In praise of organic growth vs. financial engineering

Research shows that mergers & acquisitions don’t produce the expected financial bonanza. But “organic growth” does.

The Batten Institute, part of the University of Virginia’s Darden School of Business, has released the latest results of a decade-long study of corporate earnings, establishing a correlation between organic growth and outperforming stocks. Using an Organic Growth Index (OGI), Darden professor Ed Hess compiled a list of “Organic Growth All-Stars” for the period 2003-2006. The conclusions:

In addition to consistent growth in underlying earnings, as measured by the OGI, the all-star companies’ share prices have outperformed the S&P 500 by a factor of 10 over the past 10 years.

Actual 10-year returns (1996-2006) for the OGI All-Stars were over 1,368% vs. approximately 130% for the S&P 500 Index and 144% for the Dow Jones Industrial Average.

“These companies have shown that they can grow in good times and bad. It’s not about the economic cycle. It’s about the business model,” Hess says. “Organic growth is growth the old-fashioned way: more customers, more products, better operating efficiencies,” he says. Not financial engineering or manipulation.

Hess identifies four key attributes of strong organic-growth companies:

• Simple, focused business strategies, implemented by managers who are are “execution champions”;
• Top management is home-grown and made up of “humble, passionate operators”;
• A highly-engaged workforce characterized by a strong degree of loyalty and productivity; and
• A “seamless, self-reinforcing internal growth system”

The study — and the list of 27 All-Stars — is available at this link. For some reason, the all-star list includes a couple of “dollar stores,” a couple of casual restaurant chains, a couple of big-box retailers, and the maker of Spam.

Most companies fail at forecasting earnings

Two out of every three companies are unable to accurately forecast earnings for the next quarter, missing the mark by anywhere from 6% to over 30%, according to a study of 70 multinational companies by The Hackett Group.

We’ve all seen cases where missed earnings projections led to sharp stock declines, CFO firings, or worse. But often companies don’t take the steps necessary to get better at forecasting, Hackett analysts say.

China ascendant; U.S. tech prowess peaked in 1999

China is often seen as just a low-cost manufacturing outpost, but the new “High Tech Indicators” study by researchers at the Georgia Institute of Technology clearly shows that the Asian powerhouse has much bigger aspirations.

The study of worldwide technological competitiveness suggests China will soon pass the U.S. in the critical ability to develop basic science and technology — and then commercialize those developments.

“Since World War II, the United States has been the main driver of the global economy. Now we have a situation in which technology products are going to be appearing in the marketplace that were not developed or commercialized here [in the U.S.]. We won’t have had any involvement with them and may not even know they are coming,” said Nils Newman, co-author of the study.

Georgia Tech’s “High Tech Indicators” study ranks 33 nations relative to one another on “technological standing,” an output factor that indicates each nation’s recent success in exporting high technology products. Four major input factors help build future technological standing: national orientation toward technological competitiveness, socioeconomic infrastructure, technological infrastructure and productive capacity.

A chart showing change in the technological standing of the 33 nations is dominated by one feature – a long and continuous upward line that shows China moving from “in the weeds” to world technological leadership over the past 15 years.

The 2007 statistics show China with a technological standing of 82.8, compared to 76.1 for the U.S., 66.8 for Germany and 66.0 for Japan. Just 11 years ago, China’s score was only 22.5. The U.S. peaked in 1999 with a score of 95.4.

More business travelers are headed to China

Going Places
Top destinations for growth in corporate travel spending in 2008:

1. China
2. UK
3. India
4. Mexico
5. France
6. Germany
7. Latin America (excluding Brazil and Mexico)
8. Canada
9. Japan
10. Brazil

————
Source: National Business Travel Association (NBTA) survey of 215 travel buyers (details via CFO magazine, January 2008)

Peripheral vision

Five things that caught my eye:

• After months of scandals, virtual banks in Second Life are being shut down.
• The U.S. Consumer Product Safety Commission plans to shift the target of its toy-safety enforcement efforts from manufacturers (which are mostly untouchable overseas now) to the retailers.
• Google reports that it processes over 20 petabytes of data per day.
• U.S. and Canadian antitrust agencies are investigating whether chocolate makers have colluded to fix prices, trying to offset higher dairy costs.
• iMantri is a new Web site that “seeks to match mentors up with mentees using a niche social network that focuses on goals and competencies.”

The resurgence of anti-business populism; more regulation ahead

We’ve already seen the U.S. presidential candidates embrace populist, anti-corporate appeals. Mike Huckabee, a Republican, has taken whacks at Wall Street. John Edwards, a Democrat, lays out his “stop corporate abuses” manifesto here. There’s a reason they do this: It really resonates with the public, at a time of globalization, job insecurity, outsourcing, mass layoffs, a looming recession, corporate scandals, congressional earmarks for contractors, $100/barrel oil, election campaigns funded by corporate interests (need I go on?)….

And now comes a survey, from public-affairs polling firm Ipsos-Reid, showing that it’s not just a U.S. phenomenon but a global one. Important note: The firm polled 22,000 people in 22 countries — but they didn’t interview just any warm body. The respondents are what the firm calls the “Intelligaged,” people who are online, vote in elections, discuss politics, etc. (see methodology below).

The pollsters concluded that:

…a majority of the world’s most engaged citizens is letting it be known that large companies have too much influence on the decisions of their government and they want a more aggressive crackdown on the activities and influence of national and multinational corporations…

…public opinion among the most active, connected and engaged global citizens is putting global and national corporations at risk for potential government interventions and tighter regulatory incursions because its most elite citizens will back such moves.

Specifically, the Ipsos poll found that:

• Three quarters (74%) of the “intelligaged” citizens agree that large companies have “too much influence on the decisions” of their government. This was especially true in Latin America (83%) and North America (81%).
• A full majority (72%) of the “intelligaged” citizens believe that the government of their country “should be more aggressive in regulating the activities of national and multinational corporations.”

Big Pharma faces big problems

“Over the next few years, the pharmaceutical business will hit a wall.” That’s how a major Wall Street Journal article begins (6 December 2007). The wall sits at the year 2012. The industry is “doomed, if we don’t change,” says Eli Lilly & Co. Chairman Sidney Taurel. The problems:

• Patent protections for the industry’s top-selling drugs will expire, allowing lower-priced generics to rush in. “Generic competition is expected wipe $67 billion from top companies’ annual U.S. sales between 2007 and 2012.”
• The industry’s science engine has stalled. “The century-old approach of finding chemicals to treat diseases is producing fewer and fewer drugs.” New blockbusters are lacking.

The industry is still profitable and will continue to produce new drugs — but “at too slow a rate to sustain its size and cost structure.”

That explains the recent spate of layoff announcements.

The future is said to be biotechnology (vs. chemicals) to develop drugs to treat diseases, which is why pharmaceutical companies are snapping up biotech companies and/or creating in-house biotech units. (They’re also getting into the generics business.)

By the way, this paradigm shift is bad news for chemists. See: “As Drug Industry Struggles, Chemists Face Layoff Wave,” The Wall Street Journal (11 December 2007).

Update: A new study says there are too many pharmaceutical sales reps taking up physicians’ time.

College students are taking more foreign language classes

U.S. college students seem to recognize the importance of knowing foreign languages, including Arabic and Chinese, in an era of globalization. The Modern Language Association’s survey of enrollments in languages other than English reports that enrollments expanded by 12.9% since 2002.

The study of the most popular languages — Spanish, French, and German — continues to grow and represents more than 70% of language enrollments. There is growing interest in languages such as Arabic (up 126.5%), Chinese (up 51.0%), and Korean (up 37.1%).

And, as an aside, enrollments in American Sign Language increased nearly 30% from 2002, the association reports.

The fallacy — and cost — of giving quarterly earnings guidance

Many executives believe that the quarterly game of giving Wall Street “earnings guidance” provides various benefits: visibility, reduced stock volatility, better valuations. But thorough research by McKinsey & Co. indicates that the practice doesn’t actually work — there’s no evidence that it produces the expected benefits — but carries its own costs.

The two costs:

• It takes up valuable management time to prepare the guidance reports (i.e., it’s a distraction).
• The practice produces too much emphasis on short-term performance.

In my opinion, that short-term mindset gets in the way of long-term strategic thinking and thwarts important investments in areas such as innovation, human capital, environmental sustainability, safety, and competitive intelligence. This short-term mentality — called “short-termism” — could be the No.1 problem in American business.

Oh, and McKinsey’s researchers found that, when some companies stopped providing the quarterly guidance, there were no dire consequences.

2080: Global warming leads to floods, droughts, agricultural disasters, hunger

An article in The Washington Post describes studies predicting the effects of global warming on agriculture, in the 2080s:

Several recent analyses have concluded that the higher temperatures expected in coming years — along with salt seepage into groundwater as sea levels rise and anticipated increases in flooding and droughts — will disproportionately affect agriculture in the planet’s lower latitudes, where most of the world’s poor live.

India could experience a 40% decline in agricultural productivity as “record heat waves bake its wheat-growing region, placing hundreds of millions of people at the brink of chronic hunger.”

Africa … could experience agricultural downturns of 30%, forcing farmers to abandon traditional crops in favor of more heat-resistant and flood-tolerant ones, such as rice.” Senegal and war-torn Sudan could have a “complete agricultural collapse.”

Scenarios like these — and the recognition that even less-affected countries such as the United States will experience significant regional shifts in growing seasons, forcing new and sometimes disruptive changes in crop choices — are providing the impetus for a new “green revolution.” It is aimed not simply at boosting production, as the first revolution did with fertilizers, but at creating crops that can handle the heat, suck up the salt, not desiccate in a drought and even grow swimmingly while submerged.

Fortunately, research on the new crops is underway, but it’s a race against time.