Someone strayed to this blog by asking Google "how much the stock market would correct at present". That's a good question! Let's try to answer his/her question at least in part and discuss how big stock market corrections usually are.
Before we do that, let's try our hand in predicting (=guessing) market movements a bit. Some people are afraid of a double dip where the second dip recessionwise would be on its way in the near future. However, I don't believe there will be a second dip even though it is always possible. I believe the fundamentals are so strong that there will eventually be a good surge in stock markets. No later than this fall I'm expecting a good surge, hopefully at least 10 per cent in the stock markets at least in the emerging markets and Asia. I am also hoping there will be a smallish downward plunge during the summer due to low demand in the summertime and fears that the markets are not yet through the rough patch. Therefore I took all the money under my control out of the stock markets for the summer and I am planning to put it back in come fall. So I am hoping to avoid possible 5-10 per cent downward plunge during the summer and benefit from the hopefully at least 10 percent surge between August and January. Usually trade picks up after summer and the economic news are probably by then looking continually better and all this I believe is leading to a little surge! Time will tell if my guessology will hit the mark this time...
Back to the original question. In my observations the corrections in stock markets usually hit the area of 15-30 percent of the highest values. The economic crisis in 2008-2009 was far worse and is a very exceptional and rare occasion. Typically different markets around the world lost 60 per cent of their highest market capitalization and the Russian market really hit the floor. For example the RTS index in Moscow lost about 75 per cent of its value causing total panic also in Russian government. A good reminder for Moscow, I would say, that not everything can be dictated by order of Mr Putin...
The opposite side of the coin here is that if you bought funds investing in Russian stock markets when they had lost 75 per cent of the peak value you would stand to gain 300 percent in profits when they someday reach their previous peak. Even if they don't reach the previous peak the opposite movement is certain after so rapid a plunge and you will certainly make big profits. The problem is guessing when you're close to the bottom, but I did some buying close to the bottom and when a month ago I sold everything, the Russian investment had already doubled in value.
One interesting question is how often do these plunges or crises occur? Based on my observations that would be in the range of 6-10 years, but economists put the length of these business cycles at 5 to 7 year range. That means that peaks as well as crises in stock markets occur every 5-7 years, usually. That also means that now you could probably put quite safely money into some interesting market funds and let them grow in value there for the next 3 or 4 years before the next crisis or correction is at hand. That should be a safe bet. And in any case, usually you start hearing market rumours or negative expectations in the public at least half a year prior to anything happening. So, when you start hearing these rumours more and more, it's time to get out of the market.
About the real business cycles. If my memory serves me right, there was a depression/recession in 1991-1992. The next one I remember was when the dot com bubble burst in around 2000. And then the current crisis started in earnest in 2008. These numbers, if correct, would point to around 8 years between crises.
Now, hopefully these observations will help you to develop your own Guessology ideas of future market fluctuations. I would be interested in hearing YOUR thoughts on the subject!?!
Monday, June 14, 2010
Sunday, May 16, 2010
Printing money - legally...
Have you ever noticed that public companies - that is, publicly traded companies in stock exchanges - in effect have the right to print their own money? Me neither, until one public company CEO pointed it out to me...
What this CEO meant was that a public company is free to issue new shares and sell them to the public or other entities. As these publicly traded shares are worth money and easy to liquidate in stock exhange, it is pretty much the equivalent of hard dry cash. Instead of issuing and offering these new shares to the public and investors, a public company also has another choice. These new shares can also be issued to a certain entity as a form of paying at least part of an acquisition price of another company, public or not. In other words, if you're a public company you can print your own money - that is to say, issue new publicly traded shares - and buy other companies with this "money". I had the perfect opportunity to watch from close range how this was done with masterful strokes by this previously mentioned CEO. I was privy to all the details and plans before they happened, and this CEO had predicted all the events with alarming precision. All the events took place pretty much exactly as predicted and in a little over year's time a smallish private company with a yearly turnover of 5-8 million euros morphed into a smallish international conglomerate with a yearly turnover of 80 million euros. In short, the company grew tenfold in a blink through acquisitions and mergers. That's like a fairy tale come true in business life!
To tell you an anecdote within an anecdote, I'll mention that I also learned a lot about negotiating from this CEO. He used some fairly inventive methods in negotiations and I wasn't always happy to end up with the shorter straw. I didn't make any too bad deals with him, but I felt I had given in a little too much. My own managing director at the time laughed at my complaints, but I was later vindicated. It so happened that our managing director was to renegotiate a little deal with this CEO. He did it over the phone and just a little later he came and told me that he was totally overwhelmed by this CEO. He had ended the call having renegotiated the little deal with new terms and felt happy about that. Very soon he realised that he had agreed to even worse terms than the original deal had, and he was forced to once again call him up on the issue. And our managing director was no new puppy to the game and still he had fallen. I felt some satisfaction listening to his story and how he now understood my complaints about this CEO's negotiating skills...
Back to the original story. I had made an acquaintance with this company and its CEO several years earlier when they hired me as a consultant to help them with their object oriented software development efforts. After that we ran into one another every once in a while and 5-6 years later I went to work for them full time. Their plans of going public and growing rapidly sounded very interesting to me and I saw the opportunity of doing something big and worthwhile. Therefore I joined their ranks at that point.
I was invited by their CEO to their Board of Directors' meeting where I heard their plans in detail. All the members of the Board were co-owners of the company and I was the only outsider in the meeting. The CEO detailed his plans and described every step of the way in vivid detail. I remember thinking that it's a wonderful and bold plan, and if even half of it were to come true it would be an unbelievable achievement. The basic idea was to first turn public and then use issued shares to buy other companies, first small and then bigger and bigger until the last one to be gobbled would be the biggest prize of them all. All of the acquired companies would be in the same business to enable greater synergies and financial efficiencies to be exploited. In these acquisitions almost no cash was to be used.
Most critical step in this CEO's plan was to go public because without that step completed succesfully there would be no currency to go on that wonderful shopping spree. The original plan was to go public in spring 2000, but the CEO had recently concluded it would be too late. He believed there would be too many IPOs for the last ones to succeed and therefore he wanted to expedite the initial public offering to take place half a year earlier, in fall 1999. He expected a great rush of IPOs of small companies and needless to say, he was right. Public interest might have greatly waned in the spring and the public offering might not have succeeded. I can only admire his foresight even though I know he had great contacts. Even if you have great contacts and are greatly positioned, it is not easy to interpret right the soft and weak signals you detect. You have to be visionary and in some small measure a true clairvoyant... :-)
He also envisioned the order in which the acquisitions would take place. First we would acquire several smallish Finnish companies in the business and after that we'd go on an international buying spree all over the world. And finally, we would gobble the big fish, much bigger than we were. All these acquisitions were friendly, not hostile takeovers, so I later realised that he had probably tested the waters previously and discussed his plans with the other parties to a certain degree. This makes it all the more extraordinary performance in my eyes, for he has been able to sell his vision to all these prominent and capable business people and make them come under the same umbrella, if you will. They all heard his call and came, and he himself landed on top of the new company as their CEO. I find it just amazing. Amazing.
As I mentioned earlier, the events took place quite exactly as he had envisioned they would. In a little over a year, a smallish private company with a yearly turnover of 5-8 million euros morphed into a smallish international conglomerate with a yearly turnover of 80 million euros and business literally all over the world. When the new company build-up was finished, I was assigned to the new position of Product Development Director of our Finnish subsidiary. I had in my unit half a dozen software development or software testing teams to run, each with a competent and experienced team leader, so I felt it was time to do great things. For me it was a dream assignment and it felt like tailor-made for me. Unfortunately, I wasn't to enjoy that for long, for soon I fell severely ill and was forced to give up that dream position. Even though that was a great disappointment I feel privileged to have been part of the process and having been able to watch the events unfold from a close range. Great experience!
That's it for today, folks!
What this CEO meant was that a public company is free to issue new shares and sell them to the public or other entities. As these publicly traded shares are worth money and easy to liquidate in stock exhange, it is pretty much the equivalent of hard dry cash. Instead of issuing and offering these new shares to the public and investors, a public company also has another choice. These new shares can also be issued to a certain entity as a form of paying at least part of an acquisition price of another company, public or not. In other words, if you're a public company you can print your own money - that is to say, issue new publicly traded shares - and buy other companies with this "money". I had the perfect opportunity to watch from close range how this was done with masterful strokes by this previously mentioned CEO. I was privy to all the details and plans before they happened, and this CEO had predicted all the events with alarming precision. All the events took place pretty much exactly as predicted and in a little over year's time a smallish private company with a yearly turnover of 5-8 million euros morphed into a smallish international conglomerate with a yearly turnover of 80 million euros. In short, the company grew tenfold in a blink through acquisitions and mergers. That's like a fairy tale come true in business life!
To tell you an anecdote within an anecdote, I'll mention that I also learned a lot about negotiating from this CEO. He used some fairly inventive methods in negotiations and I wasn't always happy to end up with the shorter straw. I didn't make any too bad deals with him, but I felt I had given in a little too much. My own managing director at the time laughed at my complaints, but I was later vindicated. It so happened that our managing director was to renegotiate a little deal with this CEO. He did it over the phone and just a little later he came and told me that he was totally overwhelmed by this CEO. He had ended the call having renegotiated the little deal with new terms and felt happy about that. Very soon he realised that he had agreed to even worse terms than the original deal had, and he was forced to once again call him up on the issue. And our managing director was no new puppy to the game and still he had fallen. I felt some satisfaction listening to his story and how he now understood my complaints about this CEO's negotiating skills...
Back to the original story. I had made an acquaintance with this company and its CEO several years earlier when they hired me as a consultant to help them with their object oriented software development efforts. After that we ran into one another every once in a while and 5-6 years later I went to work for them full time. Their plans of going public and growing rapidly sounded very interesting to me and I saw the opportunity of doing something big and worthwhile. Therefore I joined their ranks at that point.
I was invited by their CEO to their Board of Directors' meeting where I heard their plans in detail. All the members of the Board were co-owners of the company and I was the only outsider in the meeting. The CEO detailed his plans and described every step of the way in vivid detail. I remember thinking that it's a wonderful and bold plan, and if even half of it were to come true it would be an unbelievable achievement. The basic idea was to first turn public and then use issued shares to buy other companies, first small and then bigger and bigger until the last one to be gobbled would be the biggest prize of them all. All of the acquired companies would be in the same business to enable greater synergies and financial efficiencies to be exploited. In these acquisitions almost no cash was to be used.
Most critical step in this CEO's plan was to go public because without that step completed succesfully there would be no currency to go on that wonderful shopping spree. The original plan was to go public in spring 2000, but the CEO had recently concluded it would be too late. He believed there would be too many IPOs for the last ones to succeed and therefore he wanted to expedite the initial public offering to take place half a year earlier, in fall 1999. He expected a great rush of IPOs of small companies and needless to say, he was right. Public interest might have greatly waned in the spring and the public offering might not have succeeded. I can only admire his foresight even though I know he had great contacts. Even if you have great contacts and are greatly positioned, it is not easy to interpret right the soft and weak signals you detect. You have to be visionary and in some small measure a true clairvoyant... :-)
He also envisioned the order in which the acquisitions would take place. First we would acquire several smallish Finnish companies in the business and after that we'd go on an international buying spree all over the world. And finally, we would gobble the big fish, much bigger than we were. All these acquisitions were friendly, not hostile takeovers, so I later realised that he had probably tested the waters previously and discussed his plans with the other parties to a certain degree. This makes it all the more extraordinary performance in my eyes, for he has been able to sell his vision to all these prominent and capable business people and make them come under the same umbrella, if you will. They all heard his call and came, and he himself landed on top of the new company as their CEO. I find it just amazing. Amazing.
As I mentioned earlier, the events took place quite exactly as he had envisioned they would. In a little over a year, a smallish private company with a yearly turnover of 5-8 million euros morphed into a smallish international conglomerate with a yearly turnover of 80 million euros and business literally all over the world. When the new company build-up was finished, I was assigned to the new position of Product Development Director of our Finnish subsidiary. I had in my unit half a dozen software development or software testing teams to run, each with a competent and experienced team leader, so I felt it was time to do great things. For me it was a dream assignment and it felt like tailor-made for me. Unfortunately, I wasn't to enjoy that for long, for soon I fell severely ill and was forced to give up that dream position. Even though that was a great disappointment I feel privileged to have been part of the process and having been able to watch the events unfold from a close range. Great experience!
That's it for today, folks!
Thursday, May 6, 2010
Stifle financial "innovation"?
Now I really am disgusted. I once again read in the news the stupid banking-community-generated warning not to "stifle the financial innovation" with too much regulation. Innovation? Really? What productive innovation the banking sector really has to offer? More than what the bankers already shoved our way during the financial crisis of 2008?
This was Mr. Henry Paulson, the Treasury Secretary during the Bush administration, that this time used that stupid "financial innovation" theme in his testimony to the U.S. Congress. Well, that shouldn't surprise anybody, because this guy comes from the Wall Street. He used to be the CEO of Goldman Sachs until 2006 and he still seems to speak for the Goldman Sachs and the like.
(Check this USAToday's story: USAToday - Geithner and Paulson say more financial regulation is needed )
I don't think we need any more of that kind of financial "innovation". And I think it is VERY misleading to call those Wall-Street-inventions innovations, because it gives you the feeling that there would be something PRODUCTIVE about them. Now, if you're talking about software innovations, technical innovations or other physical product innovations, there you quite easily may have some real PRODUCTIVE innovations. However, there are no PRODUCTIVE innovations in these far fetched derivatives that only give you the possibility to bet on different things. What's worse, these derivatives based on subprime mortgages have given the possibility to endlessly bet on the same thing, which means effectively and endlessly multiplying the risk. It's a little bit different if farmers want to use some simple derivatives to insure their crops, but if you just want to bet on things and make money on that - or make money on other people betting on them - don't call them "financial INNOVATIONS". That's bogus. Like someone said well, if you really need to bet on things, that's what horse races are for.
Banking sector has some very important functions to help lubricate the machinery in the economy, but besides the basic functions I think it would be best to stifle their "innovations" a bit. Or a lot. I don't think we would be losing anything much if it was stifled a lot. There's not exactly much productivity we could lose and we could do much better with a bit smaller and less "innovative" banking sectors in the developed economies.
Off the top of my head, I would list these services the banking sector provides essential. Other than these, we could stifle the other services and "innovations" to death for all I care...
- basic banking functions (cash, withdrawal, savings, lending etc.)
- services for trading in stocks and other basic instruments
- investment bank services for mergers, acquisitions, public offerings and other BASIC operations
- raising of funds for nations, organizations and businesses
- simple basic derivatives for productive businesses to have some insurance-like-coverage against market fluctuations (NO Abacus-like highly sophisticated traps where even their creator Fabrice Tourre has no idea what they really do...)
If I left something out, feel free to complete my list. I am not an expert in financials, but I have some basic understanding of the markets thru my MBA training. These are, in my opinion, the essential services required from the banking sector and other than these, I don't think we need much of this financial "innovations" stuff. Those are mostly for making some serious extra money for the banking sector, but they don't offer anything resembling productive services to the economies.
So, don't buy into this crap that Paulson and other bankers are serving you. Think about the role of the banking sector. Its role is servicing the other sectors of economies and those other sectors of economies are the ones that take care of producing something and being productive.
Usually the gross domestic product - the GDP - is used to measured a nation's economy, its productivity and the rate of economic growth. That's a fairly good measure on how things work in our economies.
Now, how much do you think the banking sector adds to the GDP and economic growth? Exactly. Pretty close to NOTHING. Financial services are admittedly included in the GDP, as services. Services are, however, in the role of enablers in business and supporting the actual production. Consider the fact that the contribution of an item called "financial services and insurance" accounted to less than 10 percent of GDP in United States economy in 2009. Count out insurance and you probably end up with financial services accounting to less than 5 percent of GDP. See how little that could influence economic growth positively even if it was to produce something useful beyond basic services? Badly functioning banking sector may hinder economic growth, but it doesn't add anything to it, cause it doesn't produce anything, really. So much for financial "innovations"...
This was Mr. Henry Paulson, the Treasury Secretary during the Bush administration, that this time used that stupid "financial innovation" theme in his testimony to the U.S. Congress. Well, that shouldn't surprise anybody, because this guy comes from the Wall Street. He used to be the CEO of Goldman Sachs until 2006 and he still seems to speak for the Goldman Sachs and the like.
(Check this USAToday's story: USAToday - Geithner and Paulson say more financial regulation is needed )
I don't think we need any more of that kind of financial "innovation". And I think it is VERY misleading to call those Wall-Street-inventions innovations, because it gives you the feeling that there would be something PRODUCTIVE about them. Now, if you're talking about software innovations, technical innovations or other physical product innovations, there you quite easily may have some real PRODUCTIVE innovations. However, there are no PRODUCTIVE innovations in these far fetched derivatives that only give you the possibility to bet on different things. What's worse, these derivatives based on subprime mortgages have given the possibility to endlessly bet on the same thing, which means effectively and endlessly multiplying the risk. It's a little bit different if farmers want to use some simple derivatives to insure their crops, but if you just want to bet on things and make money on that - or make money on other people betting on them - don't call them "financial INNOVATIONS". That's bogus. Like someone said well, if you really need to bet on things, that's what horse races are for.
Banking sector has some very important functions to help lubricate the machinery in the economy, but besides the basic functions I think it would be best to stifle their "innovations" a bit. Or a lot. I don't think we would be losing anything much if it was stifled a lot. There's not exactly much productivity we could lose and we could do much better with a bit smaller and less "innovative" banking sectors in the developed economies.
Off the top of my head, I would list these services the banking sector provides essential. Other than these, we could stifle the other services and "innovations" to death for all I care...
- basic banking functions (cash, withdrawal, savings, lending etc.)
- services for trading in stocks and other basic instruments
- investment bank services for mergers, acquisitions, public offerings and other BASIC operations
- raising of funds for nations, organizations and businesses
- simple basic derivatives for productive businesses to have some insurance-like-coverage against market fluctuations (NO Abacus-like highly sophisticated traps where even their creator Fabrice Tourre has no idea what they really do...)
If I left something out, feel free to complete my list. I am not an expert in financials, but I have some basic understanding of the markets thru my MBA training. These are, in my opinion, the essential services required from the banking sector and other than these, I don't think we need much of this financial "innovations" stuff. Those are mostly for making some serious extra money for the banking sector, but they don't offer anything resembling productive services to the economies.
So, don't buy into this crap that Paulson and other bankers are serving you. Think about the role of the banking sector. Its role is servicing the other sectors of economies and those other sectors of economies are the ones that take care of producing something and being productive.
Usually the gross domestic product - the GDP - is used to measured a nation's economy, its productivity and the rate of economic growth. That's a fairly good measure on how things work in our economies.
Now, how much do you think the banking sector adds to the GDP and economic growth? Exactly. Pretty close to NOTHING. Financial services are admittedly included in the GDP, as services. Services are, however, in the role of enablers in business and supporting the actual production. Consider the fact that the contribution of an item called "financial services and insurance" accounted to less than 10 percent of GDP in United States economy in 2009. Count out insurance and you probably end up with financial services accounting to less than 5 percent of GDP. See how little that could influence economic growth positively even if it was to produce something useful beyond basic services? Badly functioning banking sector may hinder economic growth, but it doesn't add anything to it, cause it doesn't produce anything, really. So much for financial "innovations"...
Monday, April 19, 2010
Personal interests versus organizational interests
One of the most intriguing forces I've come across in human psychology is the individual's personal interests and their clash with the interests of a bigger entity. This conflict of interests is also a very powerful force and often much unappreciated.
This conflict of interest was, I believe, the main reason why communism failed and went down in flames. Communism and socialism had many great and noble ideas, but they ignored personal interests of human beings and presumed personal interests would give way to greater interests, the interests of the whole society. Sadly, that was not the case.
Individuals lacked any good incentives to do their job properly in the socialist system, because they didn't benefit directly from the work they did and common benefit was not enough to compel them to take their input seriously. Their output benefited all the others in the society, but not themselves directly and people lost their interest. They didn't have much to gain, so they just did what they had to do, but nothing extra. They didn't care to invent ways to make things more effective and we know the result. One big reason was probably also authoritarian leadership, but I strongly believe the lack of personal incentives played a very vital part in the collapse of socialism.
These powerful forces are still at play today as well, and will stay in play as long as humanity exists. In this conflict of interests there is also another side to the coin, and that also causes problems. Namely sometimes people have too strong individual interests at play and that may in some cases prove detrimental to bigger entity's welfare and interests. What organizations can do to change that is to try to align an individual's interests with the interests of the organization. In business world this is one important aspect of an area called organization design, which is a complicated science all on its own.
Before we plunge into how to align employee's interests with organization's, let us take a look at a greater framework first. In this context, I would ask you why exactly do we need laws and regulations and law enforcement in our societies? You guessed it already? Yes, through them we can align individual's interests with the whole community's interests. If there were no laws and regulations, it might very well be in persons' individual interests to rob people and places of their wealth so that they could themselves enjoy them. This kind of situation would lead into chaos and continuous crimes which would not be in our community's and mutual interests. In our community's interests is a situation where people can tend to their work and businesses in peace and create prosperity for themselves and for the community. That is why we have laws and regulations.
Laws and regulations and law enforcement efficiently align that above mentioned individual's interests with the society's interests, because it's not any more in that person's interest to rob other people. He stands to lose the loot and his freedom as well, and this way it is not any more in his best interests to try to rob other people but to try to create a wealth of his own by non-violent and legal means. In well thought out organization design we use rules and reward system practices in a way that aligns individual interests with the organization's as much as possible. The principle is therefore the same as in the laws and regulations governing our societies.
One simplified example of the interest debacle would be salesman's priorities. Let's assume your organization's salesman Mr. A is rewarded by paying him a certain percentage of the overall sales figure he can create in a month. So, no matter what the profitability of the deal is to the company, he get's his bonuses based on the euro value of the sales. In this situation, he might sometimes in tough competitive bids be tempted to make deals of zero - or even negative - profit to the company just to get a deal and his respective bonuses. Why would he care if the company doesn't make money on it?
If you now change his reward principles so that he earns a percentage of the deal's perceived profit to the company, suddenly his interests are more aligned with the company's in this regard and he's not any more interested in making unprofitable deals. Interesting, isn't it?
Now, how would you align the interests of different departments in your company so that they wouldn't fight so much with each other with such a different sets of objectives? And how would you align the interests of the conglomerate's subsidiaries which you would like to see co-operate efficiently instead of fighting for their own petty interests?
You could also apply this same principle to the situation where one company's individual interests differ from the interests of the nation it operates in. For-profit companies are after profit and that is their most important goal. They don't much care if their actions are not beneficial to that nation's economy either in the short or longer term, as long as they themselves can profit. Therefore the nation has to regulate individual companies' behaviour through laws and regulations and law enforcement. So, there are multiple levels of conflict of interests between an individual (a company or a person) and a bigger entity.
One interesting example of this is also the 2008 financial crisis and the involvement of investment banks in it. It most certainly wasn't in the interests of the owners of the investment banks that went bankrupt in 2008 to make those risky bets and cover their liabilities off the sheet, but it was in the interest of bonus earning employees' to make those risky bets and collect the respective huge bonuses. From the standpoint of those employees they didn't have much to lose. They had nothing to lose financially except their work and does it matter much, if you have been able to reap in a few million in bonuses in previous years? Why not try it also this year, if that is what the company pays for? "If it is not sensible in the longer term, do I have to care? I can laugh all the way to the bank, even if the company in the end goes under and I lose my job..."
That is exactly what the problem is: interests of an employee and his employer are in contradiction and they are not well aligned. Interesting example in this regard comes from the Brazilian banking system. It seems that they did not lose much of their own accord in this financial crisis and neither has there been need for a bank bailout in Brazil for several decades! Their banking system is considered VERY SAFE! And why is that? That is because the bankers are responsible for their banks' losses or bankruptcies with all of their own assets. In other words, they stand to lose their personal assets as well if the bank goes under. That means that their interests are almost totally aligned with their company's interests, in other words, their personal financial interests pretty much equal the financial health and future of their own organization. For some peculiar reason, these bankers suddenly feel the need to play it safe. Read more about the subject from this article in Finnish:
Taloussanomat - Tässäkö maailman turvallisin pankkijärjestelmä?
In other parts of the world, there clearly has been too much deregulation in the banking world. Presently new financial regulation is a hotly discussed topic in the United States. One often voiced opinion is that the banks and financial institutions that are "too big to fail" need to be chopped to pieces and kept smaller by regulatory means. New York Times columnist Paul Krugman thinks this is off the point and I happen to agree with him. In my opinion, chopping these big institutions into smaller ones is not the key issue here, it is the alignment of individual interests with the bigger interests. And if banks' and financial institutions' owners can't or won't do it, it is up to the regulator to align the interests. Name of the game has for too long been "Heads I win, tails you lose!"...
This conflict of interest was, I believe, the main reason why communism failed and went down in flames. Communism and socialism had many great and noble ideas, but they ignored personal interests of human beings and presumed personal interests would give way to greater interests, the interests of the whole society. Sadly, that was not the case.
Individuals lacked any good incentives to do their job properly in the socialist system, because they didn't benefit directly from the work they did and common benefit was not enough to compel them to take their input seriously. Their output benefited all the others in the society, but not themselves directly and people lost their interest. They didn't have much to gain, so they just did what they had to do, but nothing extra. They didn't care to invent ways to make things more effective and we know the result. One big reason was probably also authoritarian leadership, but I strongly believe the lack of personal incentives played a very vital part in the collapse of socialism.
These powerful forces are still at play today as well, and will stay in play as long as humanity exists. In this conflict of interests there is also another side to the coin, and that also causes problems. Namely sometimes people have too strong individual interests at play and that may in some cases prove detrimental to bigger entity's welfare and interests. What organizations can do to change that is to try to align an individual's interests with the interests of the organization. In business world this is one important aspect of an area called organization design, which is a complicated science all on its own.
Before we plunge into how to align employee's interests with organization's, let us take a look at a greater framework first. In this context, I would ask you why exactly do we need laws and regulations and law enforcement in our societies? You guessed it already? Yes, through them we can align individual's interests with the whole community's interests. If there were no laws and regulations, it might very well be in persons' individual interests to rob people and places of their wealth so that they could themselves enjoy them. This kind of situation would lead into chaos and continuous crimes which would not be in our community's and mutual interests. In our community's interests is a situation where people can tend to their work and businesses in peace and create prosperity for themselves and for the community. That is why we have laws and regulations.
Laws and regulations and law enforcement efficiently align that above mentioned individual's interests with the society's interests, because it's not any more in that person's interest to rob other people. He stands to lose the loot and his freedom as well, and this way it is not any more in his best interests to try to rob other people but to try to create a wealth of his own by non-violent and legal means. In well thought out organization design we use rules and reward system practices in a way that aligns individual interests with the organization's as much as possible. The principle is therefore the same as in the laws and regulations governing our societies.
One simplified example of the interest debacle would be salesman's priorities. Let's assume your organization's salesman Mr. A is rewarded by paying him a certain percentage of the overall sales figure he can create in a month. So, no matter what the profitability of the deal is to the company, he get's his bonuses based on the euro value of the sales. In this situation, he might sometimes in tough competitive bids be tempted to make deals of zero - or even negative - profit to the company just to get a deal and his respective bonuses. Why would he care if the company doesn't make money on it?
If you now change his reward principles so that he earns a percentage of the deal's perceived profit to the company, suddenly his interests are more aligned with the company's in this regard and he's not any more interested in making unprofitable deals. Interesting, isn't it?
Now, how would you align the interests of different departments in your company so that they wouldn't fight so much with each other with such a different sets of objectives? And how would you align the interests of the conglomerate's subsidiaries which you would like to see co-operate efficiently instead of fighting for their own petty interests?
You could also apply this same principle to the situation where one company's individual interests differ from the interests of the nation it operates in. For-profit companies are after profit and that is their most important goal. They don't much care if their actions are not beneficial to that nation's economy either in the short or longer term, as long as they themselves can profit. Therefore the nation has to regulate individual companies' behaviour through laws and regulations and law enforcement. So, there are multiple levels of conflict of interests between an individual (a company or a person) and a bigger entity.
One interesting example of this is also the 2008 financial crisis and the involvement of investment banks in it. It most certainly wasn't in the interests of the owners of the investment banks that went bankrupt in 2008 to make those risky bets and cover their liabilities off the sheet, but it was in the interest of bonus earning employees' to make those risky bets and collect the respective huge bonuses. From the standpoint of those employees they didn't have much to lose. They had nothing to lose financially except their work and does it matter much, if you have been able to reap in a few million in bonuses in previous years? Why not try it also this year, if that is what the company pays for? "If it is not sensible in the longer term, do I have to care? I can laugh all the way to the bank, even if the company in the end goes under and I lose my job..."
That is exactly what the problem is: interests of an employee and his employer are in contradiction and they are not well aligned. Interesting example in this regard comes from the Brazilian banking system. It seems that they did not lose much of their own accord in this financial crisis and neither has there been need for a bank bailout in Brazil for several decades! Their banking system is considered VERY SAFE! And why is that? That is because the bankers are responsible for their banks' losses or bankruptcies with all of their own assets. In other words, they stand to lose their personal assets as well if the bank goes under. That means that their interests are almost totally aligned with their company's interests, in other words, their personal financial interests pretty much equal the financial health and future of their own organization. For some peculiar reason, these bankers suddenly feel the need to play it safe. Read more about the subject from this article in Finnish:
Taloussanomat - Tässäkö maailman turvallisin pankkijärjestelmä?
In other parts of the world, there clearly has been too much deregulation in the banking world. Presently new financial regulation is a hotly discussed topic in the United States. One often voiced opinion is that the banks and financial institutions that are "too big to fail" need to be chopped to pieces and kept smaller by regulatory means. New York Times columnist Paul Krugman thinks this is off the point and I happen to agree with him. In my opinion, chopping these big institutions into smaller ones is not the key issue here, it is the alignment of individual interests with the bigger interests. And if banks' and financial institutions' owners can't or won't do it, it is up to the regulator to align the interests. Name of the game has for too long been "Heads I win, tails you lose!"...
Thursday, April 15, 2010
eReader and ePaper defined
When previously writing about eReaders I failed to define what an eReader is and what ePaper is. I will try to do so here briefly and in layman's language.
EReader is an electronic device meant for reading. EReaders are more or less some kind of computers, either full-fledged ones or highly specialized and developed for reading only. There's a wide variety out there and someone has counted that including this year's product announcements there would be at least 50 different kinds of eReaders to choose from.
Amazon Kindle DX
EReaders can have paper-like screens called ePaper- or eInk-screens, or basic computer-like LCD screens or both. What is also important is the content. Most of the eReader manufacturers try to provide their customers with both paid and free content. Good example here is Amazon's Kindle eReader (picture above).
You can download to your Kindle classic books that have already lost their respective copyrights and are in the public domain. These ones you can read for free. You can also buy electronic books or eBooks from Amazon's service on the net as well as electronic newspapers and periodicals. For example, you can subcscribe to newspapers like Washington Post or New York Times and have them delivered wirelessly to your Kindle every morning. With Kindle you can also browse the web and read what you like in paper-like format and of course you can read your personal PDF files on Kindle. So, in a thin and light Kindle device you can carry your whole library and your personal files with you where ever you go. Fairly neat, wouldn't you say?
In Kindle there's an ePaper screen. It is not suitable for watching videos or any moving pictures and most ePaper screens are still black-and-white screens. So right there LCD screens have an upper hand. In plain reading, however, ePaper has the upper hand. It is easier on the eyes, it doesn't flicker and it doesn't have any background light to drain the batteries, and neither does it fade in the sunlight like LCD screen does.
How does ePaper work and how does it imitate real paper, then? There are several technologies, but let's examine one called eInk and let's simplify it for easier understanding. Like normal computer screens, these ePaper screens are divided into very tiny points or pixels that can produce a certain colour at a certain intensity. These very small points all put together constitute a picture that the whole screen presents to the viewer.
In eInk technology there are transparent microcapsules each of which represents a pixel. Each of these microcapsules contains positively charged white pigments as well as negatively charged black pigments. These pigments float in transparent oil and can via electric charge be caused to move to the front side of the screen and therefore become visible for the viewer or they can be forced to the back side. After the electric charge the picture is formed and stays as such until a new charge is applied. Therefore the created picture doesn't require any more electricity once formed.
As the ePaper picture forms, it brings forth the black particles where required and therefore it mimics normal paper very closely. The black particles, the electronic equivalent of real ink, really physically are positioned on the surface of the screen much as real ink is positioned on the surface of the real paper. The only differences are that the ePaper Ink can be newly positioned and that there is a thin foil between the "ink particles" and the ePaper outer surface. Otherwise the arrangement closely imitates the physical representation of normal paper and is therefore called ePaper.
Things develop very fast in this arena. Fujitsu has already announced it will start the consumer sales of its new eReader FLEPia (pictured above) which is equipped with a COLOUR ePaper screen! Here you can read more about FLEPia:
Fujitsu Begins On-Line Consumer Sales of World’s First Color E-Paper Mobile Terminal FLEPia
EReader is an electronic device meant for reading. EReaders are more or less some kind of computers, either full-fledged ones or highly specialized and developed for reading only. There's a wide variety out there and someone has counted that including this year's product announcements there would be at least 50 different kinds of eReaders to choose from.
Amazon Kindle DXEReaders can have paper-like screens called ePaper- or eInk-screens, or basic computer-like LCD screens or both. What is also important is the content. Most of the eReader manufacturers try to provide their customers with both paid and free content. Good example here is Amazon's Kindle eReader (picture above).
You can download to your Kindle classic books that have already lost their respective copyrights and are in the public domain. These ones you can read for free. You can also buy electronic books or eBooks from Amazon's service on the net as well as electronic newspapers and periodicals. For example, you can subcscribe to newspapers like Washington Post or New York Times and have them delivered wirelessly to your Kindle every morning. With Kindle you can also browse the web and read what you like in paper-like format and of course you can read your personal PDF files on Kindle. So, in a thin and light Kindle device you can carry your whole library and your personal files with you where ever you go. Fairly neat, wouldn't you say?
In Kindle there's an ePaper screen. It is not suitable for watching videos or any moving pictures and most ePaper screens are still black-and-white screens. So right there LCD screens have an upper hand. In plain reading, however, ePaper has the upper hand. It is easier on the eyes, it doesn't flicker and it doesn't have any background light to drain the batteries, and neither does it fade in the sunlight like LCD screen does.
How does ePaper work and how does it imitate real paper, then? There are several technologies, but let's examine one called eInk and let's simplify it for easier understanding. Like normal computer screens, these ePaper screens are divided into very tiny points or pixels that can produce a certain colour at a certain intensity. These very small points all put together constitute a picture that the whole screen presents to the viewer.
In eInk technology there are transparent microcapsules each of which represents a pixel. Each of these microcapsules contains positively charged white pigments as well as negatively charged black pigments. These pigments float in transparent oil and can via electric charge be caused to move to the front side of the screen and therefore become visible for the viewer or they can be forced to the back side. After the electric charge the picture is formed and stays as such until a new charge is applied. Therefore the created picture doesn't require any more electricity once formed.
As the ePaper picture forms, it brings forth the black particles where required and therefore it mimics normal paper very closely. The black particles, the electronic equivalent of real ink, really physically are positioned on the surface of the screen much as real ink is positioned on the surface of the real paper. The only differences are that the ePaper Ink can be newly positioned and that there is a thin foil between the "ink particles" and the ePaper outer surface. Otherwise the arrangement closely imitates the physical representation of normal paper and is therefore called ePaper.
Things develop very fast in this arena. Fujitsu has already announced it will start the consumer sales of its new eReader FLEPia (pictured above) which is equipped with a COLOUR ePaper screen! Here you can read more about FLEPia:
Fujitsu Begins On-Line Consumer Sales of World’s First Color E-Paper Mobile Terminal FLEPia
Sunday, April 11, 2010
America's rich are in deep deep trouble...
In The Know: Are America's Rich Falling Behind The Super-Rich?
And here's more proof of the sorry state of things:
The Onion: Rich Guy Feeling Left Out Of Recession
Saturday, April 10, 2010
Stock market trading and human psychology - Part 1
In this entry I'd like to point out something I think people tend to leave out of the equation when they think about stock market trading. The prevailing notion in free market ideology concerning stock markets is that markets correctly value the prices for different stocks. Rational for this goes along the lines that the value for a company's stock is calculated by discounting future profits to the present time and that result is the correct market value of the company. In other words you estimate the profits you expect the company to make in future years and those profits you value into today's money using appropriate interest rates. And the theory also says that possible misvaluations will be corrected over time by the market itself, so that in the long run the market values of stocks will be appropriate.
It's a great, feasible theory and I myself happen to subscribe to it. However, we should also think how things works in practice. In practice, we don't everybody dutifully do our homework. Or how many of you can say that you've made the appropriate calculations before you bought stocks? How many of you bought them just on the basis of some analyst or some other expert recommending them? Or did you just buy that company's stocks because everybody else is also buying? And did you really calculate the value or did you just compare them with their historic values?
Yeah. That's exactly what I thought. Mind the fact that if nobody does their homework the price doesn't have to be anywhere near the "right" value. And that analyst. You shouldn't count on his opinion too much, because A) he can be wrong or B) he might have different incentives and may not be telling you the truth. In the end it's you who will bear the brunt for mistakes by losing your money and the analyst - he really doesn't care. So, if we all just trust anybody else's opinions, we are in effect blind as bats when placing our bets...
This brings us to the actual point. The value of a certain stock is NOT necessarily the correct market value. It is the price that the buyer IS WILLING TO PAY if the seller is prepared to sell at that price. Even if the price is 10 times what it should be, if somebody pays that price it will become the present market price. And others may blindly join the buyer believing he has some information they don't and therefore we have set a new unrealistic market price for the stock. Human psychology can really do that and has done that repeatedly in the past. I'll give you a concrete example of that a little later.
How do you calculate a company's market value, then? Well, that's not simple. It depends on what kind of business the company is in, what is the amount of required working capital, possessions of the firm, future growth view, feasibility of the strategy, quality of management etc. However, I can give you an easy rule of thumb to determine you're not catastrophically off the mark. Easy rule of thumb is that a company can't be worth much more than 2-3 TIMES ITS YEARLY TURNOVER! At times it might be even worth five times of its turnover, but that starts to be overreaching.
Let's try an example. Nokia's stock ended at a price of 11,40 euros in OMX Stock Exchange on Friday placing the whole company's market value in the neighbourhood of 43 billion euros. Nokia's turnover last year being 41 billion, that sounds reasonable, right? Market value is close to one year's turnover. If other things are fine with Nokia, that is probably a good buy, even. Let's make some other easy comparisons. For example, the profit for 2009 after taxes was 1,2 billion. So, if Nokia would want to buy all of its shares back from its owners at these prices and levels of profit, it would take 36 years, right? That sounds like a long long time and there wouldn't even be any interest included...
What about year 2008? Turnover was 51 billion and profit 5 billion. At least the payback time would diminish greatly from 36 years to a little less than 9 years at that profitability level. I will leave you to ponder Nokia's value on your own, now...
To the example I promised. Here I rely mostly on my memory, so I hope I don't make too big mistakes here. A company named TJ Group issued its Initial Public Offering (IPO) for investors in early 2000. The price of stock was set around 19-20 euros per share according to my memory. I calculated at the time the resulting market value and decided it was badly bloated. I remember calculating that the company would need to grow its turnover 40- or 50-fold before it might "fill" that market value. So, in my mind, it was mostly hot air. I didn't believe they would grow that much any time soon and the profitability level wasn't too promising, either.
Quite many others did believe in the company and it collected 237 million euros from investors in its IPO. And that with a yearly turnover (1999) of only 11,4 million euros! According to the rule of thumb I presented you previously, this company could have cost from 11,4 to 34,2 million euros (1-3 years turnover) or at it's most 57 million (5 years turnover). Sadly, the company lost about 97 % of its market value in about one year after its Initial Public Offering...
So, I am rather proud that even in that "dotcom" -market frenzy and with experts trumpeting the "new economy" and the "new rules", I did my homework and didn't buy into that. Instead, I bought into an IPO of a company called Aldata. That was a sweet buy, for it took only half a year to rise tenfold. I also bought Basware, but sadly it was too popular. Too many people bought Basware and my purchase ended up being only about 5 % of what I wanted. It was too small a share to mean anything and I sold it fast.
That's today's lesson, folks! I hope you appreciate the possible disconnection between theory and practice. Here's couple of extra points to take home:
- Theory never represents reality with great accuracy
- Law of supply and demand, as well as human psychology, affects stock market pricing, it's not just the free market theory that counts
Here are some links to refresh your memory:
Listalleottoesite - TJ Group Oyj (2.2.2000)
HS: Tilman ja Salminen TJ Groupista pidätettiin
It's a great, feasible theory and I myself happen to subscribe to it. However, we should also think how things works in practice. In practice, we don't everybody dutifully do our homework. Or how many of you can say that you've made the appropriate calculations before you bought stocks? How many of you bought them just on the basis of some analyst or some other expert recommending them? Or did you just buy that company's stocks because everybody else is also buying? And did you really calculate the value or did you just compare them with their historic values?
Yeah. That's exactly what I thought. Mind the fact that if nobody does their homework the price doesn't have to be anywhere near the "right" value. And that analyst. You shouldn't count on his opinion too much, because A) he can be wrong or B) he might have different incentives and may not be telling you the truth. In the end it's you who will bear the brunt for mistakes by losing your money and the analyst - he really doesn't care. So, if we all just trust anybody else's opinions, we are in effect blind as bats when placing our bets...
This brings us to the actual point. The value of a certain stock is NOT necessarily the correct market value. It is the price that the buyer IS WILLING TO PAY if the seller is prepared to sell at that price. Even if the price is 10 times what it should be, if somebody pays that price it will become the present market price. And others may blindly join the buyer believing he has some information they don't and therefore we have set a new unrealistic market price for the stock. Human psychology can really do that and has done that repeatedly in the past. I'll give you a concrete example of that a little later.
How do you calculate a company's market value, then? Well, that's not simple. It depends on what kind of business the company is in, what is the amount of required working capital, possessions of the firm, future growth view, feasibility of the strategy, quality of management etc. However, I can give you an easy rule of thumb to determine you're not catastrophically off the mark. Easy rule of thumb is that a company can't be worth much more than 2-3 TIMES ITS YEARLY TURNOVER! At times it might be even worth five times of its turnover, but that starts to be overreaching.
Let's try an example. Nokia's stock ended at a price of 11,40 euros in OMX Stock Exchange on Friday placing the whole company's market value in the neighbourhood of 43 billion euros. Nokia's turnover last year being 41 billion, that sounds reasonable, right? Market value is close to one year's turnover. If other things are fine with Nokia, that is probably a good buy, even. Let's make some other easy comparisons. For example, the profit for 2009 after taxes was 1,2 billion. So, if Nokia would want to buy all of its shares back from its owners at these prices and levels of profit, it would take 36 years, right? That sounds like a long long time and there wouldn't even be any interest included...
What about year 2008? Turnover was 51 billion and profit 5 billion. At least the payback time would diminish greatly from 36 years to a little less than 9 years at that profitability level. I will leave you to ponder Nokia's value on your own, now...
To the example I promised. Here I rely mostly on my memory, so I hope I don't make too big mistakes here. A company named TJ Group issued its Initial Public Offering (IPO) for investors in early 2000. The price of stock was set around 19-20 euros per share according to my memory. I calculated at the time the resulting market value and decided it was badly bloated. I remember calculating that the company would need to grow its turnover 40- or 50-fold before it might "fill" that market value. So, in my mind, it was mostly hot air. I didn't believe they would grow that much any time soon and the profitability level wasn't too promising, either.
Quite many others did believe in the company and it collected 237 million euros from investors in its IPO. And that with a yearly turnover (1999) of only 11,4 million euros! According to the rule of thumb I presented you previously, this company could have cost from 11,4 to 34,2 million euros (1-3 years turnover) or at it's most 57 million (5 years turnover). Sadly, the company lost about 97 % of its market value in about one year after its Initial Public Offering...
So, I am rather proud that even in that "dotcom" -market frenzy and with experts trumpeting the "new economy" and the "new rules", I did my homework and didn't buy into that. Instead, I bought into an IPO of a company called Aldata. That was a sweet buy, for it took only half a year to rise tenfold. I also bought Basware, but sadly it was too popular. Too many people bought Basware and my purchase ended up being only about 5 % of what I wanted. It was too small a share to mean anything and I sold it fast.
That's today's lesson, folks! I hope you appreciate the possible disconnection between theory and practice. Here's couple of extra points to take home:
- Theory never represents reality with great accuracy
- Law of supply and demand, as well as human psychology, affects stock market pricing, it's not just the free market theory that counts
Here are some links to refresh your memory:
Listalleottoesite - TJ Group Oyj (2.2.2000)
HS: Tilman ja Salminen TJ Groupista pidätettiin
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