 64 bottled water brands produced from roughly 100 bottled water factories in 34 countries around the world with 5 million litres sold worldwide. Some of its most popular water brands are PureLife (having the largest market share worldwide), Deer Park, Poland Spring, Acqua Panna, San Pellegrino, Perrier, springs, Water Park, Waterline.

Nestlé states that it supports the human right to water as a basic need, yet they makes billions bottling water that they pay nearly nothing for. 

Their marketing efforts for water have very little to do with it being necessary to sustain life and more to do with selling to the consumer. As they highlight on their site. 

“It is sometimes believed that water is just… water. In fact, every water is different. These differences depend on their origin, consistency, composition, type of protection, and treatment. As a result, every water tastes different. Nestlé Waters offers three categories of water, represented by our 51 unique brands.”

They often overlook the necessities of the water sources to communities when they step in to take them. 

Nestlé faced boycott threats in 2016 after the company purchased a well in Ontario that a small Canadian township had been trying to buy. The Swiss company was also criticised that year for increasing the amount of water it was pumping from a source in Michigan, 120 miles from Flint, a city known for its water crisis. The company was paying just $200 in extraction fees, according to a 2017 investigation by Bloomberg

State of California officials carried out a 20-month investigation and concluded in December 2017 that the company took an average of 62.6 million gallons of water from the San Bernardino spring each year from 1947 to 2015, but didn’t have valid rights for much of the water it has been drawing. However, Nestlé is disputing the findings of the investigation, arguing the company is entitled to keep piping water out of the San Bernardino National Forest — even more water than it has been bottling and selling in the past few years.

More recently, on April 2, 2018, the Michigan Department of Environmental Quality approved a widely-protested plan that would allow Nestlé to pump 250 gallons of water a minute from White Pine Springs. Although there is plenty of water in the Great Lakes area of Michigan (except maybe for Flint), groundwater is rapidly depleting across the United States, and therefore, drought looms ever and ever larger.

Nestlé’s annual sales of bottled water alone total roughly CHF 10 billion ($10.05 billion).