Avoid Companies with CEOs Who Golf Too Much

Malcom Gladwell is back with his second season of Revisionist History. The first episode is A Good Walk Spoiled

In the middle of Los Angeles — a city with some of the most expensive real estate in the world — there are a half a dozen exclusive golf courses, massive expanses dedicated to the pleasure of a privileged few. How do private country clubs afford the property tax on 300 acres of prime Beverly Hills real estate? RH brings in tax assessors, economists, and philosophers to probe the question of the weird obsession among the wealthy with the game of golf.

What does golf have to do with investing?

CEOs Who Golf Too Much

The gem in this podcast starts around 5:35 minutes and continues till 9:19. If you include – and I don’t know why you wouldn’t – the little dig at former Bear Stearns CEO Jimmy Cayne for leaving early on Fridays to play golf while his firm collapsed.

“The more golf a CEO plays, the worst his firm does.”

“The more golf a CEO plays, the more likely he is to be fired.”

Some further reading.

Fore! An Analysis of CEO Shirking

Ron Baron’s Tesla Predictions Versus the Base Rate

On Tuesday Ron Baron appeared on CNBC and made some bold Tesla (TSLA) predictions.

Ron Baron’s Tesla Predictions

To summarize, Ron Baron believes in 2.5 years Tesla will achieve the following.

  • By 2020, Tesla’s share price will be $1,000
  • By 2020, Tesla will have $70 billion in revenue
  • By 2020, Tesla will sell 1 million cars per year
  • By 2020, Tesla will have $10 billion in operating profit

Tesla (TSLA) is already a large holding for Ron Baron and his fund company Baron Asset Management. Tesla’s stock has done well for them since their purchase in 2014. Because of this, Ron is making his predictions from an Inside View.

Sales Growth from the Inside View

Ron is focusing too much on how unique he believes Tesla to be.

This is not to say Ron and his team did not create financial models, develop forecasts for Tesla’s potential total addressable market, and predict Tesla’s future market share.

They did.

But they made their models and assumptions from an Inside view. The Inside View is prone to overly optimistic assumptions and overconfidence in one’s own abilities.

Ron Baron believes Tesla will grow its trailing twelve-month sales from $8.55 billion to $70 billion in 2.5 years. A compound annual growth rate of 131%.

Maybe Tesla achieves this.

But did anyone at Baron Asset Management ask, “In the history of publicly traded companies, across all sizes and industries, how many companies were able to grow their sales at a compound annual growth rate of 131% over 2.5 years?

Sales Growth from the Outside View

Michael Mauboussin and his team at Credit Suisse created the Base Rate Book to help with the outside view. The Base Rate Book addresses our sales questions above.

Sales Base Rate
Table from The Base Rate Book

Only 2.5% of all companies since 1950 have achieved a compound annual growth rate over 45% during a 3-year time span.

I’m willing to bet this rate drops below 1% for a CAGR greater than 100% over 3 years.

An even better Outside View is to see how many companies with sales numbers similar to Tesla’s have achieved a compound annual growth rate greater than 45% for 3 years?

Outside View for $7-12 Billion in Sales

The Base Rate Book also has sales data broken down into smaller cohorts.

Tesla had $8.55 billion in trailing twelve months sales which places it in the $7-12 billion sales cohort.

Base Rate
Table from The Base Rate Book.

Only 0.7% of companies with $7-12 billion in existing sales were able to achieve a compound annual growth rate greater than 45% over 3 years.

Goal of the Fundamental Investor

From the introduction to the Base Rate Book

The objective of a fundamental investor is to find a gap between the financial performance implied by an asset price and the results that will ultimately be revealed. A useful analogy is pari-mutuel betting in horse racing. The odds provide the probability that a horse will win (implied performance) and the running of the race determines the outcome (actual performance). The goal is not to pick the winner of the race but rather the horse that has odds that are mispriced relative to its likelihood of winning.

As a result, investing requires a clear sense of what’s priced in today and possible future results. Today’s stock price, for example, combines a company’s past financial performance with expectations of how the company will perform in the future.[emphasis added]

The fundamental investor needs to compare their Inside View assumptions to the Outside View.

The fundamental investor needs to ask what has happened to other similar companies in this situation. Then determine if the current stock price and its implied assumptions represent a mispriced bet or an overpriced bet?

Is Tesla a Mispriced Bet or an Over Priced Bet?

Tesla’s share price is trading at an all-time high near $380 per share. Tesla’s current market capitalization is $62 billion. This is greater than Ford’s at $44 billion and General Motors’ at $52 billion.

GM Market Cap Chart

GM Market Cap data by YCharts

Ford and GM’s trailing twelve-month revenues are $153 billion and $170 billion respectively. Tesla had $8.5 billion.

GM Revenue (TTM) Chart

GM Revenue (TTM) data by YCharts

Ron Baron is predicting Tesla will grow its sales at a compound annual growth rate of 131% over the next 2.5 years.

Only 0.7% of companies with $7-12 billion in existing sales has ever achieved a CAGR above 45% over 3 years since 1950.

Given Tesla’s current share price, market capitalization, and implied assumptions about its future does Ron Baron’s bet look mispriced or over priced?

Dividend Stock to Avoid: Energizer Holdings (ENR) and the Secular Decline of Alkaline Batteries

Energizer Holdings (ENR) is a well-known consumer brand. The company recently underwent a corporate restructuring, a spin-off. Energizer Holdings current dividend yield is 2% with a payout ratio at 50%. Finally, Energizer recently increased its quarterly dividend by 10%.

Energizer is what we classify as a new dividend payer and given its recent history, it is a company we should be interested in buying. But we’re not.

Why?

It starts with this photo.

Old Consumer Electronics in iPhone
Source unknown.

Everything in the photo above and a whole lot more resides in this device.

iPhone
Click image to enlarge.

All those old consumer electronic devices ran on alkaline batteries. And now your smartphone runs on a rechargeable lithium battery.

The old household battery drawer filled with AA, AAA, C, and D batteries has now been replaced by the drawer full of USB cables.

Alkaline Battery Secular Decline

Because of this, Alkaline batteries are in a secular decline.

Alkaline Battery Decline
Click image to enlarge. From Stephen Saroki’s 2017 Ira Sohn Presentation.

From Energizer Holding’s 2016 10-K we see total battery sales declining too.

Energizer Battery Sales
From 2016 10K.

For the foreseeable future, alkaline batteries will not completely disappear. The argument then is alkaline batteries sales will level out and/or shift into a much slower decline. Especially once the smartphone markets mature. Price increases should help offset future declines in volume.

Given the low capital needs to maintain the battery business Energizer Holdings will continue to produce strong cash flows. Much like tobacco companies and cigarette sales. And now soda companies.

The difference is tobacco companies’ customers are extremely addicted brand loyal to a specific cigarette. Soda drinkers are brand loyal too. Not to the extent of a smoker.

Both products provide a sensory experience for their customers. Batteries do not.

E-Commerce & Brand Value

Before the internet, the smartphone, and the ease to comparison shop traditional advertising made it easy for consumers to pay up for the branded product, “I know this brand. Therefore I trust this brand. I shall buy this brand.”

The ability to comparison shop on the internet and access to other customer reviews have changed this.

Amazon Basics Batteries
From Stephen Saroki’s Ira Sohn 2017 Presentation.

Which battery would you buy?

Both have the same star rating but you get double the batteries for about $2 cheaper with the Amazon Basics brand.

Before the internet and customer reviews, if you saw the same set-up in the store you might assume the Amazon Basics batteries were of lower quality. Now you don’t.

The brand of the battery is less important with consumers today.

Amazon’s Increasing Market Share

The Amazon Basics battery is the leading battery sold online.

Amazon Private Label
From Mary Meeker

Online battery sales account for 2-4% of total battery sales. E-commerce is still in its infancy and rapidly growing. Online battery sales will grow along with e-commerce further hurting the sale of premium branded batteries. Pricing and margins for premium batteries will continue to decline.

Amazon does not make its own batteries. It contracts that out to a battery manufacturer in Asia. Even if that contractor is Energizer Holdings it does not make Energizer a worthwhile investment for a dividend growth investor.

As a private label contractor Energizer is now a price taker instead of a price maker. Amazon will play the other battery manufacturers off each other to get the best deal for its customers. Energizer’s position would be tenuous at best and Energizer would have to keep sacrificing margin to keep the business.

Growth

This is all a long-winded way of saying we don’t see the long runway of growth we want in a dividend growth investment.  Energizer’s revenue is not recurring nor highly repeatable. The value of its brand is deteriorating.

Energizer may be able to keep growing its dividend for the next couple of years but we don’t see how Energizer will be able to grow its dividend at above average rates over a long period of time.

Will President Trump Finish His First Term? The Inside View and The Outside View

If you want to bet on anything there is a market ready to take your bet. Like if you want to bet on whether President Trump will complete his first full term as President or not.

After President Trump fired FBI Director James Comey the probability for President Trump not finishing his first term jumped up to 50%.

Not finishing his first term includes impeachment, resignation, and death by natural causes.

My immediate reaction is these odds seem high. While other people, maybe under the influence of the Halo and Horn Effect, believe these odds to be too low.

Whatever your viewpoint, what this does offer us is a look at the Inside View and Outside View.

Inside View

The inside view can be described as intuitive forecasting. From Michael Mauboussin in his book Think Twice,

An inside view considers a problem by focusing on the specific task and by using information that is close at hand, and makes predictions based on that narrow and unique set of inputs.

The inputs may include and grossly overweight “anecdotal evidence and fallacious perceptions.”

Michael uses the example of Big Brown and his bid to win the Triple Crown in 2008.

Big Brown won the first 2 legs of the Triple Crown (the Kentucky Derby and the Preakness) with the Belmont Stakes remaining. Based on how handily Big Brown won the first 2 races and how weak the field would be in the Belmont, Big Brown was the overwhelming favorite to win. Even Big Brown’s trainer, Rick Dutrow, proclaimed it was a “foregone conclusion” that Big Brown would win.

Right before the race bettors pushed Big Brown’s odds of winning to 3/10 or a 76% chance to win.

Then Big Brown lost and he lost big. Big Brown came in dead last.

Racing fans and bettors put too much weight on Big Brown’s recent wins. A belief that Big Brown was just too dominant to lose permeated bettors’ minds.

What the majority of bettors never asked was how many has horse been one win away from the Triple Crown? And then how many times has that horse won?

Outside View

Again, Michael Mauboussin in his book Think Twice describes the outside view as such.

The outside view asks if there are similar situations that can provide a statistical basis for making a decision. Rather than seeing a problem as unique, the outside view wants to know if others have faced comparable problems and, if so, what happened.

Continuing with Michael’s example of Big Brown.

Of the 29 horses that were one win away from the Triple Crown, only 11 have done so. This is a 38% success rate.

But Michael then points out that before 1950 8 out of 9 horses won their Triple Crown bid but after 1950 only 3 out of 20 horses won their bid, a 15% success rate.

Base Rate

The outside view is also known as the base rate.

The base rate for winning the Triple Crown falls within the range of 15-38%. With the post-1950 numbers being the most applicable.

Big Brown’s chances of winning the Triple Crown were pushed up to 76%. A large divergence from the base rate.

What is the Base Rate for a President not Finishing Out a Full 4-Year Term?

We need to know a couple things.

How many President’s have died in office but were not assassinated?

  • William Henry Harrison
  • Zachary Taylor
  • Warren G. Harding
  • Franklin Delano Roosevelt

Only 4 out of the previous 44 Presidents or 9%.

How many Presidents have resigned from Office?

  • Richard M. Nixon

1 out of the previous 44 or 2.27%.

How many Presidents have been impeached while in office?

  • Andrew Johnson
  • Bill Clinton

2 out of previous 44 or 4.55%.

How many Presidents were impeached and removed from office?

  • Zero

The House starts the impeachment process but the Senate conducts the trial. No President has been found guilty by the Senate.

For the most part, these events are mutually exclusive and we can simply sum each probability.

(We could make it harder by focusing only on those events that happened in a President’s first 4-year term but let’s keep it simple.)

The base rate for President Trump not finishing his first term because of either death, resignation, or being impeached by the House and found guilty in the Senate is.

9% + 2.27% + 0% = 11.27%

Base Rate is the Starting Point

The lesson from Phillip Tetlock’s book the Superforecasting: The Art and Science of Prediction is any prediction needs to start with the base rate. Then given new information and specific knowledge you will incrementally raise or lower your odds based on the new information.

If you do not have any new knowledge or specific insights then stick with the base rate.

The firing of James Comey is definitely new information. Optically, the timing of his firing – with the FBI opening up an investigation into Trump’s Russia connections – is bad. Even if it is just that, poor timing.

Some people are comparing the firing to Nixon’s Saturday Night Massacre. When President Nixon fired the special prosecutor investigating into the Watergate break-in.

Is it enough new information to move the odds that President Trump doesn’t finish his first term up to 50%?

I don’t know.

What I do know is I don’t have any special insight into such matters. So I’ll stick with 11.27%.