Nothing succeeds like success
In modern times, the view that success breeds success was first put into print by English writer and dean of the Privy Council, Sir Arthur Helps. In 1868 Helps produced, Realmah, in
which he wrote "Nothing succeeds like success." Surely, he didn't know what he was doing at the time. If he did, he might have paused and reconsidered his work because, arguably, his statement represents the roots of what The Economist calls the "management guru industry". Whilst the industry is populated by high profile, fantastically wealthy and well-known personalities, such as Stephen Covey, Jim Collins and Tom Peters, it is not altogether clear that their pride of place at the top of the management pile is deserved.
To be sure, in The three habits ... of highly irritating management gurus, The Economist uses the work of Andrew Henderson of the University of Texas - whose compelling work "A Random Search for Excellence Why Great Company Research Delivers Fables and Not Facts" - is used to support the view that the work of gurus is ... well ... the work of gurus.
Perhaps we would all be better off if Helps had delayed his writing to allow for the guidance of oil tycoon John Paul Getty. Getty argued that the secret of success is a cocktail of determination, hard work and good fortune or, more prosaically, luck. To quote Getty's formula for success: "Rise early, work hard, strike oil ..."
Getty, of course, is on the money. But then advice like this doesn't sell.
The Economist's article is reproduced below.
The three habits ... of highly irritating management gurus
STEPHEN COVEY is fond of telling people that he is writing a book on the evils of retirement, “Live Life in Crescendo”. There is no danger of a diminuendo for this particular guru. Mr Covey is working on nine other books, including one on how to end crime. He also presides over a business empire that is even more sprawling than his ever-growing family (he had 51 grandchildren as The Economist went to press).
Mr Covey has been stretching his brand since 1989, when the publication of “The 7 Habits of Highly Effective People” turned him into a superstar. He followed up with a succession of spin-offs such as “The 7 Habits of Highly Effective Families” and “The 8th Habit”. He is also the co-founder of a consultancy, FranklinCovey, that markets success-boosting tools and techniques. So far the original “7 Habits” has sold 15m copies in 38 languages and three of Mr Covey’s other books have sold more than a million copies.
His stroke of genius was to blow up the wall between management and self-help. “The 7 Habits” mixes the language of management consultancy—“synergy” and the like—with the moral exhortations that you find in Samuel Smiles’s “Self-Help”, Norman Vincent Peale’s “The Power of Positive Thinking” and the 12-step literature put out by Alcoholics Anonymous and its offshoots. Mr Covey insists that the key to success, for both individuals and organisations, is to unleash the power that resides in everyone. “Private victories precede public victories,” as he likes to say.
It is tempting to dismiss Mr Covey as merely a fringe figure. But this would be a mistake. He is a paid-up member of the management-theory club, with an MBA from Harvard. The club contains many serious thinkers, some of whom, such as Clayton Christensen, have endorsed him in glowing terms. He says that he got the idea for “The 7 Habits” in part from the claim of Peter Drucker, the most hallowed of gurus, that “effectiveness is a habit” and that the third (curiously) of the seven habits, “put first things first”, comes straight from Drucker. FranklinCovey claims 90% of Fortune 100 and 75% of Fortune 500 companies as clients.
Nor is Mr Covey the first to mix management with self-help. In the early 1900s Frank Gilbreth, one of the pioneers of industrial psychology, tried to raise his 12 children according to Frederick Taylor’s principles of scientific management. He discovered that you could cut the time it took to shave if you used two razors at once—but then abandoned the idea when he found that it took an additional two minutes to bandage the resulting wounds.
Mr Covey is only an outlier in the sense that he embodies, in an extreme form, many of the most irritating habits of the guru industry, not least the habit of producing numbered lists of habits. Three habits are particularly worth noting.
The first is presenting stale ideas as breathtaking breakthroughs. In a recent speech in London Mr Covey declared capitalism to be in the middle of a “paradigm shift” from industrial management (which treats people as things) to knowledge-age management (which tries to unleash creativity). Gary Hamel, who according to the Wall Street Journal is the world’s most influential business thinker, proclaims, “For the first time since the dawning of the industrial age, the only way to build a company that’s fit for the future is to build one that’s fit for human beings.”
But management gurus have been making this point for decades. William Ouchi announced it in 1981 in the guise of “Theory Z”. Elton Mayo and Mary Parker Follet had made much the same point 60 years before. It makes you long for some out-of-the-box thinker who will argue that the future belongs to companies that are unfit for human beings (which it may well do).
The second irritating habit is that of naming model firms. Mr Covey littered his speech in London with references to companies he thinks are outstandingly well managed, including, bizarrely, General Motors’ Saturn division, which is going out of business. Tom Peters launched his career with “In Search of Excellence” in 1982. Jim Collins has written a succession of books celebrating the great and the good of the corporate world.
In search of rigour
But do these corporate hagiographies prove anything? The gurus routinely ignore such basic precautions as providing a control group. Five years after “In Search of Excellence” appeared, a third of its ballyhooed companies were in trouble. Andrew Henderson of the University of Texas has recently subjected “excellence studies” to rigorous statistical analysis. He concludes that luck is just as plausible an explanation of their success as excellence.
The third irritating habit is the flogging of management tools off the back of numbered lists or facile principles. Mr Covey reinforces his eight habits with various diagnostic devices such as “the XQ test” (which measures organisational efficiency much as an IQ test measures intelligence). Consultancies like to tell their clients that the key to success lies in “customer-relationship management” and then sell tools to improve it.
But most of these rules are nothing more than wet fingers in the wind. Gurus preach the virtues of “core competences”. But in the developing world many highly diversified companies are sweeping all before them. Customer-relationship management is all about learning about and from your clients. But Henry Ford pointed out that if he had listened to his customers he would have built a better horse and buggy.
Which points to the most irritating thing of all about management gurus: that their failures only serve to stoke demand for their services. If management could indeed be reduced to a few simple principles, then we would have no need for management thinkers. But the very fact that it defies easy solutions, leaving managers in a perpetual state of angst, means that there will always be demand for books like Mr Covey’s.
Friday, October 30, 2009
The Three Habits
Thursday, October 1, 2009
Is The Market Cheap?
A Strong Rally
Equity markets have enjoyed a strong rally off the low base that was set in the early part of this year. In the case of the US market, for instance, the S&P500 Index has risen more than 55 percent since the low reached in the first quarter of 2009. In a similar vein, the Johannesburg Stock Exchange’s (JSE) All Share Index (ALSI) is up just over 35 percent since March.
Importantly, these instances are not exceptions: since March developed markets have gained about 65 percent, whilst emerging market equities, measured by the MSCI Emerging Markets Index, have almost doubled.
This dramatic recovery in equity prices poses the critical question: “Are equity markets still attractively priced?”
One way to answer this question is to use the market’s price-earnings ratio as a guide. Taking the case of the US, the S&P500 is trading on a trailing price-earnings ratio of 120 times, which is more than six times the market’s long-term average of 18. This figure is exceptionally demanding, and suggests that equities in the world’s largest stock market are very expensive. That said, it is essential to recognise that the price-earnings measure has two elements to it, namely the numerator, price, and the denominator, earnings. And on this front, whilst the price recovery noted above explains some part of the stretched price-earnings ratio, earnings over the past 20 months have collapsed (to 75% below their peak level). Thus, the demanding rating is as much a consequence of lower earnings as it is a result of higher stock prices.
Lies, Damned Lies and Statistics
This last point is a key consideration, because relying on a single year’s earnings to assess investment merit is fraught with danger. The reason for this is earnings are temporal and cyclical, often highly so as has been the case of the past year. Similarly, earnings in the middle years of this decade were extremely inflated, which using single year earnings made stock valuations appear cheap, while the market overlooked the unsustainably high levels of earnings.
For this reason, it makes greater sense to use a number of years’ earnings when assessing the price-earnings ratio for a company or a market. As long ago as the 1930s, Benjamin Graham and David Dodd argued in favour of using between seven and ten years of earnings data to arrive at a normalised earnings figure for a company or a market. In turn, Graham and Dodd argued, by using normalised earnings, investors afforded themselves some protection from reading too much into recent events, such as a collapse or ballooning in prior year’s earnings. Thus, the Graham and Dodd price-earnings ratio, (which in recent years has come to be known by some as the Shiller ratio, after Robert Shiller of Irrational Exuberance fame), is a more sober measure of the attractiveness of equities.
The World’s Largest Is Not the Cheapest
Returning to the question, then, using the Graham and Dodd price-earnings tool, it is evident that the S&P500 is expensive, but not nearly as expensive as suggested by the one-year price-earnings ratio. To be more exact, the 10-year price-earnings ratio for the US stock market is 18.7 times. This is slightly higher than the historical norm of 16.3 times. As shown in Figure 1, the US equity market is neither extraordinarily expensive nor extraordinarily cheap, despite the growling of some noted bears.
Value aside, what is more interesting in this data is not the exact price, but the action surrounding overshoots and undershoots. In each of the instances where the S&P500 approached an extreme overshoot of, say 20 or 25 times ten-year earnings, the market undershot over the course of the following five years, falling to a price-earnings ratio of between 5 and 10 times. This over-reaction on the upside and downside will be unsurprising to disciples of value investing.
To demonstrate the extent and implication of over-reaction, Figure 2 shows the deviation of the Graham and Dodd price-earnings ratio, measured in terms of the percentage move above or below the long-term average.
Notwithstanding the one-year price-earnings ratio of 120 times, adopting a longer-term investment perspective, it appears that the world’s largest equity market is not overly expensive or inexpensive. Yet, it is interesting to note that the S&P500 has not collapsed to the downside despite the largest overshoot in the history of the market. This suggests that there is much more work to be done on the downside as price-earnings ratios contract and the US equity market digests the excesses of the last decade.
Turning for Home
Repeating the above analysis in the case of the JSE, the current one-year trailing price-earnings ratio measures 14.5 times. This represents a sharp increase from the recent low of 8.4 times that was recorded in March, and the rise is a result of the combined forces of price gains and falling earnings. To be more exact, the market’s earnings fell a little over 25 percent over the past eight months, whilst prices have risen 35 percent. In any event, whilst the JSE’s one-year price-earnings ratio of 14.5 appears extremely cheap compared to the S&P 500’s ratio of 120 times, the figure is above the domestic market’s long-term average of 13.0 times one-year earnings.
By using the Graham and Dodd price-earnings ratio to strip away the noise of the past year, it becomes apparent that despite the strong recovery in domestic equity prices, the domestic stock market continues to hold investment merit. As shown in Figure 3, the ALSI currently trades on a Graham and Dodd price-earnings ratio of 14.4 times. This is modestly below the long-term average of 16.5 times (since 1980).
Source: Cannon Asset Managers (2009)
Putting valuation aside for a moment, it is evident from Figure 4 that the JSE exhibits the same pattern of mean reversion. That is, expensive markets collapse to become cheap, whilst cheap markets, with strong momentum behind them, rise to become expensive.
Source: Cannon Asset Managers (2009)
It also is clear from Figure 4 that the JSE has experienced the type of correction that still is absent from the US market. Read against this backdrop, and notwithstanding the strong price recovery seen since March, the Graham and Dodd toolkit suggests that the JSE continues to display value.
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