Apr

27

 Umberto Eco wrote a great essay about how when new products start they are used first by high end users, and then gradually diffuse to the masses so that by time the masses use them, the marginal utility keeps reducing and the first users that got real value out of it stop using them. He points to such things as railroad use and cell phones as examples.

We have see how IPO's prospectuses follow this model with info in it being completely worthless as they have to go through so many hoops that it becomes merely a boiler plate to reduce the settlements in class action litigations when the case is settled.

One notes now the apparently standard thing in financial statements "cautionary note regarding forward looking statements".

I note in a company like Rimm 30 cautionary notes including "difficulties in forecasting quarterly results" and "regulation certification and health risks". My goodness, there was a time when management statements could actually convey useful information that had a high marginal revenue.

Could we attribute this syndrome to crony capitalism or flexionism or just a natural outgrowth of the law of diminishing marginal utility? 

Rocky Humbert writes:

While the chair's assertion that disclaimers have proliferated since the passage of the PSLRA is correct, there is scant evidence that management statements ever have consistent predictive value w/r/t either the organic performance of the business or its market valuation — over a reasonable investment time period. See wikipedia on the Private Securities Litigation Reform Act.

One reason for this is that companies which are performing well have no need for management cheerleaders or CEO soothsayers; the market will eventually figure that out on its own. In fact, the worst companies are the ones where the CEO is front and center (giving "upbeat" guidance) when things are rosy, but then when things turn challenging, release 8-K's on Friday afternoons using terms such as "exogenous factors" and "one-time adjustments" (and the CEO is nowhere to be seen.) Citing Philip Arthur Fisher's Rule #14: "Does the management talk freely to investors about its affairs when things are going well but "clam up" when troubles and disappointments occur?" It's a rare company that does an IPO or secondary when business is sickly (the exception being banks which sell stock at the behest of regulators.) Hence the entire IPO process can be viewed as a possible violation of Rule #14.

On a related point, one notes that INTC stock (which was mentioned recently by Dr. P) has a compound annual return since 1982 of about 15.6% per year (versus 11% for the S&P). During the same period, AAPL stock has produced a 17.5% compound return. Yet, right now, INTC has a 10x p/e and AAPL has a 17x p/e. Both of these companies have demonstrated good long-term organic growth, RoE, product innovation, and impressive market dominance. Yet, if Mr. Market would reward Intel with only a market multiple, it's return-to-shareholders would blow away Apple — demonstrating once again that Mr. Market's valuation at any given moment dwarfs every other factor for a profitable enterprise. I submit that it's folly to attribute this irrefutable statement to crony capitalism or flexionism or the law of diminishing marginal utility. The blame should be place squarely on the market participants who continue to make the same mistakes (such as buying INTC at a 70x p/e on 3/1/2000) but shunning it at a 10x p/e on 3/1/2011. 

Ken Drees writes:

Consider the cell phone and its recent tracking news out of apple– or police being able to plug a device into your cell phone and download all your data from it– the high end user will now need tech applications to shield their privacy and will demand a next generation product that the masses do not have– a private communication device. The cycle keeps moving forward. Maybe a self destruct feature will come on the scene.on the subject of mumbo useless jumbo in fin states. Is not persistency of litigation like ants digging into the timepiece to blame for the creeping destruction of worthy information?

Bill Rafter writes:

In looking to eliminate stocks in mergers or merger talks I cannot always get that information as quick as I would like. Sometimes I have to resort to looking at the individual stock's news headlines. Before I even get to the news about the merger I see the inevitable: "The law office of Dewey, Cheetham and Howe launches an investigation into possible breaches of fiduciary duty by the Board [of the company]…"

That, I contend, is why you don't get useful information.

An Anonymous Commenter writes:

I recently read an article that the author was try to further disgrace a Euro based company whose board member had made a remark at a meeting referring to "the weaker sex". The article told of the various ways, non business groups and political active parties tried to protest these remarks. However while raising a good smoke screen; the parties complaining were inefficient and did not understand business. Has any body done a study on the stock price of a company whose leadership made non PC remarks? Could it actually increase the price, due to the signal of boldness and management willing to think outside the box? Would not such a study have been quoted in these articles that hold a company up to ridicule? Could such a study have been done but be not published due the opposite than hoped for results?


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2 Comments so far

  1. david on April 28, 2011 4:38 pm

    It’s like the warning labels that come with the medication one is given by doctors now day, if you read them, no one in their right mind would take the drugs because of all the possible side affects……or just a way that the drug manufactures cover their butts from law suits……….take this you’ll be cured but you may grow a third nut, but ya been warned!!

  2. Reference needed on May 1, 2011 9:40 pm

    which essay or which book is this essay from? Thanks!

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