You know what really grinds my gears? Investors who complain (or use any more graphic metaphor you want) when the companies they choose to invest in decide to recommit capital to building their businesses rather than paying out everything as dividends or share buy backs. My blood started boiling late last week after the Amazon earnings release (full disclosure: I don’t own any position in Amazon) when I’m sure to the shock of no one it turned out that the Amazon Fire phone was a complete dud and there was going to be a significant charge for the unsold inventory. Amazon’s come under a tremendous amount of pressure from sell-side analysts and commentators who demand that Amazon stop it’s R&D campaign to develop new product lines, focus on improving earnings with the goal of boosting shareholder returns from eventual dividends.
First of all, if you really want stocks that pay dividends go buy stocks that historically have paid dividends but more importantly and Amazon has been signaling for years that its focus is on growing their business, not financial re-engineering. It’s time to drop this myopic focus on maximizing shareholder return. James Montier gave an address recently (more here) where he called out shareholder maximization’s advocates and pointed out the flaws with that strategy. But maybe it’s easier to do this the business school way with a case study.
So far in 2014 Amazon is down 28.02% while the Consumer Discretionary Select Sector SPDR (XLY) is down .25%…what’s more interesting is who’s having a GREAT year. First is one firm that Amazon has firmly displaced, Sears Holding, down a mere 1.93% now after the mother of all short squeezes as well as Amazon’s most direct competitor, Barnes and Noble up almost 38% in 2014. Yes, both Barnes and Noble and Sears can attribute some of their performance in 2014 to short squeezes not to mention several years of bad performance but the real secret to their success? They’ve given up.
Wall Street likes predictable; they like dividends, stock options and share buybacks. Not only because they’ll boost “returns” but because when you engage in those behaviors are you signaling a policy that means predictability. Reinvestment in the business is out; your goal is simply to boast the stock price to help yourself (assuming you’re in management) to get out with the most you can as quickly as you can. As Montier pointed out; the average lifespan of an S&P 500 member has shorted drastically while CEO tenure has nearly been halved…probably coincides with average life of stock options.
Let’s start with Barnes and Noble (B&N), who’s market cap has become all of 1/132 of Amazon’s while the company has become a punchline in jokes about the future dead retailers of America. After half-a$%ing their own internet presence and doubling down on physical stores, they have spent years trying to develop their own e-reader, the Nook. Now they’ve largely abandoned the struggle and now seem committed to trying to maintain their position as the largest physical book-seller in America. Go ahead and ask me when the last time I bought a book at B&N was…I can’t remember either. In fact, besides coffee I haven’t bought anything at one of their stores in years and their revenue growth reflects that. One reason I couldn’t understand the need for Amazon phone was because there’s already an app to scan barcodes and buy it on-line. Now B&N’s goal is simply to enhance their cash cycle, cut out excess inventory and keep capital expenditures to a minimum. Not a bad strategy, but it just delays the inevitable which might be exactly what their management wants.
After holding steady from 2012 to 2013, executive compensation at B&N has risen over 77% in 2014 as management has been rewarded for destroying value and then abandoning their strategy for the Nook with new stock options. I know the textbook answer…stock options help to align yadda yadda yadda for the long-term, but that’s rubbish. What investors love is that they think management will do everything in its power to maximize the stock price and they can come along for the ride. Of course B&N will be dead in five years baring a sale of the company, but who cares right? You won’t own it. Neither will the founder, Len Riggio, who after initially pursing an attempt to buy the company ex. Nook to take private decided against it…and has been selling off his large holdings in the company ever since. Amazon meanwhile has actually cut executive compensation as their strategy has faltered.
And what about Amazon’s growth prospects? As a former employee of B&N, I’m not ashamed to admit that I buy nearly everything including appliances, video downloads, even gym equipment from Amazon and I didn’t blink an eye when they raised the cost of a Prime subscription. “Free” shipping has gotten me to spend more on Amazon that any one time sale could have done. So could Amazon be smarter about their business development strategies? Of course they could but what’s more important is how they use their resources to grow the business. From January 1, 2009 to December 31, 2013 B&N has enjoyed a return of all 11.08% versus 223.61% for XLY, 104% for the S&P 500 and 677% for Amazon.