Friday, March 7, 2014

Sure! Blame Baby-Boomers

colorful composite photo image of the mid-body of a Psychedelically dressed hippie
Are Baby-Boomers Retiring?
A dropping unemployment rate says jobs are coming back. Unfortunately, main street can't see the improvements. Why not blame Boomers? 
Come to find out that the unemployment rate has dropped because workers are leaving the job market and not because of job creation.
Normally, disillusioned workers would be a terrible indicator of a failing system. So, to make us feel better, our leaders are blaming Boomers. Their story is that only retiring Boomers are departing the job market in large numbers because of age. But the argument seems convenient at best. As the government loses track of millions of workers who have fallen out of the labor market, our leaders in Washington are missing a few hints.
It turns out that it doesn't make sense to blame Boomers.
First, Boomers are not like their parents. Members of the Greatest Generation liked telling stories of war as they chilled under the porch. Boomers, on the other hand, are much more active. They dislike both dependency and immobility.
From early on, Boomers' free spirit drove them to change the rules to society. Starting with the role of women, they then demystified sex and even found a place for drugs. As their personal productivity increased, they became the biggest spenders in the history of the planet.
But spenders they are no more. You see, Boomers are kind of broke. They do not have enough money to retire. So, they will have to continue to work longer than their parents to make ends meet.
How can I be sure? Well, if they had enough to retire, we would witness great signs of celebration honoring their accomplishments; from parties, to travel, to spoiling grand kids. Boomers have left no doubt about their desire to do everything bigger, better and faster than any other generation. But I just don't see the indication that this is taking place.
Chart of US Labor Participation Rates vs. Recessions (by Thomson Reuters)
Labor Participation Rates vs. Recessions
(by Thomson Reuters)
Moreover, if boomers were truly preparing for retirement, we would see great asset liquidations. As a result, there would be massive drops in the price of everything from Harley Davidson motorcycles to fishing boats. While this may still take place a few years from today, it isn't retirement that's in the minds of Boomers right now. They still think they can ride the Harley without much back pain.
So what's pushing Labor Participation Rates down? Who are the workers giving up looking for jobs?
If my assumption is correct, a different large group must be leaving the work force in place of Boomers.
It is evident in the Labor Participation Rate chart above that rates peaked at the end of the 90's. More recently, rates have collapsed further after the recession ended. Unlike with all other recessions in the chart, this one failed to rebound, even after a prolonged period of time.

Who is missing?
Composite image of an age-group member female plus chart of US Labor Participation Rate for those 65 year and older
Labor Participation Rate (65 years and over)
Looking at the Labor Participation Rate for those ages 65 and above, there is no doubt that they have not given up. The chart is clearly on a sustained uptrend which started in the mid 90's.
Honestly, the clear lack of correlation between this and the chart of the total Participation left me stunned as I reviewed the information. While I did not believe the story promoted by many mainstream economists, I certainly did not expect for this age bracket to contradict the trend by such large margin.
Composite image of an age-group member female plus chart of US Labor Participation Rate for those 55 to 64 years
Labor Participation Rate (55 to 64 years)
Now look at workers between the ages of 55 and 64. While their participation is flattening, it has certainly not dropped in sympathy with total participation.
I should probably highlight that the probability of a sudden change in direction of an uptrend is very low. It is much more probable that these uptrends move sideways as they exhaust the energy that pushed them higher.
So far, these two charts corroborate my suggestion that Baby-Boomers are not moving towards retirement yet. There is no doubt that at some point they will, as it is natural. We will simply have to wait longer.

If not Boomers, then who?
Composite image of an age-group member female plus chart of US Labor Participation Rate for those 16 to 24 years
Labor Participation Rate (16 to 24 years)
Let's look at the other side of the spectrum. Thus far we know that many 16 to 24 year olds still live at home with their parents, have large tuition debt and display a higher degree of entitlement than other generations. Could these characteristics show on Labor Participation? You bet!
Perhaps counterintuitively, this group has been pushed further and further out of the labor force. The decline in the chart dates to the end of the 90's. Furthermore, the recent declines are very robust in nature. You see, when we discuss impacts on demographics, we tend to focus mainly on Baby-Boomers because they are the largest single group that can easily affect economy. But what we often miss is that their children, the Millennials, are showing up in two larger waves. In the aggregate, there are more Millennials than Baby-Boomers. It thus makes sense that Millenials would also create seismic shifts on the economy.
Composite image of an age-group member female plus chart of US Labor Participation Rate for those 25 to 54 years
Labor Participation Rate (25 to 54 years)
Now look at the group in the middle. Definitely, the 25 to 54 years group dictates the main shape of the total participation rate curve. Meanwhile the 16 to 24 years group determines the acceleration. Together, these last two groups oppose the positive influence of those who are closer to retirement.
That these charts completely contradict the general consensus among economists who think that Labor Participation drops are due to Baby-Boomer retiring is not surprising. We live in a world where everybody is afraid of being exceptional. Everyone follows everyone else; even if it means we all end up in the precipice.
This is one more piece of evidence that the stories served by our nation's leadership are bogus at best. Our Presient would like us to believe that jobs are coming back thanks to his great economic projects. But the reality behind the scenes is different. Boomers are having to work longer to pay for retirement. With a lack of jobs, Boomers face accepting lower paying jobs; something that takes entry level jobs away from younger professionals.
We are letting headlines distort our economic impressions in a way that directly contradicts our intuition. In a nutshell, the country is broken and our leadership is either driving disinformation or they have no idea on how to better our position.

Friday, February 28, 2014

Limitless - US Federal Debt

Are politicians racking up debt that your children will have to pay?
photo image of a toddlers holding a pink pen with hundred dollars in the background.
National Debt is Silly!
Anyone who has visited my Blog has probably noted the US Debt counter on the right side of the main page. To me, national debt is a serious issue.
While my biggest concern has to do with what's done with the money borrowed, the overall amount is also hard to ignore.
Whether we pay the money through loosing buying power due to inflation or through income confiscation (taxes), the amount we owe is so large that there is just no way for our present generation to pay for it. As a result, it will be our children who are left with the bill.
But in every family, there is someone who just does not understand the problem of spending. Most of them see government as a kind of deity (God) who has the power to create money from thin air. What they miss is that the problem is not about the creation of the money but the creation of value.
image of the Empire Estate Building.
To pay a trillion in debt to the
Chinese, we need about
1,500 Empire Estate Buildings
For example, if the Chinese lend us a trillion dollars, we will have to give them a document that promises we will pay in ten years. Such document is a 10 year treasury bond. Well, in ten years, the Chinese will come back to get paid. But we will have to give them something of value. They will want to trade their bond for corn, cars or famous buildings. Of course that they will be fine with first receiving cash that they can then exchange for the Empire Estate Building and a few other landmarks. But what do you think will happen if the money we give them is not good? They will certainly refuse to accept dollars and would rather get paid with the buildings directly. After all, the money they lend us has value when we borrow it. They expect the same in return.
This is exactly what happened with German money after the first World War. The country was broke and as a result their money was worthless, So, the rest of Europe demanded to get paid with gold and other valuables.
Now think. Would you like the US government to come to your house in ten years and tell you that you have just lost your house to the Chinese as payment for the money Uncle Sam borrowed ten years before? What if they tell you that your house is exactly your fair portion of the total amount owed? Would such fairness make you feel any better? Do you think that it is fair for the Chinese not to get paid instead?
But you may be thinking that the government just prints money that the Chinese can then use to buy whatever they want. But the question is: if the government can just print money out of thin air, why did it had to borrow in the first place? The answer is because they can print money but not value. To pay the Chinese back, Uncle Sam will have to take your money or your goods. It is as simple as that.
If we are a nation that does things right, we need to have a good plan on how we will pay for what we spend before we use the money.
image of the chart illustrating US debt during the 20th century.
President Obama, in his attempts to take advantage of the public's ignorance, claims that we should raise the debt limit because we should pay what we owe. With this, Obama uses the high moral ground as his argument without explaining how money payments really work. By the time he is done, Obama will double the debt accumulated by all US Presidents combined.
It's not about not wanting to pay. The US has the best credit in the world because we do pay. Instead, it's about making sure we don't default. The best way to prevent default is to spend within our means. Unfortunately, this is at the core of our incompetence. We just can't do it. We love to talk about spending money for fireman and teachers even when it isn't our money we are giving away.
To see how ridiculous this situation is, look at this video.
Rather than making things complex by using national debt, the video simplifies things by putting everything within the context of family in debt. Make sure to share the article with anyone who needs to understand the topic better. Let's be more responsible. Enjoy!

Thursday, February 27, 2014

Jobs or no Jobs

image of an educated professional holding a jobless cardboard sign.
Photo by
In what seems like a repeat of 2007, macro-indicators continue to soften. Just like in 2007, the reasons behind the shift abound. But if history rhymes, we may be witnessing the next cyclical downturn.
Today, the Jobless Claims report surprised experts with a 348,000 claims headline. Before to the announcement, the expected range was between 330,000 and 345,000. The prior report was adjusted down 2,000 to 334,000; thus making the current report a substantial increase.
Since the report is volatile in nature, it is always best to use a moving average when looking at the data.
So when could we expect confirmation of a failed recovery in jobs? Cycle theory advocates concur that any time in 2014. Their idea is that markets oscillate in a fairly periodic basis and that it is now time for the next swing lower.
Demographers generally agree. Demographers look at the effect that Baby-boomers have on the overall economy.
Just remember that these are not sharp points on a graph but rather a slow turning curve. So, keep an eye on the broad trends.
Look at this morning's Jobless Claims chart.
New Jobless Claims chart with 4 week moving average made with data from Haver Analytics.
Jobless Claims data by Haver Analytics
Today, new data continued to build on a trend that started during the third quarter of last year. If the bad weather argument holds, the 4 week moving average (the cyan line) will soon correct down.
But if the thesis fails, we should be challenging the top end of the larger trend, which is marked by the channel I drew over the chart. There is a strong chance that in about seven to eight weeks we will test the channel's integrity with the 4 week moving average line. The target is near 350,000 claims.
As we approach the upper channel band, the chart may display a bit of volatility (noise). But soon after, we will know the outcome.
Even if the resulting trend moves sideways at a 350,000 level after breaking above the channel, it would still be a confirmation that the so called recovery in jobs failed.
Why is employment important? Well, because the consumer is a massive portion of the US economy.
Yes, I am geeking out with the technical chart analysis this morning.

02-27-2014 10:14 AM Update:
Consumer Electronics expert Barry Vogel made a very relevant comment in my LinkedIn page:

To my way of thinking, the jobless reports and related reports are a meaningless exercise. When the vast majority of jobs created are minimum wage or near minimum replacing solid middle class jobs, the numbers are meaningless. When people are forced out of the workforce before they wish to retire, the numbers are worthless. When formerly hard working people have given up after failing to find meaningful employment after more than a year, the numbers are an insult. To your point, the economy is far more fragile than anyone cares to admit. I do not believe that we have recovered. The economy could not stand on its own without being propped up by government spending. We are just one major financial blow away from disaster at any time.

This was my response:

You are very correct Barry. 
The Unemployment report, which is reported separately, fails to include (1) people with expired benefits and (2) those with part time jobs who would rather have full time employment. But if today's Jobless Claims report increase, as it is now evident, then things would be worse than you have clearly noted. It's a bit of bad on top of bad. 

Thanks for the great insight.

Wednesday, February 19, 2014

US Builders; Anything But Confident

Like when discovering that Santa doesn't really bring toys to children around the world, economists everywhere fell off their chairs after receiving Builder Confidence Data this morning.
illustration of a small home
Negative NAHB Builder Sentiment
Today, the National Association of Home Builders' Housing Market Index shocked the world of academia by revealing a negative confidence level among US builders. Considering that any number below 50 is bad news, last month's 56 was pretty OK; especially now that we convinced ourselves that mediocrity is the new recovery normal. Experts anticipated a number between 54 and 58. Now imagine their surprise when the news of an silly 46 hit the wire.
Naturally, the immediate reaction was to blame the weather. And why not? Everybody is blaming the weather.
aerial photo of the hoover dam
US builders aren't sissies
But if I know something about builder greed is that it is stronger than the weather. Think of all the great construction feats that took place in this country over the last couple of centuries. From trains to bridges, builders are anything but sissies.
Does this mean that something else may be at fault? Well, how about Greed's balancing partner: Fear?
Back on May of last year, I covered the real estate market in an article called Robust Real Estate Hides Truth. There, I described the fundamental issues challenging the industry. But lets bring everybody up to date on those issues.
Last year, homes were being sold too cheaply for builders to want to compete. This is because, after inflation, it was more expensive to build a house than to buy one built ten years ago. This is especially true when investors where the main market buyers. Remember that investors buy wholesale. The retail consumer had no chance to compete because homes were being appraised about 15% below the asking price while bids were being made 10% above ask. This meant that only buyers with a 20% to 30% of extra cash at hand could play the bidding game.
logo in black background of FHA logo with "Your door to homeownership" legend
FHA buyers were out of luck last year
Then consider the fact that this was an environment where the banking system failed to fully come back as a source of real estate loans. Even today, builders are complaining about the difficulty to get their projects funded. Just think of little home buyers. Now completely forget about FHA buyers. Low appraisals take most of them totally out of the market. I am sure that you heard stories about people spending up to a year trying to buy a house. These poor souls were being outbid by pro's.
Most homes were being sold to investment managers like BlackRock, rather than families. The interesting part is that this was no secret. Recently, BlackRock unveiled bonds made up from billions of dollars of securitized trounces of homes bought specifically to be rented. It should be clear that any home price increases were due to the vicious fight for inventory being waged between various investment managers.
Now put yourself in the shoes of builders. Imagine a market where capital is either too expensive or impossible to get. Add the fact that market prices for the goods you make are much lower than your cost to manufacture them. Then, consider that your main customer has yet to find reliable loan sources. Finally, think of the fact that the next generation of potential home buyers prefers to live at home with their parents.
All things being considered, there is simply no reason why builders should be upbeat.
Thankfully, they have enough sense as to not blame the weather. But the same can't be said about economists who insist that the weather is behind the malaise we are now seeing across the economy. From government to academia, naive optimism about a recovering real estate market abounded despite the evidence.
photo of three large snow plowers clearing a highway after heavy snow
Don't blame the weather
In Robust Real Estate Hides Truth I described how the so called recovery lacked fundamental strength. The fact that a part-timer like myself can analyse the same data as the pro's and come to diverging conclusions isn't surprising. What's incredible is when the pro's see their models crashing back to earth after such a short time.
This is why I have a hard time thinking of economics as a science. Pseudo-scientists like economists are great at curve-fitting until they see what they want from charts. Real scientists would be glad to be surprised by the evidence rather than by the failure of their fully developed models.
Illustration of "Fear to Greed" gauge showing that fear is stronger
Fear is stronger in this market
In a nutshell, this morning's news should have surprised no one. The home market is out of inventory and those who make the widgets have no incentive to make any more. These are the distortions typical when ineptitude is rampant among those who control the economic levers. So far, housing and employment have demonstrated the degree of market distortion and dysfunction that is our present reality. This despite a clueless president who continues to brag about his brand of recovery.
For now, keep walking people. There are no new news here!

2014/02/19 9:06 AM Update
Housing Starts and New Housing Permits data collapse in January. 
From an expected 975,000 in New Housing Permits, the final number came in at a meager 937,000 for a 5.4% in month-to-month decline. 
New Home Starts did worse. From the anticipated 950,000, the real number dropped by 16% when compared to last month to 880,000.
Despite the now normal tendency to blame the weather, the West may tell a different story. The West fell by 26% in a Permits month-over-month comparison and by 17.4% in month-to-month New Home Starts. The West is the second largest component in the survey and was not affected by the weather. 
Whether this is a fluke or a fundamental indicator of a weak economy, time will tell. To me, this has an eerie resemblance to April, 2006. Despite clear fundamental flaws, the data had just begun to show housing weakness. Back then, it took two years for everyone to finally admit we had a problem. 
In 2006, the problem was irrational exuberance; too much of a good time. Today, the issue is incompetent malaise driven by a White House leadership that insists in maltreating capital and business; thus creating a level of uncertainty that can't be lifted by all the money pumping at the Fed and through the Japanese carry-trade industry.

Wednesday, February 12, 2014

Is the Venezuelan Circus our own Show

What's happening to Venezuela? Is democracy failing them or is it totally absent?
photo image of clashes between Venezuelan civilians and army soldiers
I agree with the contemporary idea that democracy is not for everyone; especially democracy the way Americans define it. History shows plenty of communities where democratic levels were weak, yet progress abounded. Just look at China today.
Also consider the fact that a high degree of democracy in a nation of ignorance will lead to great consensus but definite failure.
Thus, I feel that Venezuela's problems did not arise from its democratic level. But, while democracy isn't for all, food surely is. The real shame of the Venezuelan regime is that it has turned one of the best economies in Latin America into a circus. Whether suffering from a shortage of toilet paper or milk, whether today or fifty years ago, these regimes have yet to learn that central planning by bureaucrats never succeeds.
The worst that could happen now is for oil to drop in price. The country would then have to borrow more from a market already reluctant to buy their bonds. But such is the luck of oil economies.
Income from high oil prices made Chavez' economic incompetence look like brilliance. When the price of oil is high, the leader in place looks like a hero. When oil goes down, the boss gets excommunicated.
The only constant is the dependency on high oil prices and the cyclicality of the pain. If only these so called leaders would help the economy diversify while things are cyclically great, the result would be the opposite. Instead, they opt to spend surplus funds on things that keep them in power; things that do not improve national productivity.
American's are very familiar with the problem. Borrowing money from the Chinese to acquire Wal-Mart stuff to fill their closets is wasteful. Buying Wal-Mart stuff results in the accumulation of things that nobody wants to buy from us. We become the end of the chain.
image of a calculator, a pen and a few quarters placed over a business chartThe inverse took place during the fifties when any money borrowed went into business spending. Investing in businesses created things that others value. We were then an important part of the chain.
The formula is simple. Opt for saving rather than buying personal things; meanwhile invest aggressively in business for maximum results. While this article begins with a question about the source of Venezuela's difficulties, it is evident that the problems of Venezuela can easily replicate elsewhere; including the US. The only thing helping America is the fact that it is already diversified. Unlike Venezuela, the US has plenty of vibrant industries that have succeeded with or without government intervention. The problem for us is that, like Venezuela, our leadership is focused on the kind of entitlement spending that doesn't lead to the creation of things that others would want to buy. How does a union change whether others want to buy things from us or not? How effective is paying irresponsible teachers a higher wage when it comes to making our products more desirable? In either case the benefit is for either the unions or the irresponsible teachers only. They add zero value to our marketable products. In America, we are forgetting to curve personal spending and to invest in business first.
While I am not optimistic that Venezuela will recover any time soon, I am hopeful that we do. I would love to see us prioritize business investing once again.

Saturday, February 8, 2014

Credit Card Debt Up - Boomer Jobs Down

Image of multiple credit cards over a flat surface
There is a consumer borrowing
party going on
Is the consumer-borrowing party getting louder out of happiness or desperation?
Today, the Federal Reserve reported that consumer borrowing took a surprisingly large jump of $18.8 billion in December to $3.1 trillion for the year.
Some argue that this is due to the Christmas season. Others claim that it is a good sign that the economy is improving. Both are wrong.
I will remind those who think that the jump is due to Christmas of the fact that 2012 also had one of those. The total last year was $2.9 trillion compared with the $3.1 trillion for 2013. So the substantial increase was not due to the holidays.
With regards to higher borrowing being a sign of confidence, I would say that it is possible but improbable. While spending could be a sign of consumer confidence, I would instead expect to find the initial signs of confidence among employers. But so far I see none.
Chart of Nonfarm Productivity and Unit Labor Costs by Haver Analytics for February 6, 2014
Nonfarm Productivity and Unit Labor Costs
 by Haver Analytics 
Employers hire employees when the balance between greed and fear tilts towards greed. Unfortunately, employers are acting with a bias towards fear. Fear makes them behave controlled and measured. On the other hand, greed creates stampedes. Fear drives efficiency up. Greed drives it down. The efficiency report from this week clearly showed that efficiency is way up. Productivity went up while unit of labor cost went down. Less input to more output equals higher efficiency. Again, this behavior is rather typical of fear periods.
The signs clearly point at a consumer who is using more credit cards not out of optimism but rather out of need. Consumers are rebuilding leverage again, but absent an economic boom this time. People are borrowing the money they don't have. If this assumption is correct, in a few months we will see unsecured-loan defaults rising. So be prepared just in case I am right and the extra spending isn't due to a better economy. In your shoes, I would not hold my breath.
I only wonder what it would take for people to remove the blinders. In 2006 I told anyone who would listen to skip buying a house. I told them all to sell their home instead and to rent one in the mean time. People thought it was a stupid idea.
Today, I see the same about the ineptitude of this White House. Here, Congress is not an excuse because they have always been trouble for any president. The variable this time is a president who has no clue of the social aspects of markets. He either does not understand what makes economies work or refuses to do the right thing. He is either incompetent or unethical; you chose. The fact is that there are not enough jobs being created. We need about 400K new jobs per month instead of the joke of a number we are getting.
The only reason for the low unemployment is the low participation. But here, the President argues that the low participation is due to Baby-boomers not seeking jobs. But this too does not match reality.
image of baby boomer making a deal
If boomers were no longer looking for jobs, there would be an excess of job openings in the jobs they previously held; jobs as managers and sales people. Instead, the lack of employee supply is for welding positions. These were not the jobs that most Baby-boomers had. They were insurance agents, traveling reps, real estate agents. Unfortunately, the real supply imbalance in these areas is one where there are not enough of these jobs for the many job seekers fighting for them. I recently saw a job listing for COO where more than 150 people applied for the one job. What? 150 Chief Operating Officers for just one job? This directly contradicts the assumption that jobs for the educated are plentiful. As someone commented in CNBC today, unemployment for those with college degrees remains about 4% higher than before the recession. So much for that spin.
In simple terms, the government's claim is just hiding the truth from naive citizens. I say naive because it seems clear to me that they wrongly elected the President because he sounded well while delivering empty speeches. If I had anyone of them read the speeches rather than hear Obama say them, they would think very differently of the message. So, let's just hope that this President does not take us so far into the hole that we can't recover later on.
image of several chinese yuan bills over an american 100 dollar bill
As for the risk at hand, keep in mind that we already owe more money than any other country in the history of the planet. In a nutshell, your taxes (assuming you pay any) fall way short of what government spends. For every dollar in taxes, we ask the Chinese for 60% in extra loans. Soon they too will realize we just don't have any money.
The facts continue to contradict the White House's spin. While they can attempt to impress us with the best displays of curve-fitting by Nobel Prize economists, the fundamental reality continues to call attention to the fact that consumers are being squeezed, boomers are out of their jobs and employers are scared. Let's demand better leadership.

Thursday, January 30, 2014

Valuation; a Tricky Business

Will you sell your business now that you are looking at retirement. What is your business worth? 
image of baby-boomer trying to sell her family business
How much is your business worth?
If you are like many baby-boomers, it is getting close to the time when you'll need to divest from your assets to pay for retirement. It is now time to sell the business. But how much is it worth?
There are many books and articles covering different ways to value a business. Some use profit multiples. Others look at revenues. And there are those from the tech-boom years that focus on future growth.
The reality of it all is that none of these methods matter if the author is not willing to buy the business from you. How much is a valuation worth if no one would pay it? In a market, prices are set by market players willing to sell or buy an asset. Everyone else is just noise.
Let's look at Apple's stock to help us understand better. Two days ago, on January 28th at 10:30 AM, AAPL reached a per-share valuation of $513.00. Today, also at 10:30 AM, each share dropped to $498.69. In just two days, the shares dropped $14.31.
metallic Apple Inc. Logo over black ground
Apple Inc. Logo
The change in price was not due to earnings surprises or anything that could hurt valuation. In fact, Apple's earnings were announced on January, 27th, leaving enough time for the market to adjust.
Can an industry analyst argue that the company remains just as valuable today as it was two days ago? Yes, of course. I am even sure that the analyst would offer great reasons why the valuation should remain at the $513.00 price. But his opinion is garbage. To talk costs nothing and thus has no value. There is no way in hell that Apple is worth the $513.00 today. How do I know? Simple; because no one paid that price. No one who was willing to part from their cash was willing to do it at $513.00. And believe me, with close to 25 million shares sold, there were plenty of opportunities for someone to pay the higher price. Yet, not a single buyer did.
What's interesting is that all sellers would have preferred to sell at the higher price of two days ago. But with no willing buyers, they had to settle for the lower price. Alternatively, their other choice was to sit on the shares and not sell.
The same applies to your business. You may think that your business is worth, say, a million dollars. You may even have documented evidence of why it's worth the price. But does it mean that it's worth the million? No! Not if the highest bidder offers much less for it. This means that you too may have to select between taking a lower price or to not sell if your highest bid is lower than the million.
The problem here is that many business owners never plan an exit strategy. As a result, they usually try to sell the business when they have no more time to wait. This is why, after listing a business for sale with a broker, the owners often get tired and give up. They take home whatever inventory is left and break the lease. From one day to the next, a viable business is closed. Because of a lack of planning and the unwillingness to take a lower price, the owners run out of time and get nothing instead.
image of "retirement next exit" post card with a "enjoy the journey" tag
Do you have an exit strategy?
Think about it. How many people do you know who are out there looking to buy a business? How many have the money to do so? For sure, I know many people who want to start a business, but they are not thinking about buying one. In fact, most of them lack the business experience to know that brokers exist. Moreover, these aren't the kind of people who would walk into your business to ask if you would sell. So even with willing sellers, these buyer don't know where to find them. In short, there aren't enough buyers available who know where the sellers are. In technical terms, this means that the market of small businesses for sale lacks transparency and liquidity.
When it comes to buyers and sellers finding each other, selling a business is worse than the real estate market. Just the fact that a home seller is willing to advertise to everyone while the business seller isn't should clarify the reasons behind the difference.
Compare this to buying Apple stock. Within a fraction of a second, I can sell my APPL shares without any concern of who is at the other end of the transaction. There is plenty of liquidity in the Apple shares market. Furthermore, I know the exact price it is worth at any time. Pricing information is publicly available through the stock exchanges. Better yet, the price is not determined by analysts but by buyers putting out their cash. There is a high degree of transparency in this market. Clearly, selling your business lacks both, transparency and liquidity in the market. This means that selling requires adapting.
image in dark tones of old clock
Time compensates for liquidity
What can you do? Well, first understand that allowing plenty of time is essential for a successful sale. This is the only way to compensate for the lack of market liquidity. Plan ahead. Don't leave this until your optimism for the business fades. Most people fail to plan because they think that tomorrow will be better than today. So they get their heads deep into the business. This means that the blinders only come off once they starts losing interest. By that time, doing what's necessary to get a higher valuation for the business will be impossible. It will be too late.
Remember that your goal all these years was to run the business in a way that would give you the highest standard of living rather than the highest valuation. They are not the same. In fact, many common business practices destroy valuations. Now that if this happens to you, don't worry; you are not the first.
Next, you should understand that any valuation given to you by an expert is garbage. The only valuation that you can take to the bank is that from a willing buyer with cash on hand. So, have some flexibility.
There is nothing wrong with thinking that you are the best negotiator in the world and that you will get the best deal; every business owner thinks the same. But no amount of negotiation will reliably help you sell your business if your valuation is unreasonable. If you ask me, I think that your odds would be close to those from playing the lottery. I would advise to take an alternative with a higher probability of success instead.
Think of the following:, buyers do not want to buy your business just to make you happy. Rather, real investors, the kind who would know how to find you, are interested in making money and don't care much about anything else.
To make money is not to buy and sell stuff. Many businesses buy and sell every day until they go bankrupt. High profit percentages aren't good enough either, if sales are so low that receipts do not cover costs. Even high profits in paper are useless. Most naive business owners fall under the trap of thinking that the P&L is all that matters to the business.
No! They don't want funny P&L's. Investors want positive net cash flows. Just look at what commercial banks measure when deciding on a loan for your business. Cash it's what matters. Even Warren Buffet is famous for looking at cash rather than the P&L.
image of chart of Enron stock prices during its collapse
When cash flows are negative
Did you know that Enron had great P&L's before they collapsed? Their whole mirage begun to unravel after short-seller Richard Grubman challenged Enron's CEO, Jeff Skilling, for the absence of a cash flow statement with their earnings during the earnings call on April 17, 2001. In paper, Enron was the most profitable company in the world. But, like a Ponzy scheme, they were running out of cash and needed to create new ways to get capital infusions to stay alive. Just like a Ponzy scheme, they eventually failed; leaving a trail of total devastation. They weren't producing any cash.
So tell me, how much is your business equipment worth if your business is not creating positive cash flows? The answer is "nothing". How much is the building worth, assuming that you own it, if there are no cash flows? Zero! Have you ever heard that many businesses are worth more broken apart than together? Well, you now know why. If your business is located in a building you own, I may advise to sell them separately. If the business produces very little cash, it will drag the value of the building down. Subsequently, a buyer looking at having to buy both may not be willing to pay the price you are asking for; which will surely make you think that the buyer is unreasonable. But in reality the opposite is true. Think of it in the following way. If a buyer seeks to get the highest return on his capital, why would he put cash into a asset that doesn't improve returns. Often, large capital outlays will reduce return on capital. This is why Dell's model is much more profitable than Apple's. Dell never had to use cash to buy a piece of inventory. Apple does.
image of hand holding a wad of one hundred dollar bills
What is your return on capital?
You see, to buy a building, the buyer will have to park a large amount of money in exchange for small savings with the hope that it will appreciate in the future. This is why businesses who keep a close eye on return on capital prefer to pass the burden of sinking lots of cash to financial institutions and opt to rent instead. This is a way to leverage other people's capital. The math is simple. If you can get higher returns on the cash you have by renting rather than buying, then rent. This is certainly the case when rapidly growing a business. It is best to put valuable cash into whatever yields the fastest turns. And buying a building achieves exactly the opposite. It turns scarce capital into slow money.
I can not stress enough the point that the way you run your business may not be what gets you the highest valuation. Things like high net cash flows, fast growth, and high returns on capital are very important when attracting serious buyers. As you can see, these three prioritize money. Your management style, on the other hand, prioritized you.
Finally, be flexible. Whenever I look for buyers, I always try to find what the buyer values more: P&L, Statements of Cash Flows or Balance Sheet. Are they seeking to show the highest difference between input and outputs? Are they in a capital intensive business or are they growing fast? Are they trying to improve their Debt Ratio? This is because a buyer may be willing to pay a higher price if it helps them improve cash. Terms are a great alternative in such cases. This brings me to asking you: which of the three is most important to you. Knowing what matters to you and to the buyer will help you both get a deal where everybody gets what they want. The message here is that you need to customize to get the best deal.
In conclusion, plan your exit as soon as possible. Do not wait a minute more. After your business earns you a comfortable living, learn the things that can get you a higher valuation. Incorporate this knowledge into your business. Give yourself time to find the best buyer. Be flexible with the price. There are ways to exchange an asset for something other than just cash-at-front. Be creative when making the deal. Good luck.

Monday, January 27, 2014

Math's for Winners - Regression Analysis and an Upset Status Quo

I tend to make some people really mad because of my affinity for data. If in doubt, just look at the feedback I received from a reader to my previous post. He was pretty worked up by the fact that I used statistical distribution to show that his experience agreed with mine. He even went as far as calling me a bourgeois; implying that my methods were snobbish. This comment surprised me since the term bourgeois describes business oriented middle class people instead.
image with various chart types of statistical distributions
Different Statistical Distributions
To him, my use of data destroyed the human side of business. I can see why, but I disagree. As a result he will not be the last one I upset.
To those like him, their experience tells them that data is the flag of the insecure. Data, or numbers, make anyone sound smarter than they are and keeps others form asking further proving questions. Perhaps worse, data also fails on an almost periodic basis. Who can forget the market catastrophe that resulted from Long Term Capital Management's misguided deployment of Nobel Prize winning mathematics? In 1998, the famous algorithms created a global economic meltdown.
Image of the late richard feynman
Late Richard Feynman
But this isn't the only example of high-math. Anyone who has studied the work of the late Richard Feynman knows that math can be a structural part of great progress, for example. As speculative as it may have seemed at the time, Feynman's work continues to prove its accuracy and utility.
To me, what makes data fail is not data itself, but our inability to use it properly. Whether an ignorance of what to measure or of how to interpret what was measured, data can prove to be quite difficult for even the most committed. This is especially true for the many who think that math is something that was left behind as we departed from school and that it should have no place in the real wold of business. But science offers this fantastic tool to help us make desired results predictable and repeatable. We just need to learn how to use it properly.
image of Moneyball book by author Michael Lewis over an old table
Moneyball by Michael Lewis
A great example of this is illustrated in the great book Moneyball; The Art of Winning an Unfair Game by Michael Lewis. Yes, the same Michael Lewis who used to be a bonds trader and who wrote the Wall Street favorite Liar's Poker.
As a science optimist, I very much loved the book. Reading that Baseball has already demonstrated that regression analysis and statistical rigor can be used for unbelievable performance left me as happy as a child in a candy store. And that says nothing about the fact that the benefits can be quantified in real dollars. Baseball teams pay for success with either dollars or math.
The book is not a dry regurgitation of data. No, it is a fun narration by a writer who has demonstrated tremendous bandwidth and an ability to communicate in the most fluid fashion. If you love baseball, you will enjoy the book. On the other hand, if you are religious about the "proper" way the sport of baseball should be played, then this book will piss you off. The dividing line is quite fine.
image from Wikipedia of the chart showing the salaries of the different great leagues baseball teams.
Moneyball 2002 Year; source: Wikipedia
Likewise, I know that my insistence in mathematical rigor is welcomed by those with an open mind and hated by the ones who "know how things should be done". Thus, it is helpful to have a very thick skin and a lot of confidence in one's methods.
In the end, math helps the underdog win. And who in America doesn't like to root for the underdog?

Friday, January 17, 2014

Occupy Keystone - to Complain or to Engineer Solutions

image from the Sierra Club
Sierra Club - Occupy Keystone 
Do you want factory jobs back in the US? Well, lower fuel costs are neutralizing the effects of low Chinese labor. Now that energy is so much cheaper in the US, factories are coming back.
The same goes for helping consumers save money during a time when they need it. Lower gas costs have pumped lots of money back into consumer pockets. For an idea of how much money has been given back to consumers just wait to see your next gas bill, now that gas supplies weren't enough for this difficult winter.
What's important about these issues is that no politician has anything to do with them. Markets do it on their own.
But to many of the anti-hydro-carbon lobby. None of this matters. They want to complain rather than solve the energy demand problem.
image of a data center
Data Centers - Energy Black Holes
It's easy for whiners to complain about hydro-carbons when the subject of energy isn't well understood.
Whiners complain, yet continue to use washers, refrigerators and now the "cloud". But they are not credible. I see no one picketing outside of appliance stores or the many massive data centers. Do you have any idea of how much energy is wasted to power the "cloud" and the internet? Data centers consume so much energy that it's shameful. But no whiner complains. The ridiculous asymmetry is clear.
Rather than complaining about a pipeline which will not add supply since the supply is already handled by trains, how about all these hipsters study Energy Engineering. I know the math may be intimidating for the lazy types but that would at least try to fix the issue at a fundamental level. The core of the problem is s growing demand for energy and not the supply.
I ask the question of what makes these whiners think that only they can have access to a cars, washing machines, refrigerators and the internet? Nothing.
Because every one in the planet wants the same things, the demand is what will drive massive exploitation of hydro-carbons in the next several years. Complaining about it solves nothing.
image of a electric car's battery pack.
Electric Vehicle Battery Pack
Moreover, wind and solar are only feel-good patches. If deployed in mass, these would create new problems of their own. Just think of the problem from managing millions of tons of used-battery waste if all cars were electric.
We need new solutions that can be taken to critical mass without negative effects. This is a problem that can only be solved through engineering. But in the US our children do not have an education level high enough or the dedication to enter engineering schools. I guess that we will have to wait until millions of new Chinese engineers graduate before we can solve the problem.
In the mean time, if whiners can't be part of the solution, they should get out of the way and let the rest of us handle the tasks at hand.

Thursday, January 2, 2014

Failure at the Top

What's the most common problem in a failing company? This is the question I am often asked. Who or what is at fault in a struggling business?
old image of a large industrial era business with hundreds of desks
Many assume that bad employees or products are the cause
My answer? The top!
In general, once you have worked with a few diverse groups of employees you'll probably also conclude that all have a fairly typical distributions consisting of a star or two, many average performers and one or two who seem to enjoy sabotaging everything. But since this mix is typical in all companies and since all companies perform at different levels, failure must be elsewhere.
Instead, management is generally at the core of the problems. Things like emotional insecurity and dysfunction, abusive tendencies, lack of leadership and outright incompetence are normal characteristics of those at the top of poor companies.
And this would make sense if we think that management's activities are leveraged through the rest of the company's team. A great manager's input would multiply into much larger outputs. Likewise, the inverse would be the case.
photo image of an office environment with an aggressive and upset manager approaching a desk with a computer
Poor leaders display low emotional intelligence
Bad managerial actions create environments with silos, where cannibalism increases the need for shelter and safety. The high degree of distrust prevents synergistic cooperation among team members. Distrust then engenders management's perception of the need to micro-manage employees. Bureaucracy becomes abundant.
In general, employees hate coming to work, have long forgotten about personal or corporate goals and have no time or energy to create value. Yes, this is exactly how a vicious cycle works. A participant's actions reinforce negative systemic outcomes. This repeats time and time again until things spiral out of control.
Unfortunately bad leadership also happens with previously successful managers. Often, markets are so frothy that even bad business practices are rewarded with higher profits; gains that end as soon as the tide turns. Just as the Peter Principle defines that employees will inevitable get promoted to their level of ineptitude, so will bosses.
A previously successful sales person gets promoted to manager and fails due to the lack of adequate skills and understanding. The company then loses a great sales person after he is fired. Even demotion works to eventually end his successful career at the company.
In the same fashion, success in previous environments do not necessarily qualify a leader for the next challenge. Then, since hubris usually appears after a few wins, the manager is rendered blind and incapable of understanding how to solve the new problems being faced. This new take on the Peter Principle focuses on managers rather than employees.
Blue and black image of mountain climbers demonstrating high trust.
Trust in business is paramount
What is the solution? In technical terms, all vicious cycles require an externality before reversal could happen. An externality is a new outside influence to the system. Applying the right amount of pressure and the correct types of externalities can in fact reverse things enough that a virtuous cycle replaces the vicious one.
But what is an externality in practice? Usually, I am; but you too could be one.
When I come into a company, like the recent factory I worked with, I face the need to quickly and forcefully apply an external force over the key fundamental factors that define the troubles. For example? I must quickly give confidence to all participants that the problem is solvable, and that the right knowledge to to so exists and is well understood.
Trust is essential in a vicious environment before anything else can happen. But do keep in mind that I am not talking about a cumbaya moment. I prefer to stay focused on the reality of the matter by making sure that there are no elephants in the room that have not been addressed. Trust is built through transparency and a commitment to progress in exchange of lots of commitment.
It is also important that the team gets a few immediate wins to start creating positive momentum. This will also show saboteurs that things are no longer safe for them; that the team is now moving positively. I usually do not have to fire bad elements. Peer pressure and group progress sends the best message. Bad players simply quit on their own. I just need to make sure that there's lots of transparency on everybody's actions. Good performers get plenty of team cheers. High-five opportunities increase. Destructive lagers find it uncomfortable and try to save face by leaving. They usually land "a great job" elsewhere.
Standards and peer accolades must remain high through out. If anyone does anything good, I tell the world. The point is to push, push, push in a positive direction, which is what being an externality is all about.
image of hundreds of words out of focus and the word "focus" in focus
Eliminate Distractions
I also remove distractions to save the energy that will be needed to achieve the new ambitiously high goals. As previously said, bureaucracy is high at these places. Bureaucracy creates friction to movement. So, I temporarily eliminate useless reports and meetings. This creates the sense of clear air around the office. It is paramount to use the new breathing room to push hard for what's important.
While structure is very good once a company has achieved maturity, it could slow down progress in a struggling company that must change to survive. What things? Well, at first it is never clear. The only obvious answer is that something must.
A study of the fundamental constraints to progress and a risk/reward analysis of possible solutions are key. Things that waste resources and offer low returns are then easy to de-emphasize, to put it politely. Hear the sound of sacred-cows falling everywhere.
Next, I begin to create personalized plans that align employee success with company progress. It is my experience that improving employee practices and skills at work also creates benefits to their personal life. So, make sure to help them see the connections between improvements in these two worlds.
photo image of Spain's soccer team as it wins the Euro-cup
In the best teams, everybody wins
This stage is about negotiating for mutual value. Once locating the important points, I must be the relentless couch who drives them to success. Personal progress must be measured often; not for punishment, as it is often used, but to show them how to gauge their good decisions. An important goal is to help employees learn how to independently operate in an upward direction.
As part of my job, I have to try to create a temporary gap between management and their team. I need at least a little separation and some time to improve things. As the source of the troubles, management is usually not very patient. I thus have little time and must act swiftly. Fast visible improvements are key. I must maintain a focus on positives and as much transparency as management can handle. It is not easy but it's what makes the challenge fun.
It goes without saying that costs must quickly be cut, that receivables collection must be accelerated and that supplier terms should be extended. While not a solution themselves, cash and cost improvements grant the time needed to solve things. They are thus very important.
Even when anyone can drive cash and cost improvements, those within the company usually struggle. This too must change. A revived team that has been conditioned to think in terms of cash flows will ensure that cash is never a problem again in the future.
graphical image in color of a few trends with one of them resembling a hockey stick. The image also has a hockey stick over the graph.
The only hockey-stick chart that works for me
is the one that looks back at factual data
At the end of the day, expect measured performance of the improved team to seem to come right out of a too-good-to-be-true presentation. You know, the same charts showing logarithmic improvements which inevitably raise suspicion.
I too do not believe in hockey-stick charts as a forecasting tool. But when they are used to report on verifiable performance, then I love them.
The best part of working with struggling companies is that I am left with many long term friends; people who have quantifiably outperformed all bench marks.
And how about their bad managers? Well, some get better jobs elsewhere. Others demonstrate that the Peter Principle does not negate improvement-after-failure. In fact, the creation of a virtuous cycle is so infectious that everyone. including management, comes on board.
There is just something fantastic about sharing a golden moment with all these fantastic people. I love doing turnarounds.

Update January 5, 2014
An expert in the matter, commented the following in an e-mail sent directly to me:

"The failure of a company is not always caused by "the top", at best only 65% of the time. The picture that you draw in your article is pretty heavy handed and very convoluted. It reminds me of an old saying, "it is not what you say, but how you say it." 
In my 33+ years as a retained search consultant, I have replaced many a CEO, and the first thing we do is a forensic analysis of what went wrong and why. As I mentioned earlier, failure from the top is only about 65% of the causal factor."

He is right! 
The problem with making any statement like mine is that it comes out as being absolute. And as he correctly observes, there are no absolutes in complex systems. 
My apologies!
I am nonetheless excited to see that his experience results in a close to 65% number. 
image of a chart comparing a typical and expected distribution with that of leadership failures in business
Failures at the Top
Typical Outcome Distribution
vs. those from 65% CEO/CFO/COO
and 50% CEO
If we apply a little statistical distribution modeling, we know that it is exceptional to see that such a small group of company employees (CEO's) account for such high number of failure events. Under normal distributions (I am geeking out here), the worst one percent (1%) of any group would be responsible for about 25% of failures. This comes from breaking down the curve of a common 80/20 distribution. 
So a 65% would certainly result from a curve with a very fat head and almost no tail. 
This is not an attempt at being cute. To find what is normal in business and what's not, I always try to look at how observed distributions compare to what would be expected under typical circumstances. In this case, while my implied message that 100% of business failures are due to failure at the top would be absolutely wrong, a 65% of failures coming from leadership would be equivalent to a catastrophic score card for the C-Suite. 
I therefore feel that my comments are statistically supported by the evidence gathered through this gentleman's long experience. 
My goal with my blog is not to just be heard but to open educational discussions, even if in the end it is proven that I am wrong. I thus feel that the value from this update lies on the way that one should benchmark things. 
I once met an executive who religiously followed an exhaustive hiring method. When I asked him how many of the chosen ones would go on to succeed at what was expected of them, he said 25%. 
Well, if I had a monkey flipping coins to decide who to hire, I would end with a random group. It could then be expected for the group to reach a success threshold around 20% of the time. In other words, his results were not much better than those from random luck. Needless to say, I was not impressed with his process, which I though was more of a pacifier than effective. 
On the other hand, one of his industry competitors achieved a 42% success rate hiring for the same positions. Now that was impressive. Any time that one can double expected results, the system is doing good work.
I appreciate the opportunity granted by this gentleman to address what I feel is a very important tool for management.