Winehole23
06-28-2009, 01:50 AM
Via BoingBoing (http://boingboing.net/)
America’s Corporate Shell Game (http://jontaplin.com/2009/06/27/americas-corporate-shell-game/)
June 27, 2009 · 7 Comments (http://jontaplin.com/2009/06/27/americas-corporate-shell-game/#comments)
http://jtaplin.files.wordpress.com/2009/06/roa.jpg?w=499&h=246
My friend John Seely Brown just sent me a report from his Deloitte Center for The Edge called The Shift Index (http://www.deloitte.com/dtt/article/0,1002,sid%253D227141%2526cid%253D266128,00.html?i ntrolist). They make no attempt to hide the bad news for the U.S. Economy–“return on assets for U.S. companies has steadily fallen to almost one quarter of 1965 levels,at the same time that we have seen continued, albeit much more modest, improvements in labor productivity.” The meaning of this is staggering–any productivity gains from the digital revolution have been more than wiped out by our corporate (as well as personal) addiction to debt. To understand this, it’s important to grasp the difference between return on equity (the classic Wall Street measurement) and return on assets. A case study of General Motors from 2003 (http://www.investopedia.com/articles/basics/05/052005.asp?), when SUV’s were selling like hot cakes and the management was touting it’s ROE is instructive.
Let’s calculate ROE for the automotive giant General Motors for 2003. To get the necessary data (http://www.investopedia.com/articles/basics/05/052005.asp?viewed=1#), go to the GM’s Investor Information (http://www.gm.com/company/investor_information/stockholder_info/index.html) website and look for the2003 Annual Report. You’ll see on GM (http://www.investopedia.com/articles/basics/05/052005.asp?viewed=1#)’s 2003 Income Statement that its net income totaled $3.822 billion. On GM’s 2003 Balance Sheet, you’ll find total stockholder equity for 2003 was $25.268bn and in 2002 it was $6.814bn.
To calculate ROE, average shareholders’ equity for 2003 and 2002 ($25.268bn + $6.814bn / 2 = $16.041 bn), and divide net income for 2003 ($3.822bn) by that average. You will arrive at a return on equity of 0.23, or 23%. This tells us that in 2003 GM generated a 23% profit on every dollar invested by shareholders.
Many professional investors look for a ROE of at least 15%. So, by that standard alone, GM managements’ ability to squeeze profits from shareholders’ money appears rather impressive.
Now, let’s turn to return on assets, which, offering a different take on management’s effectiveness, reveals how much profit a company earns for every dollar of its assets. Assets include things like cash in the bank,accounts receivable (http://www.investopedia.com/terms/a/accountsreceivable.asp), property, equipment, inventory and furniture. ROA is calculated like this:
Return on Assets = (Annual Net Income/Total Assets)
Let’s look at GM again. You already know that it earned $3.822bn in 2003, and you can find total assets on the balance sheet. In 2003, GM’s total assets amounted to $448.507bn. GM’s net income divided by total assets (http://www.investopedia.com/terms/a/asset.asp) gives a return on assets of 0.0085, or 0.85%. This tells us that in 2003 GM earned less than 1% profit on the resources it owned.
This is an extremely low number. In other words, GM’s ROA tells a very different story about the company’s performance than its ROE.The big factor that separates ROE and ROA is financial leverage (http://www.investopedia.com/terms/l/leverage.asp), or debt (http://www.investopedia.com/terms/d/debt.asp). The balance sheet’s fundamental equation shows how this is true: assets = liabilities + shareholders’ equity. This equation tells us that if a company carried no debt, its shareholders’ equity and its total assets would be the same. It follows then that their ROE and ROA would also be the same.
ROA gives an idea as to how efficient management is at using its assets to generate earnings. If Wall Street and investors had been focusing on GM’s ROA in 2003, they would have seen that it was a train wreck about to happen.
But it’s not just GM as the Deloitte report points out, it’s the whole corporate economy. By masking their absolutely dismal performance in the last 40 years in ROA, by taking on more and more debt to juice ROE, both Wall Street and America’s corporate elite are engaged in a massive shell game, in which the average investor is the mark. The Deloitte study points out the real game, although in somewhat opaque language–”While the performance of U.S. firms is deteriorating, at least some of the benefits of the productivity improvements appear to be captured by creative talent, which is experiencing greater growth in total compensation.” I love the term “creative talent” as if we were talking about Steven Spielberg, instead of some CEO who is good at massaging the numbers of his company in creative ways, so as trigger his stock options.
Six months ago I wrote about the role of Mike Milken (http://jontaplin.com/2009/01/31/a-grand-theory-of-our-present-dilemma/) in transforming the economy from ROA metrics to ROE metrics by creating the Junk Bond. Milken started in the early 1970’s and by the time he went to jail in 1991, any company that wasn’t leveraged to the gills was a target of a corporate raider or private equity baron.
It’s time to return to sanity. The Wall Street analytical community must start using ROA as a key performance measurement. The folks at the Center for the Edge have some great ideas about how we can increase ROA through knowledge flows. But until we recognize the basic problem we are living in a fools paradise.
America’s Corporate Shell Game (http://jontaplin.com/2009/06/27/americas-corporate-shell-game/)
June 27, 2009 · 7 Comments (http://jontaplin.com/2009/06/27/americas-corporate-shell-game/#comments)
http://jtaplin.files.wordpress.com/2009/06/roa.jpg?w=499&h=246
My friend John Seely Brown just sent me a report from his Deloitte Center for The Edge called The Shift Index (http://www.deloitte.com/dtt/article/0,1002,sid%253D227141%2526cid%253D266128,00.html?i ntrolist). They make no attempt to hide the bad news for the U.S. Economy–“return on assets for U.S. companies has steadily fallen to almost one quarter of 1965 levels,at the same time that we have seen continued, albeit much more modest, improvements in labor productivity.” The meaning of this is staggering–any productivity gains from the digital revolution have been more than wiped out by our corporate (as well as personal) addiction to debt. To understand this, it’s important to grasp the difference between return on equity (the classic Wall Street measurement) and return on assets. A case study of General Motors from 2003 (http://www.investopedia.com/articles/basics/05/052005.asp?), when SUV’s were selling like hot cakes and the management was touting it’s ROE is instructive.
Let’s calculate ROE for the automotive giant General Motors for 2003. To get the necessary data (http://www.investopedia.com/articles/basics/05/052005.asp?viewed=1#), go to the GM’s Investor Information (http://www.gm.com/company/investor_information/stockholder_info/index.html) website and look for the2003 Annual Report. You’ll see on GM (http://www.investopedia.com/articles/basics/05/052005.asp?viewed=1#)’s 2003 Income Statement that its net income totaled $3.822 billion. On GM’s 2003 Balance Sheet, you’ll find total stockholder equity for 2003 was $25.268bn and in 2002 it was $6.814bn.
To calculate ROE, average shareholders’ equity for 2003 and 2002 ($25.268bn + $6.814bn / 2 = $16.041 bn), and divide net income for 2003 ($3.822bn) by that average. You will arrive at a return on equity of 0.23, or 23%. This tells us that in 2003 GM generated a 23% profit on every dollar invested by shareholders.
Many professional investors look for a ROE of at least 15%. So, by that standard alone, GM managements’ ability to squeeze profits from shareholders’ money appears rather impressive.
Now, let’s turn to return on assets, which, offering a different take on management’s effectiveness, reveals how much profit a company earns for every dollar of its assets. Assets include things like cash in the bank,accounts receivable (http://www.investopedia.com/terms/a/accountsreceivable.asp), property, equipment, inventory and furniture. ROA is calculated like this:
Return on Assets = (Annual Net Income/Total Assets)
Let’s look at GM again. You already know that it earned $3.822bn in 2003, and you can find total assets on the balance sheet. In 2003, GM’s total assets amounted to $448.507bn. GM’s net income divided by total assets (http://www.investopedia.com/terms/a/asset.asp) gives a return on assets of 0.0085, or 0.85%. This tells us that in 2003 GM earned less than 1% profit on the resources it owned.
This is an extremely low number. In other words, GM’s ROA tells a very different story about the company’s performance than its ROE.The big factor that separates ROE and ROA is financial leverage (http://www.investopedia.com/terms/l/leverage.asp), or debt (http://www.investopedia.com/terms/d/debt.asp). The balance sheet’s fundamental equation shows how this is true: assets = liabilities + shareholders’ equity. This equation tells us that if a company carried no debt, its shareholders’ equity and its total assets would be the same. It follows then that their ROE and ROA would also be the same.
ROA gives an idea as to how efficient management is at using its assets to generate earnings. If Wall Street and investors had been focusing on GM’s ROA in 2003, they would have seen that it was a train wreck about to happen.
But it’s not just GM as the Deloitte report points out, it’s the whole corporate economy. By masking their absolutely dismal performance in the last 40 years in ROA, by taking on more and more debt to juice ROE, both Wall Street and America’s corporate elite are engaged in a massive shell game, in which the average investor is the mark. The Deloitte study points out the real game, although in somewhat opaque language–”While the performance of U.S. firms is deteriorating, at least some of the benefits of the productivity improvements appear to be captured by creative talent, which is experiencing greater growth in total compensation.” I love the term “creative talent” as if we were talking about Steven Spielberg, instead of some CEO who is good at massaging the numbers of his company in creative ways, so as trigger his stock options.
Six months ago I wrote about the role of Mike Milken (http://jontaplin.com/2009/01/31/a-grand-theory-of-our-present-dilemma/) in transforming the economy from ROA metrics to ROE metrics by creating the Junk Bond. Milken started in the early 1970’s and by the time he went to jail in 1991, any company that wasn’t leveraged to the gills was a target of a corporate raider or private equity baron.
It’s time to return to sanity. The Wall Street analytical community must start using ROA as a key performance measurement. The folks at the Center for the Edge have some great ideas about how we can increase ROA through knowledge flows. But until we recognize the basic problem we are living in a fools paradise.