Tuesday, May 31, 2011

Dubious Conventional Wisdom

When something is repeated often enough—whether it makes sense or not—it becomes part of the conventional wisdom.  Take, for example, the assignment of a p/e multiple to U.S. Treasury notes as a way to argue that stock prices are attractive.  Yet, in Barron’s this weekend, a prominent fund manager stated that the 10-year Treasury note has a p/e of 32 ½, and it then follows that stocks are a great buy.

The return on a bond is the interest income plus the change in market value given the change in interest rates before the bond matures at par.  The change in interest rates will normally be driven by inflation expectations.  (The artificial demand for bonds by the Federal Reserve over the past two years has distorted this normal relationship.)  What are the profits of the U.S. Government, as opposed to equity in a corporation, in trying to assign the “e” in a p/e?  I suppose that if a fund can invest only in either equities or bonds that the aforementioned approach is an adequate, though crude, way to compare the two asset classes. 

But when bonds are unattractive, that doesn’t mean that stocks are a good buy.  Why isn’t cash the default when either stocks or bonds are unattractively valued?  The investment opportunity set is not just what exists today.  It also is what exists in the future, and cash reserves provide the means to take advantage of future opportunities if they’re better than what’s available now.  So I just can’t accept this bit of conventional wisdom of a p/e for bonds.

Steve Lehman

Friday, May 27, 2011

Steps Forward, Steps Back

Lockheed-Martin, the large military contractor, recently reported progress in corporate sustainability.

The company met its waste-to-landfill goal two years early, and instituted a green IT program that has saved $2.6 million a year.  It decreased its waste generation that ends up in landfills by 26% between 2007 and 2010, beating its goal of a 25% reduction by 2012.  It also has consolidated 4,000 data servers since 2008, saving 26 million kilowatt hours of electricity.

Lockheed says it is on track to meet its goals for a 25% reduction in water use and greenhouse-gas emissions by 2012.  Since 2007, it has reduced its water usage by 22% and its carbon emissions by 15%.

The Carbon Disclosure Project has named Lockheed as an environmental leader for its GHG reduction efforts.

Finally, the company has expanded its sustainable supply chain program to eliminate extra packaging and to use more recycled content containers.

Despite these laudable accomplishments, the company still has work to do with legacy pollution.  Lockheed has been fined several times recently in pollution cases concerning contaminated groundwater at two Superfund sites near Los Angeles.

There are also fundamental issues concerning such positive press releases.  Are the announced gains true?  Reports of a company’s financial results require audits using generally accepted accounting principles (GAAP) in order for investors to have confidence in the accuracy and truthfulness of the reported results.  It seems that as sustainability factors take on more importance, it will be important to work toward a similar level of independent verification. 

Thursday, May 26, 2011

Profits and Good Deeds

GlaxoSmithkline, the large British drug company, is showing that it is possible to help those in dire need while still remaining a leading, highly profitable company.

Glaxo recently announced that it is cutting prices of “essential” drugs it sells in Kenya by 50 percent.  Sharply lower prices of antibiotics, asthma medicines, and dewormers will enable far more households to have access to such crucial medicines.

Glaxo plans to reduce the cost of its “essential” drugs in developing countries to as little as 25 percent of prices in the developed world.

Well done, Glaxo!

Steve Lehman

Friday, May 20, 2011

A Tale of Two Countries

The juxtaposition on my coffee table was striking.  The daily newspaper had a front-page headline, “Big Oil Defends Its Tax Breaks,” accompanied by photos of the CEOs of the five largest oil companies as they testified before Congress against proposed legislation that would end a relatively modest set of tax breaks for the industry.  They claim it would cost jobs (though similar subsidies for clean energy would produce jobs).

The entrenched power of companies that produce 19th century fuels (oil and coal) exists in a country where until the greatest ecological disaster in American history occurred a year ago, a popular slogan was “Drill, Baby, Drill.”  Many Americans seem to think that cheap gasoline is an American birthright.  Despite the deplorable state of bridges and roads in the country because gasoline taxes haven’t been raised in many years, people are clamoring for government to do something to reduce the price of gasoline, notably reduce gasoline taxes.  (They don’t seem to realize or care that it is those taxes that provide funds for repairing crumbling roads and bridges.)  Many still don’t grasp the simple math where the U.S. has between 2-4% of the world’s oil reserves, yet consumes 25% of global oil production.  Yet we’re supposed to cut the price of gasoline and consume more?  People do indeed have short memories.  With the Gulf oil disaster only a year ago, we now hear the slogan, “Drill Here, Drill Now.”

The political clout of these dirty businesses is couched in another means of duping the public--that of the myth of the miracle of an unfettered free market and the notion that government is inept.  Yet it was deregulation and out-of-control greed that caused the greatest financial disaster since the Great Depression just three years ago.

In contrast to this picture, also on my coffee table is a report on Denmark and why it is a leader in clean energy technology.  It is another myth that the capitalist U.S. is outperforming the sluggish, socialist Europe, particularly Scandinavia.  (Europe compares quite favorably on a GDP growth per capita basis versus the U.S., and the Swedish economy is growing rapidly while the government budget is in surplus.) 

Since 1980 Denmark has increased its GDP by 80% while keeping its energy consumption stable and reducing carbon emissions.  Denmark has a national goal of becoming independent from fossil fuels by 2050.  It is well on its way toward meeting this goal, as wind power already generates 20% of its electricity.  Denmark is a leader in “smart-grid” electrical distribution, and the country is home to a number of the leading companies in clean energy technologies.  Which country has a brighter, more sustainable future?  The one favoring 19th century fuels that cause thousands of premature deaths each year, or the one providing global leadership in 21st century fuels?

Steve Lehman

Wednesday, May 18, 2011

The U.S. Falls Further Behind in Progressive Policies for a Sustainable Future

While the U.S. is bogged down in diverting resources to fighting three wars, other nations are investing in innovative solutions to global problems and creating new industries—and jobs.

As gas prices have risen as part of growing resource scarcity,  the American public has responded by clamoring for reducing gasoline prices, specifically by reducing already meager gasoline taxes (that provide funding for repairing or replacing crumbling roads and bridges).  Meanwhile, other countries have adjusted differently—or are well underway in doing so—to the realities of resource scarcity.  Europe and Scandinavia impose high taxes on energy and are far ahead of the U.S. in renewable fuel development.  Those regions are often derided in the U.S. as being inefficient, “socialistic” nations, yet they have had superior economic output per capita compared to the U.S.   It is not just advanced nations that are seeing the future and seizing opportunities for progress.  Besides the huge investments that China has made in solar and wind energy, Brazil has a growing economy that has adapted to its highly efficient sugar cane-derived ethanol (while the U.S. forces nearly 40% of its corn crop to be used for ethanol, which might even use more fuel than it generates).

The news about climate change, alternative fuels, and the consequences for future competitiveness is becoming so obvious that one almost has to try not to notice.  The headlines provide almost daily reminders.  Yesterday a headline indicated that Great Britain—under a conservative government—will announce a goal of sharp reductions in greenhouse gases of 50% by 2025 that will be more ambitious than even that of Europe.  This is at a time of extraordinary austerity measures in that country. 

Why is it that the rest of the world—not just progressive Scandinavia, but even China—“gets it,” while the U.S. clings to 19th century fuels and protects those dirty industries?  

Saturday, May 14, 2011

Sustainable Investing Conference

I recently attended a fascinating and energizing conference sponsored by the Boston Area Sustainable Investment Consortium.  The overriding message is that money can be used for good in the world, and investors who control large amounts of money can do good things while not sacrificing returns on their money.

It is unfortunate that the pioneering work in what was known as Socially Responsible Investing (SRI) was tagged with the dubious reputation that investment results suffer when social considerations are added to financial analysis.  The challenge with this approach isn’t that investment results necessarily suffer (they don’t), but that many investment managers or plan sponsors are reluctant to engage in the slippery slope of where to draw the line about what types of practices or businesses are objectionable.

The SRI approach has broadened in recent years from values-based screens that exclude certain industries or companies from a portfolio to a broader realization that a company’s practices can affect its profitability, competitive position, reputation, and even its long-term viability.   The emphasis is on risk assessment and consequently performance enhancement, and the evidence is that companies with progressive policies and forward-thinking senior management flourish.  This broader approach is known as Sustainable Investing or ESG –based (environmental, social, and governance) Investing.

One panel at the conference discussed the benefits of gender diversity in affecting positive change in both non-profit and profit-oriented enterprises.  Women make numerous contributions in the world, from fighting global poverty to improving the performance at major corporations.  In the business world, gender diversity is an example of progressive policies in the workplace, notably the extent of women in leadership roles.  Leading companies recognize the valuable contributions of women in the workplace, and gender diversity has positive financial consequences, as including women in leadership roles tends to make businesses better at anticipating changes.  It is anticipating change that helps a business not only to survive over time but to be a superior long-term investment.

Another panel at the conference discussed climate change, water scarcity, and fracking.  The science on climate change is indisputable among leading climate scientists, and climate change already is having large impacts on crop yields and the occurrence of violent storms.  Climate change already is a fiduciary issue, as the Securities and Exchange Commission in February 2010 deemed climate change a materials risk that corporations must disclose as it relates to that business.  How businesses are affected by tighter pollution controls (when climate change is finally addressed seriously) or a dependence on plentiful water are examples of significant risk factors in considering a potential investment. 

In addition, with drought exacerbating the water supply for crops around the world, water scarcity has other consequences.  In the U.S., e.g., 40% of water withdrawals are used for the cooling of power plants.  And the coal industry, despite its unfortunate political clout, faces serious risks relating to coal ash disposal, toxic air emissions, and the lack of feasibility anytime soon of carbon capture and disposal.  These are not just values issues but financial issues for potential investors.

Whether or not and how to invest in energy is a good example of the merit of a broader approach in effecting positive change.  Some firms refuse to invest in energy companies, as energy is one of the most environmentally damaging industries.  Yet energy is crucial for economic growth, and it is a significant segment of the stock market.   Instead of simply screening out energy producers from a portfolio, there are various ways to approach energy companies that might yield better results in energy conservation and pollution reduction. 

Some firms as shareholders use shareholder resolutions at annual company meetings to effect change in a company’s conduct.  Others engage company managements in direct dialogue to effect change in practices over time.  Still others invest in “best in class” firms, even if the industry overall is a major polluter or is otherwise not known as having progressive policies. 

And other firms invest in companies that are part of the solution to problems, in energy, e.g., by providing products or services that generate much cleaner or renewable energy, or which help to conserve energy.  Johnson Controls, e.g., has long been part of providing solutions as a leader in energy management of large buildings as well as its work in advanced vehicle batteries.  The company is already playing a significant positive role in advancing energy conservation and reducing pollution, with positive consequences for climate change.  The company also is rated #1 this year in Corporate Responsibility’s 100 Most Responsible Companies survey.

Overall, the conference showed that there are various ways that investment firms can effect positive changes even in sectors that produce negative externalities that are not captured in a market-based system.  It left me hopeful and energized to do my small part on behalf of investors and the world we share.

Steve Lehman 

Thursday, May 5, 2011

Record U.S. Stock Prices With 1.8% GDP Growth?

It might seem incongruous for U.S. stock prices to be reaching record levels while economic growth is sluggish and millions of households have made no real financial progress in years.  Yet, corporate profits continue to be impressive, and it is the largest companies that are flourishing because of faster-growing international operations (and associated foreign currency gains).

Avon Products is a good example, as it reported that net income tripled.  This was despite a 2% revenue decline in North America, given the economic struggles of middle-market American consumers.  But Latin America, its largest market, had revenue growth of 16%.  Brazil, which has outstanding long-term prospects with its agricultural and water resources, was particularly strong for Avon.  Overseas operations account for 80% of Avon’s total revenues.

Better yet for Avon are its sustainability characteristics.  Its progressive management landed the company #16 in Corporate Responsibility magazine’s list of the 100 Best Corporate Citizens in 2011.  Avon was rated particularly high in Human Rights, Employee Relations, and Corporate Governance.  And the evidence is clear that companies with strong ESG (environmental, social, and governing) characteristics reflect superior management and better prospects for not only remaining viable, but flourishing.

Steve Lehman