New Mauboussin Report: The Incredible Shrinking Universe of Stocks – The Causes and Consequences of Fewer U.S. Equities

Credit Suisse’s Global Financial Strategies team has published a new report, “The Incredible Shrinking Universe of Stocks – The Causes and Consequences of Fewer U.S. Equities”

  • There has been a sharp fall in the number of listed stocks in the U.S. since 1996.
  • While listings fell by roughly 50 percent in the U.S. from 1996 through 2016, they rose about 50 percent in other developed countries. As a result, the U.S. now has a listing gap of more than 5,800 companies.
  • The propensity to list is now roughly one-half of what it was 20 years ago. The net benefit of listing has declined.
  • Mergers and acquisitions (M&A) are the leading reason for delisting, and initial public offerings (IPOs) are the primary source of new listings. In the last decade, M&A has flourished while IPOs have floundered.
  • Regulation has increased the cost of listing and facilitated meaningful M&A.
  • As a consequence of this trend, industries are more concentrated and the average company that has a listed stock is bigger, older, more profitable, and has a higher propensity to disburse cash to shareholders.
  • Exchange-traded funds have filled part of the list gap.

Click here to read the full report.

See here for a collection of links to other Mauboussin papers.

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New Mauboussin Report: To Buy or Not To Buy – A Checklist for Assessing Mergers & Acquisitions

To Buy or Not To Buy: A Checklist for Assessing Mergers & Acquisitions

“Companies that act early in an M&A cycle tend to generate higher returns than those that act later. The first movers enjoy the benefits of a larger pool of targets and cheaper valuations than companies that buy later in the cycle. Cheap and accessible financing prompts action by buyers at the end of the cycle. So do bandwagon effects, or what Warren Buffett, chairman and chief executive officer of Berkshire Hathaway, calls the ‘institutional imperative.’”

Credit Suisse’s Global Financial Strategies team has published a new report, “To Buy or Not To Buy.”

  • Companies spend more on mergers and acquisitions (M&A) than any other alternative for capital allocation.
  • Empirical analysis shows that M&A creates value in the aggregate, but that the seller tends to realize most of that value.
  • While the market’s initial read of a deal is not perfect, there does not appear to be a bias.
  • Careful studies show that value creation is largely independent of EPS accretion or dilution.
  • Buyers see their stock rise when the present value of synergies exceeds the premium they pledge to the seller.
  • The form of financing and category can send signals about a deal’s merit.
  • We suggest answering four questions in order to assess mergers and acquisitions: How material is the deal? What is the market’s likely reaction? How did the buyer finance the deal? Which strategic category does it fall into?

Click here to read the full report.

See here for a collection of links to other Mauboussin papers.

New Mauboussin Report: Looking for Easy Games – How Passive Investing Shapes Active Management

Looking for Easy Games – How Passive Investing Shapes Active Management

“As they say in poker, ‘If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.’” –Warren E. Buffett

  • Investors are rapidly shifting their investment allocations from active to passive management. This trend has accelerated in recent years.
  • The investors leaving active managers are likely less informed than those who remain. This is equivalent to the weak players leaving the poker table. Since the winners need losers, this can make the market even more efficient, and hence less attractive, for those who remain.
  • Active management provides price discovery and liquidity, valuable social goods. However, the fees are higher for active managers than passive ones, identifying skill ahead of time is not easy, and there is a cost to assessing skill.
  • Passive management has lower costs and hence higher returns per dollar invested than active management does in the aggregate. But passive management introduces the possibility of market distortions.
  • Active managers have to constantly ask, “Who is on the other side?” The unrelenting objective is to find easy games, where differential skill pays off.

Click here to read the full report.

See here for a collection of links to other Mauboussin papers.

New Mauboussin Report: Capital Allocation Outside the U.S. – Evidence, Analytical Models, and Assessment Guidance

Capital Allocation Outside the U.S. – Evidence, Analytical Models, and Assessment Guidance

Credit Suisse’s Global Financial Strategies team has published a new report, “Capital Allocation Outside the U.S.” It includes new charts and examples and reflects the latest academic research.

  • Capital allocation is a senior management team’s most fundamental responsibility. The problem is that many CEOs don’t know how to allocate capital effectively. The objective of capital allocation is to build long-term value per share.
  • In this report we examine the sources and uses of capital for Japan, Europe, Asia/Pacific excluding Japan, and Global Emerging Markets. This extends our analysis beyond the United States, which we discussed in a prior report.
  • Countries or regions with a high return on invested capital (ROIC) can fund a substantial percentage of investment internally whereas those with low ROICs must rely more on external financing.
  • Capital allocation is also determined by the largest sectors in a country’s or a region’s economy, the stage of economic development, cultural norms, and regulations.
  • We provide a framework for assessing a company’s capital allocation skills, which includes examining past behaviors, understanding incentives, and considering the five principles of capital allocation.

See here for a collection of links to other Mauboussin papers.

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Measuring the Moat (Updated Version)

Credit Suisse’s Global Financial Strategies team has published an updated version of the report, “Measuring the Moat.” It includes new charts and examples and reflects the latest academic research.

Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation 

  • Sustainable value creation is of prime interest to investors who seek to anticipate expectations revisions.
  • This report develops a systematic framework to determine the size of a company’s moat.
  • We cover industry analysis, firm-specific analysis, and firm interaction.

See here for a collection of links to other Mauboussin papers.

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New Mauboussin Report: Capital Allocation – Evidence, Analytical Models, and Assessment Guidance

Capital Allocation: Evidence, Analytical Models, and Assessment Guidance

Credit Suisse’s Global Financial Strategies team has published a new report, “Capital Allocation.”

  • Capital allocation is a senior management team’s most fundamental responsibility. The problem is that many CEOs don’t know how to allocate capital effectively. The objective of capital allocation is to build long-term value per share.
  • Capital allocation is always important but is especially pertinent today because return on invested capital is high, growth is modest, and corporate balance sheets in the U.S. have substantial cash.
  • Internal financing represented more than 90 percent of the source of total capital for U.S. companies from 1980-2015.
  • M&A, capital expenditures, and R&D are the largest uses of capital for operations, and companies now spend more on buybacks than dividends.
  • This report discusses each use of capital, shows how to analyze that use, reviews the academic findings, and offers a near-term outlook.
  • We provide a framework for assessing a company’s capital allocation skills, which includes examining past behaviors, understanding incentives, and considering the five principles of capital allocation.

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See here for a collection of links to other Mauboussin papers.

New Mauboussin Report: The Base Rate Book

The Base Rate Book: Integrating the Past to Better Anticipate the Future

Credit Suisse’s Global Financial Strategies team has published a new report, “The Base Rate Book.”

Successful active investing requires a forecast that is different than what the market is discounting.

Executives and investors commonly rely on their own experience and information in making forecasts (the “inside view”) and don’t place sufficient weight on the rates of past occurrences (the “outside view”).

This book is the first comprehensive repository for base rates of corporate results. It examines sales growth, gross profitability, operating leverage, operating profit margin, earnings growth, and cash flow return on investment. It also examines stocks that have declined or risen sharply and their subsequent price performance.

We show how to thoughtfully combine the inside and outside view.

The analysis provides insight into the rate of regression toward the mean and the mean to which results regress.

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See here for a collection of links to other Mauboussin papers.

New Mauboussin Paper: Thirty Years

“But great investors do two things that most of us do not. They seek information or views that are different than their own and they update their beliefs when the evidence suggests they should. Neither task is easy.”

―Michael J. Mauboussin, Thirty Years

Thirty Years: Reflections on the Ten Attributes of Great Investors

Credit Suisse’s latest report is out: Thirty Years – Reflections on the Ten Attributes of Great Investors

“Perhaps the single greatest error in the investment business is a failure to distinguish between the knowledge of a company’s fundamentals and the expectations implied by the market price.”

  • The world of investing and business has seen a great deal of change in the past 30 years.
  • This report shares thoughts on the ten attributes of great fundamental investors.
  • Accounting is the language of business and you need to understand it to appreciate economic value and to assess competitive positioning.
  • Investors face a slew of psychological challenges. Perhaps the most difficult is updating beliefs when new information arrives.
  • Position sizing and portfolio construction still do not get the attention they warrant.
  • The substantial shift from active to passive management has profound implications for the investment industry.

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Ten Attributes of Great Fundamental Investors

The top ten attributes discussed in the paper are:

  1. Be numerate (and understand accounting)
  2. Understand value (the present value of free cash flow)
  3. Properly assess strategy (or how a business makes money)
  4. Compare effectively (expectations versus fundamentals)
  5. Think probabilistically (there are few sure things)
  6. Update your views effectively (beliefs are hypotheses to be tested, not treasures to be protected)
  7. Beware of behavioral biases (minimizing constraints to good thinking)
  8. Know the difference between information and influence
  9. Position sizing (maximizing the payoff from edge)
  10. Read (and keep an open mind)

See here for a collection of links to other Mauboussin papers.

Think Twice: Checklists

“Before I enumerate those actions, let’s start with what you need not do. You needn’t think twice before every decision. Since most decisions will be straightforward, with clear-cut repercussions, the mistakes in this book will not be relevant. We all make lots of decisions every day, and the stakes are generally low. Even when they are not low, the best course is often obvious enough.

Think Twice’s value comes in situations where the stakes are sufficiently high and where your natural decision-making process leads you to a suboptimal choice.

So you must learn about the potential mistakes (prepare), identify them in context (recognize), and sharpen your ultimate decisions when the time comes (apply). Here are some thoughts on what you should do differently tomorrow.”

—Michael Mauboussin, Think Twice

Mauboussin on Creating a Checklist

Think Twice by Michael Mauboussin is a great book for everyone who wants to gain a deeper understanding and learn more about the different kinds of heuristics, i.e., mental shortcuts that allows people to solve problems and make judgments quickly and efficiently. These rule-of-thumb strategies shorten decision-making time and allow people to function without constantly stopping to think about their next course of action. Heuristics are helpful in many situations, but they can also lead to cognitive biases.

Mauboussin wraps up by offering some very concrete actions based on the discussion in the book. The actions are: 1) Get Feedback, 2) Create a Checklist, 3) Perform a Premortem, and 4) Know What You Can’t Know.

Since the subject of checklists has been up for discussion on this blog before, I thought I’d save the part from Mauboussin’s concluding thoughts and discussion about the second action point: Create a Checklist.

Below is an excerpt from Think Twice: Harnessing the Power of Counterintuition, written by Michael Mauboussin. I encourage you all to read it. Every page is full of insights and advice that you will benefit from in your day-to-day operations and decision-making.

Create a Checklist. When you face a tough decision, you want to be able to think clearly about what you might inadvertently overlook. That’s where a decision checklist can be beneficial.

For example, in 2009 the New England Journal of Medicine published the results of a study tracking the rate of complications from surgery before and after the introduction of a checklist. The study was based on data from more than seventy-six hundred operations in eight cities around the world. The researchers found that rate of death dropped almost by half when the doctors used the checklist, and that other complications fell by one-third. [7] Pilots, of course, also find great value in checklists to ensure safety. But the question is whether you can develop a checklist for all activities.

People underutilize checklists. But a checklist’s applicability is largely a function of a domain’s stability. In stable environments, where cause and effect is pretty clear and things don’t change much, checklists are great. But in rapidly changing environments that are heavily circumstantial, creating a checklist is a lot more difficult. In those environments, checklists can help with certain aspects of the decision. For instance, an investor evaluating a stock may use a checklist to make sure that she builds her financial model properly.

A good checklist balances two opposing objectives. It should be general enough to allow for varying conditions, yet specific enough to guide action. Finding this balance means a checklist should not be too long; ideally, you should be able to fit it on one or two pages.

If you have yet to create a checklist, try it and see which issues surface. Concentrate on steps or procedures, and ask where decisions have gone off track before. And recognize that errors are often the result of neglecting a step, not from executing the other steps poorly.

[7] Atul A. Gawande, MD, et al., “A Surgical Checklist to Reduce Morbidity and Mortality in a Global Population,” New England Journal of medicine 360, no. 5 (20009): 491-499. See also Peter Bevelin, Seeking Wisdom: From Darwin to Munger, 3rd ed. (Malmö. Sweden: Post Scriptum AB, 2007), 287-296.

Checklists come with pros and cons. Handle with care, and hopefully, your checklist will help you in your attempt to make smarter and more insightful decisions.

See here for earlier blog posts in the category: Checklists. Here you’ll find more to read about Atul Gawande, among other things.

Further Reading: Mauboussin

Check out the official homepage of Michael Mauboussin here. Below are a list of other great books from Mauboussin worth reading.

Further Reading: Atul Gawande

Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

New Mauboussin Paper: Operating Leverage

“There’s a quick and easy way to test whether an activity involves skill: ask whether you can lose on purpose.”

―Michael J. Mauboussin, The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing

Operating Leverage: A Framework for Anticipating Changes in Earnings

Credit Suisse’s Global Financial Strategies team has published a new report, “Operating Leverage.”

  • MM_OpLevAnalysts are commonly too optimistic about earnings growth and often miss estimates by a wide margin.
  • This report outlines a systematic way to assess earnings revisions with a specific emphasis on operating leverage.
  • We cover the drivers of sales growth and then discuss the value factors, which determine the impact of sales changes on operating profit.
  • To measure operating leverage, we examine the relationship between the change in sales and the change in operating profit for the top 1,000 companies from 1950 through 2014. We also examine eight sectors.
  • Operating leverage and financial leverage together determine earnings volatility.
  •  Sales growth, profit growth, and value creation do not always go together.

Want More?

See here for a collection of links to other Mauboussin papers.