Tuesday, October 29, 2013

How Much is $1 of Earnings Worth?

Investors often treat reported earnings as the "yield" of equities due to the wide availability of reported earnings and the ubiquitous Price-to-Earnings ratio, however this can be a misleading measure of the actual economic value created for shareholders if earnings are overstated during cyclical upturns and the subsequent adjustment during downturns is reported as one-time items or direct-to-equity adjustments. I propose an alternate measure, a sum of the change in reported book value and dividends paid out as a proxy for the economic value created in a period.

Over the last 22 years, every $1 of S&P500 reported earnings has only led to $0.76 of dividends + book-value gains. If you exclude 2008, the year in which reported earnings and the alternate measure previously described differ most, every $1.00 of earnings generates only about $0.84 of economic value to investors. The sample, admittedly limited in size, was obtained using Bloomberg. Bold red line indicates a slope of 1, lighter black line is a simple OLS regression trend-line with no intercept.

Change in BV + dividends vs reported earnings

Change in BV + dividends vs reported earnings ex-2008
EDIT: A reader helpfully pointed out that I left-out the effect of buy-backs, which accrue to the price of shares but are functionally equivalent to dividends. Lacking a time-series of total buy backs, I can't correct the post to include that. Additionally, any buy-back made at a P/B multiple of > 1 would  dilute BV per share. Assuming book value is understated is a reasonable assumption for companies where marginal investment turns out to be profitable or during inflationary periods where the nominal value of capital stock is understated as a result. My apologies for these careless omissions. I will not remove the post, but I think it is worth noting that these omissions make the prior analysis basically useless.

Saturday, October 12, 2013

The short-term car rental service of the future

In the previous post, I wrote about how I envision smartphones replacing many of the functions of in-car entertainment and navigation systems. In this post I will be focusing on how that can affect automobile ownership and culture.

One of the small features that really blew my mind when I purchased my car was proximity-based keys which allow you to enter and start your car without having to ever put a key inside a lock. Not only that, but each key stores all sorts of preferences, from mirror and seat positioning and suspension settings, allowing each key holder to customize their driving experience. While I welcome this marginal innovation, it leads me to ask, “Why do we even need keys?” With the introduction of NFC and like-technologies into our smartphones, there’s no reason why keys can’t be replaced with our smartphones, the same ones which can then be docked into the car to load your personalized settings. Turning the automobile into a “thin-client” of sorts would allow any car to be your car, introducing a whole new opportunity set for the future of automobile rentals.

A couple of weeks ago I was in Paris for a couple of days. Having limited time and wanting to see as much of the city as possible during my short stay, I opted for renting a bike (velib) and riding around the city. One of the things that caught my eye as I tried to navigate roundabouts and punished my coccyx on cobblestoned streets was the presence of an electric car sharing system called Autolib. While it may not be suitable for many Americans, the success of Zipcar in dense, urban, locations is proof that there is a market for short-term car rental within close proximity to people’s homes. Improving this model by using electric cars with inductive-charging capabilities and reserved docking parking spots located throughout the city, eliminating the need to return the car to the same point of origin would remove some of the final inconveniences.

Imagine basic compact, inexpensive and utilitarian automobiles parked every couple of blocks. If you are a service subscriber, you simply walk-up to the car, use the NFC-capability of your phone to unlock it, and dock your phone on the dash to double as a navigation/entertainment display. The unique identifier of the car is recorded by the phone and submitted to a central database, and if your account is in good standing, a one-time use key is digitally delivered to your phone which allows the car to start. Your phone’s built-in navigation system includes all the car rental locations and availability of both cars and spaces is updated in real-time. A parking-assist function (much easier to implement in fully-electric cars) helps keeps dings to a minimum and internal diagnostic checks are run and uploaded at the time of docking the automobile, allowing the rental operator to easily keep track of maintenance needs and fleet location. Because your identity is linked to your phone and entry / ignition are recorded and associated to you, there is a strong disincentive to vandalize or abuse the cars, and no need to worry about someone breaking-in to steal a stereo--you’re carrying it out.

The uses for this range from short local round trips to places inaccessible by transit, to one-way trips for those nights when you may want to feel free to indulge in a few cocktails with dinner and not have to worry about driving home at the end of the night. Additionally, reducing the cost of not driving your own car out may lead to reductions in drink-driving, an additional positive externality. The logistic challenges are not trivial, but they are not great and all of the technologies listed in this post are already available today, it’s just a matter of someone putting it all together.

Mobile computing and the future of the automobile

I'm deviating from my usual focus on capital markets here to share some early thoughts on what I believe to be the future of the automobile industry.

Recently, after a decade of not owning an automobile, I purchased a car. The car comes with an in-dash entertainment/navigation system that would have likely blown my mind ten years ago but today, despite it being an award-winning top-of-the-line system, it feels nothing short of antiquated. I find myself constantly thinking, “My phone would be better at this.” The problem, in my opinion, is the mismatch between mechanical and computing life cycles. The median age of the American automobile fleet is 11.2 years according to consulting firm Polk. In a computing time-table, 11 years is an eternity. To put it in context, the first generation iPhone was released only 5 years ago, in June 2007. In that short span of time we’ve seen cellular data technology transition from GPRS/G2 to 3G to 4G to 4G LTE which represents an increase from ~150kbps effective speeds for non-EDGE 2G to 11-16mbps on the newer 4G LTE networks. In the last 4 years alone, mobile phone bandwidth has increased by a factor of 6 and screen resolution has doubled and we’ve seen the introduction of what is probably the most advanced voice-recognition technology available to the mobile consumer.

How is this relevant? Except for functions that are unlikely to change much in coming years like speakerphone capabilities or digital audio playback, the technologies at the center of modern in-car computers like data connectivity, A-GPS-aided navigation and voice recognition are evolving more rapidly than the replacement cycle of automobiles, leading to cars which have useful lives multiple times longer than the technology at the center of the user interface. Which brings us to the question; does the automobile really need an embedded computer?

As smart-phones become ubiquitous and the computing power available in them grows exponentially, it makes sense to allow our smartphones to become our on-board entertainment and navigation systems. Just like the embedded car-phone gave way to Bluetooth hands-free technology and trunk-loaded CD changers were replaced by mini jacks and Bluetooth audio, so will data connectivity and navigation / entertainment systems. It simply makes no sense to embed wireless connectivity circuitry that will be woefully out-of-date in 3 years to a machine expected to last 15 years or more. It artificially severely limits the useful life span of an automobile and non-luxury producers will soon adapt as they see the opportunity to reduce costs while touting it as an advantage for the type of consumer that can’t afford to replace a car every 3 or 4 years.

Once products like Ubuntu EDGE become a reality, there will be no need for auto manufacturers to include on-board entertainment computers anymore. Cars will feature a “dock” (wired initially, but eventually transitioning to wireless and featuring inductive-charging) and the necessary peripherals (microphone, displays, speakers, physical controls, if any). Your handset already has your music, your phone book, your address book, voice recognition, data-connectivity and A-GPS capabilities. Most importantly, your handset can (and does for many of us) back-up wirelessly and constantly to the cloud, ensuring that replacing our smartphone is as easy as buying and activating a new device and ensuring the possibility of massive data loss is minimal and the pain of transferring information to a new car (for example, a rental) is painless.