Capital Returns
Capital Returns

Capital Returns

Managers in a business with high current profitability may face a problem akin to the prisoner’s dilemma. (Location 417)

If several players simultaneously expand their operations, their aggregate profits will decline at some future date. (Location 418)

should also be noted that capital cycles vary in length, and nobody knows in advance when they will turn. This (Location 431)

Capital cycle analysis, however, focuses on supply rather than demand. Supply prospects are far less uncertain than demand, and thus easier to forecast. (Location 443)

firm’s profitability comes under threat when the competitive conditions are deteriorating. The negative phase of the capital cycle is characterized by industry fragmentation and increasing supply. The aim of capital cycle analysis is to spot these (Location 450)

A rash of IPOs concentrated in a hot sector is a red flag; secondary share issuances another, as are increases in debt. (Location 453)

The capital cycle analyst is particularly wary of the actions of investment banks, and the work of their in-house propagandists, (Location 457)

Instead, they spend their time trying to forecast the next quarter’s earnings, which is good for generating turnover and commissions, and occasionally going “over the wall” to help their banker colleagues (Location 461)

The first being to the effect that most chief executives have risen to the top of their companies because they “have excelled in an area such as marketing, production, (Location 471)

Capital cycle analysis requires patience, a certain doggedness (willingness to be wrong for a long period) and a contrarian mindset. (Location 489)

Changes in supply drive industry profitability. Stock prices often fail to anticipate shifts in the supply side. •The value/growth dichotomy (Location 500)

the capital cycle enters a dangerous phase when high profitability leads to rising capital spending, as has occurred in both the mining and oil sectors in recent years. (Location 512)

such companies may benefit from network effects, occupy secure niches, be firmly embedded an industry’s supply chain, or enjoy pricing power because their products are sold through third parties more concerned with quality than price. (Location 520)

Fast-growing companies with little or no profits and high valuations, such as Amazon, can still make good investments provided their industry’s supply side remains supportive. (Location 522)

financial crisis took most of the world by surprise. Yet banks can also be analysed from a capital cycle perspective. When bank assets (loans) are growing strongly, this is generally a negative indicator. (Location 529)

Their actions have interfered with the economic process of creative destruction. Low return businesses are able to survive in the era of ultra-low rates, creating the possibility that Europe is entering an era of “zombie” capitalism – akin to Japan’s lost decades. (Location 535)

Many investors believe that investment returns follow economic growth. (Location 538)

A common theme linking these pieces is the importance of understanding how competition – or the supply side – evolves over time, and the role it plays in determining both industry and individual company returns on capital. (Location 624)

too often, high returns attract capital, breeding excessive competition and overinvestment. (Location 627)

Axelrod found that a policy of “tit for tat,” or reciprocity, was the most successful strategy to adopt in the long-run. He pointed to an intriguing example of “tit for tat” in the trenches of World War I. (Location 634)

The trick is to identify conditions where cooperative behaviour can exist or may evolve, while avoiding those industries where this is unlikely to happen. (Location 639)

in an industry can represent a potential opportunity, since cooperative behaviour is more likely to break out if companies are responding to the imperative of balance sheet repair. (Location 640)

observed that financial stability is destabilizing since it leads to all kinds of excessive behaviour, so instability can, from a capital cycle standpoint, create conditions of stability. (Location 642)

The ideal capital cycle opportunity for us has often been one in which a small number of large players evolve from a situation of excess competition and exert what is euphemistically called “pricing discipline.” (Location 643)

although barriers to entry are also required to deter opportunistic entrants from taking advantage of any price umbrella. (Location 646)

Carmakers have to decide not just on price, but also on specification, customer financing terms, new model launches, service and warranty terms etc., leading to the paradoxical conclusion that product differentiation can (Location 649)

In airlines, the habit of protecting “national champions” has not died out in Europe as yet. (Location 655)

Again, contrast this with an industry such as the automotive glass industry in Europe, where the three remaining participants enjoy long-term supply agreements and infrequent decisions on new capacity that are signalled clearly in advance. (Location 657)

The generals of WWI, infuriated by the policy of “live and let live” adopted by their troops realized that the way to change behaviour was to remove the “shadow of the future.” (Location 661)

Industries where managers can be seen to be extending the “shadow of the future,” by signalling how they will respond to competitor behaviour, are thus wholly welcome. (Location 664)

Employment or anti-trust concerns blunt the efficacy of this process, most notably via Chapter 11 bankruptcy protection. (Location 666)

replacing an investment/tech bubble with a housing/credit bubble – has (so far) stymied many of the natural evolutionary (Location 668)

It is relatively easy to identify those industries where these conditions exist currently (just look at existing returns on capital), and it is for this reason that the really juicy investment returns are to be found in industries which are evolving to this state. The joy from a capital cycle perspective is that most investors are, for a variety of behavioural reasons, taken by surprise. (Location 671)

What follows here is a précis of the book from an investor’s perspective, with apologies to Mr Kurlansky for reinterpreting his fine work. (Location 683)

Almost the entire fish can be put to use: in (Location 685)

In fishing, cod’s where the money is (or, at least was). (Location 688)

It is probably a safe bet that the price of cod reflected these trials, enough at least to fund industry development, as by the mid-sixteenth century over 60 per cent of the fish eaten in Europe were cod, a percentage that remained relatively unchanged for almost two centuries. (Location 691)

The result was a cod processing boom, and “men of no particular skill, and with very little capital, made fortunes.” (Location 696)

However, the pinch-point in the system, where the excess profits were made, did not stay with the fishing ports for long, as their harbours were too small to berth transatlantic cargo vessels. (Location 697)

Ordinarily capital would leave the industry, productive capacity would shrink, and prices rise toward an economic rate of return. (Location 722)

has evolved from one where excess profits were earned at the ports, then the market, then the food processors, to one where it is the consumers of fish that are the industry’s chief beneficiaries. (Location 726)

(the size of the pinch-point – what is the capacity of Boston’s port?) (Location 730)

And for firms with less control of their destiny, we focus on the industry supply side for signs of rising levels of competition. (Location 733)

In semiconductors, excess profits are wrung out in less than two years. (Location 737)

Part of the reason for the boom is demand from emerging countries, notably China and India, whose economies are growing rapidly with high levels of construction and relatively inefficient production. (Location 748)

Indeed, some mining companies believe that there is enough supply coming on stream in copper for there to be a sizeable market surplus in a couple of years’ time. Supply bottlenecks do not last forever. (Location 770)

namely, that of the container shipping industry. (Location 780)

The operational leverage of oil company profits is rising, so their earnings are particularly vulnerable to a severe correction in the oil price. (Location 943)

These valuations may look attractive, but a closer examination of the recent financial performance of the five oil majors reveals a fairly worrying picture. (Location 951)

A surge in the Brent crude price between 2003 and 2007 (increasing at 33 per cent a year) resulted in the aggregate return on equity for the oil majors rising to 27 per cent. (Location 955)

Despite this rise in capex, net income has actually fallen slightly in aggregate, which explains the marked drop in returns on equity for the large energy companies – from 27 per cent in 2007 to 17 per cent in 2012, at a time when the oil price increased by nearly 20 per cent. (Location 957)

Lately, the quality of oil exploration projects coming on stream has not matched that of the legacy assets. (Location 962)

An ever greater amount of capital has been required to deliver the same level of production, resulting in the inevitable decline in return on invested capital. (Location 963)

Of course, given the long-term nature of oil projects – the average time lag to reach full productive capacity is around six years – the impact of recent capex spending may yet be seen over the next five years, with an attendant rise in earnings. (Location 966)

And there is the very real possibility that the oil price falls in the medium term – witness the progress in the way energy is both produced and used. (Location 975)

First, the sheer quantum of capex required on an annual basis means the investor is forced to place a large degree of faith in the management team to allocate capital correctly. (Location 977)

laying the foundations for an inflection in returns on capital and more healthy stock returns. (Location 983)

From what is misleadingly labelled the “growth” universe, we search for businesses whose high returns are believed to be more sustainable than most investors expect. (Location 988)

From the low return, or “value” universe, our aim is to find companies whose improvement (Location 989)

potential is generally underestimated. (Location 990)

Purchase Candidate A is a company capable of sustaining high returns beyond the market’s expectation (the upper dotted line) – that is, the company remains above average for longer than average. (Location 995)

Candidate B is a company which can improve faster than the market generally expects (the lower dotted line). (Location 997)

One is the underestimation of the durability of barriers to entry. Another is the underappreciation of the scale and scope of the addressable market. (Location 999)

Investors also appear to be biased against “boring” high return companies, such as Bunzl, which do not offer the prospect of immediate high share price appreciation. (Location 1003)

The conditions leading to Purchase Candidate B often stem from the market misjudging the beneficial effects of reduced competition as weaker firms disappear, either through consolidation or bankruptcy. (Location 1007)

The turn in the capital cycle often occurs during periods of maximum pessimism, as the weakest competitor throws in the towel at a point of extreme stress. (Location 1009)

Its capex-to-depreciation had risen from just over 1 times in 2005 to nearly 5 times in 2008, contributing to excess capacity in the wind turbine sector. (Location 1023)

The primary driver of healthy corporate profitability is a favourable supply side – not high rates of demand growth. Hence, it is possible for there to be rapid growth (Location 1068)

but rather the supply side. Our goal is to find investments in depressed industries at positive inflection points in the capital cycle and in sectors with benign and stable supply side fundamentals. (Location 1083)

looked to invest in companies from sectors where capital was being withdrawn and to avoid companies in industries where assets were increasing rapidly. (Location 1134)

The insight being that both profits and valuations should generally rise after capital has exited an industry and decline after capital has poured (Location 1135)

Yet the same mode of analysis can be used to identify companies which, for one reason or another, are able to repel competition. (Location 1137)

From a capital cycle perspective, it can be observed that a lack of competition prevents the supply side from shifting in response to high profitability. (Location 1140)

Part of the reason for this apparent contradiction is that we have found that smaller companies with above average growth prospects are often (Location 1157)

The latter, however, believes (or at least did believe) that these high-quality businesses were cheap (i.e., good value relative to the present value of their expected future returns) and still regarded himself as buying value. (Location 1170)

Our capital cycle process examines the effects of the creative and destructive forces of capitalism over time. (Location 1174)

Marathon’s portfolios have an average holding period of around five years, a figure which in all likelihood will rise in the coming years as the quality of the companies in the portfolio (as measured by normalized returns on capital and growth potential) has risen, post bubble. (Location 1200)

Long-term investors therefore seek answers with shelf life. (Location 1216)

As bottom-up investors, however, we are more interested in the capital cycle as it affects individual companies than in aggregate corporate profitability. (Location 1339)

(1) the emergence of oligopolies in industries hitherto characterized by low returns and excessive competition; (2) the evolution of business models with high and rising barriers to entry; and (3) management behaviour which encourages these trends. (Location 1340)

agency business models, including medical devices and building equipment (locks, electrical and plumbing fittings, etc). (Location 1345)

Essentially, these companies rely on an intermediary to sell their products (a doctor, plumber, locksmith (Location 1345)

This shift to quality should render Marathon’s European portfolios less dependent on a precise answer to the question of whether aggregate corporate profits, whether for cyclical or structural reasons, are about to be squeezed. (Location 1377)

The level of capital intensity required to achieve these impressive returns was relatively low. (Location 1401)

This low level of capital intensity has allowed free cash flow conversion at a consistently high level, on average at over 100 per cent of net income. (Location 1402)

The answer lies in an understanding of the supply side of this industry – the specifics of the production process, market structure, competitive dynamics and pricing power, which together constitute the essence of capital cycle analysis. (Location 1409)

a differentiated product and company-specific “sticky” intellectual capital – reduce market contestability. (Location 1421)

Hence switching costs are high, both improving pricing power over the product lifecycle (often ten years or more) and the degree to which revenues are recurring. (Location 1431)

Both Analog Devices and Linear Technology currently offer free cash flow yields of 5 per cent. With long-term growth in free cash flow likely to be similar to historical levels, our (Location 1440)

Investment models, however, encourage anchoring. Most (Location 1453)

Consider, however, that Baidu has a 70 per cent market share in an industry where profits accrue disproportionally to the market leader, (Location 1469)

helpful in managing overinvestment and working capital creep, the two great dangers of a rapid growth model. (Location 1471)

Pricing power has arguably been the most enduring determinant of high returns for these investments. (Location 1482)

The first is a concentrated market structure, closely associated with effective management of capacity through the demand cycle which encourages a rational approach to pricing. (Location 1483)

The second is “intrinsic” pricing power within the product or service itself. Intrinsic pricing power is created when price is not the most important factor in a customer’s purchase decision. (Location 1484)

An obvious one is consumer brands. In the toothpaste category, private label penetration is only 2 per cent, supporting Colgate’s excellent economics. (Location 1487)

long-term customer relationship, as in case of the agency business models (Legrand, Assa Abloy or Geberit), where the customer relies on intermediaries (electricians, architects and plumbers respectively). (Location 1489)

The agent’s interest is safety, quality, reliability, availability, and perhaps his own ability to earn a commission. (Location 1490)

Finally, technological leadership (Intel, Linear Technology) can be another important intangible asset – although this is perhaps one of the less durable sources of pricing power, unless combined with others. (Location 1496)

combine in a situation in which the cost of the product or service is low relative to its importance: for example, the analog semiconductor chip which activates the car airbag, yet costs little more than a dollar. (Location 1498)

Critically, this higher rate of compounding comes at a lower level of risk as the economics of a high return business tend to be more resilient to adverse shocks. (Location 1507)

Performance-related pay for money managers at most investment firms is weighted to annual performance, which discourages long-term thinking. (Location 1517)

returns, rising turnover, and glorious prospects, only to stumble in later years. (Location 1532)

have found is well worth paying a premium for. Our preferred growth stocks undertake apparently unglamorous activities that are essential to their customers (Location 1535)

encounters such companies, the common refrain of managers is that their products (or services) constitute only a small part of the customers’ total cost and yet are of vital importance to them. (Location 1537)

Hence, reliability weighs more highly than price. (Location 1540)

Sometimes this means that the component is mandated for use over the lifecycle of a product, as is commonplace in the automotive and aerospace industries. (Location 1544)

Regulations create barriers to entry. Products often require FDA approval as part of the drug manufacturing process, raising potential switching costs. (Location 1569)

Buffett’s observation that “after ten years on the job, a CEO whose company retains earnings equal to 10 per cent of the net worth will have been responsible for the deployment of more than 60 per cent of all capital at work in the business.” (Location 1620)

Fortunately, our small team of generalist investment professionals spotted in advance the dangers created by capital misallocation, mismanagement and murky accounting at the world’s third largest supermarket group. (Location 1633)

Analyzing the company’s cash flow over a five-year period, on the other hand, got one quickly to the key point that Ahold’s management had failed to generate cash from its core business. (Location 1652)

we were told that the chief executive was primarily rewarded on the basis of earnings per share (EPS) growth – a metric which can be boosted with acquisitions and by the use of leverage. (Location 1671)

The company achieved the notable feat of 23 consecutive quarters of double-digit EPS growth. (Location 1677)

It is generally the case that most managements, and indeed whole industries, engage in procyclical behaviour. (Location 1693)

only to raise fresh capital at the trough. Shareholders invariably lose out in the process. Alas, this time was no different. (Location 1694)

As the markets climbed towards their 2007 highs, companies spent a record amount on acquiring overvalued equity through cash-based M&A transactions and buybacks, as Chart 3.1 shows. (Location 1696)

These took place mostly in the banking sector, where BNP pounced on Fortis (the Belgian and Luxembourg businesses); Barclays bought the Lehman’s US business; Sampo acquired a significant stake in Nordea (which is already showing a €1bn profit); Santander snapped up Alliance & Leicester, Sovereign Bancorp and parts of BNP. In the auto sector, Fiat acquired Chrysler for nothing and some government guarantees. (Location 1717)

The lure of cheap debt and apparently rosy growth prospects enticed many managements into thinking that not only were their own shares cheap, but that the equity of other companies also offered good value, (Location 1729)

When an investor makes a long-term investment in a company, success or failure generally turns on the investing skills of senior management. (Location 1735)

Financial companies are probably the most challenging of all for CEOs to manage, as they require many more capital allocation decisions compared with, (Location 1743)

The combined group controlled a 37 per cent market share in Norway, 23 per cent in Sweden and 5 per cent in Denmark. New discipline (read: oligopolistic pricing) (Location 1759)

Sampo took advantage of the financial distress of its partners and bought out 100 per cent of the equity in the P&C operations at an implied value for (Location 1762)

For this transaction, Sampo achieved a top of the market price of €4.1bn in cash. (Location 1766)

and takes a dispassionate approach to selling assets when someone is prepared to overpay (Finnish bank divestment). (Location 1780)

This openness to outsiders stands in contrast to recent developments in Southern Europe, where Italy and France are engaged in a race to the bottom to redefine strategic industries for protectionist purposes. (Location 1808)

The company’s strategy of remaining focused on a limited range of growing industrial applications around the world has paid off in competitive terms. (Location 1821)

Scandinavian unions recognize that healthy job prospects are only possible if the company has a secure future, and that this demands both continuing profitability and overcoming competitive threats, whether current or prospective. Within Marathon’s (Location 1827)

For this reason, we normally prefer corporate incentives schemes to be benchmarked against the stock market index, in line with our own performance fees. (Location 1882)

Our portfolios have tended to be skewed towards companies where successful entrepreneurs run their companies and retain sizeable shareholdings. (Location 1899)

pitfalls. It’s often the case that the interests of the family are elevated above outside investors. (Location 1913)

Everyone knows the saying that rich families go from rags to riches and back to rags in three generations. (Location 1915)

The Internet company,, which is 20 per cent-owned by founder Jeff Bezos, appears happy to endure operating margins of 4 per cent while it invests in technology and dominates competitors on price, just as Wal-Mart, another family-controlled firm, achieved in bricks and mortar retailing. (Location 1921)

how family businesses deteriorate over time as later generations become more interested in the trappings of wealth than its generation. (Location 1946)

“The real question is do companies redeploy free cash flow accretively, or do they waste (Location 2002)

“No, no, no, no. I didn’t lose a lot of money when I tried to sell the business. I lost the money when I bought the bloody thing. That’s when you park your money, it’s not when you try to find a bigger idiot than you to take it off your hands.” (Location 2009)

does the CEO think in a long-term strategic way about the business? Understand how the capital cycle operates in their industry? Seem intelligent, energetic and passionate about the business? And interact with colleagues and others in an encouraging way? Appear trustworthy and honest? Act in a shareholder-friendly way even down to the smallest detail? (Location 2052)

Real strategy, whether military or commercial, involves an assessment of the position one finds oneself in, the threats one faces, how one plans to overcome them, and how opponents might in turn respond. (Location 2068)

what does your global competitive environment look like? In the last three years, what have your competitors done to alter the competitive landscape? In the same period, what have you done to them? How might they attack you in the future? What are your plans to leapfrog (Location 2071)

Discussing how a firm uses investment bankers and how it makes acquisitions (e.g., whether it prefers friendly negotiated deals to contested auctions) can be revealing. (Location 2079)

To unsettle the more promotional CEOs, we like to ask what is not working and wait to see whether they have given the matter much thought. (Location 2086)

The CEO in denial often blames problems on a divisional boss and follows up by saying that management has now been changed. (Location 2088)

Signs of vanity are generally off-putting. (Location 2093)

We were equally impressed to learn that senior executives at another company preferred the underground to chauffeured limousine when travelling around London. (Location 2100)

Frugal cultures may not sound attractive to employees, but when married to decentralized profit-sharing schemes, they can work wonders. (Location 2119)

If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength ... . On a daily basis, the effects are imperceptible; (Location 2131)

When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as “widening the moat.” (Location 2132)

The true answer – one which the Queen presumably was not supplied with – is that economists had developed a deeply flawed paradigm for how the economy operates. (Location 2189)

On the contrary, in the years prior to 2008 many serious investors and independent strategists were alert to the dangers posed by strong credit growth, (Location 2193)

Anglo Irish has grown from a small finance business, with a market capitalization of €8m in 1986 and an asset base of €138m, into a large bank with a market capitalization of €4.3bn and assets of €25.5bn. (Location 2374)

acquire premises that had previously been leased, or are borrowing against property to release capital. (Location 2378)

Provisions against non-performing loans are 217 per cent, compared with a European average of 80 per cent. As for valuation, the bank earns a return on equity of 32 per cent, trades at 4.2 times book value and offers a yield of 1.6 per cent. Earnings per share grew at 34 per cent last year, having compounded by 41 per cent annually since (Location 2384)

At the weekly credit committee meetings, up to 25 loans are approved with an approval rate of 95 per cent. (Location 2389)

Management presents Anglo Irish’s credit risk in terms of current debt-servicing, but this overlooks potential repayment risk. (Location 2390)

whereby borrowers are only able to cover their interest payments from earnings, as opposed to the more prudent “hedge finance” whereby borrowers can meet all their liabilities, including interest and principal payments, from current cash flows. (Location 2394)

Without a deposit base, Anglo Irish’s cost of funds would rise quickly. (Location 2401)

Not many €10m loans would have to turn sour before Anglo Irish’s €1bn equity base was seriously compromised. (Location 2403)

Charles T. Munger is fond of saying that there are “more banks than bankers.” (Location 2411)

an obsession with growth, combined with overpromotion, is likely to end in tears. (Location 2414)

Upon delivery, this asset is sold by the airline to a newly established securitization vehicle at a price closer to list price, and subsequently leased back for the life of the aircraft. (Location 2425)

But in a recession or a bankruptcy filing, when payments are suspended, the owners of the senior strata are able to seize the collateral. (Location 2432)

That an industry which has rarely earned an acceptable return on capital should have access to such cheap capital is quite astonishing. (Location 2436)

In an age obsessed with quarterly earnings, ownership of unlisted assets allows private equity firms to take longer-term decisions than would be acceptable to stock market “investors.” (Location 2466)

Managers in private equity firms are not encumbered by the increasing bureaucracy for listed firms, called forth by the Sarbanes-Oxley legislation. (Location 2469)

Deals with multiples of 6–7 times EBITDA are now not uncommon. “Seven is the new five,” as one observer put it, raising the spectre of a credit bubble. (Location 2475)

there have been few defaults on historical private equity loans (a “driving-via-the-rear-view-mirror” argument). (Location 2477)

the risk is less with private equity firms and more with the suppliers of debt – namely, the banks or whoever has acquired the loans from the banks. (Location 2480)

in a number of recent cases, large amounts of debt are being applied to highly cyclical businesses. In the case of Rexel, a French distributor of electrical parts, the €3.7bn buyout has been funded on a debt to EBITDA multiple of almost 7 (Location 2483)

According to the British venture capital firm 3i, three-quarters of all capital ever raised by private equity firms has been raised in the last five years. (Location 2488)

if an investment in the S&P had employed the same leverage as private equity, then annual returns would have compounded at 86 per cent. (Location 2494)

For instance, Hicks Muse recently paid 16 times operating profits to acquire the venerable Weetabix breakfast cereal business. (Location 2498)

by Niels Kroner, describes the history and culture of the bank and, as the title suggests, argues that many of the recent problems of the financial system could have been avoided if other banks were run in the “Handelsbanken way.” (Location 2802)

Handelsbanken’s decentralised business model encourages branch managers to make loans based on local, face-to-face knowledge of customers rather than relying on centralised credit scoring techniques, as their competitors do. (Location 2806)

“Carpets don’t make money,” was the reply. (Location 2810)

Handelsbanken has succeeded by not committing what he calls the Seven Deadly Sins of Banking. These are as follows: (Location 2811)

based on “a 95 per cent confidence interval and a one day holding period” – of $157m. (Location 2853)

when the group’s return on equity exceeds the weighted average of a group of other Nordic and British banks. (Location 2861)

The foundation channels a large part of its resources into Handelsbanken stock and currently holds 11 per cent of the bank’s equity. (Location 2864)

have worked as the CEO or as a security guard. The system undoubtedly contributes to the bank’s tribal culture and aligns employee interests with shareholders. (Location 2868)

strongly influenced by J.A. Schumpeter’s notion of creative destruction, namely that competition and innovation produce a constantly evolving economy and spur improvements in productivity. (Location 2925)

Some of the best appeared in industries where capital was rapidly withdrawn after the bust and consolidation took (Location 2929)

These problems have been exacerbated by the post-crisis policy of ultra-low interest rates which, by lowering funding costs, have allowed weak businesses – the corporate zombies – to continue limping along. (Location 2934)

For the first time in 50 years, the yield on US Treasuries has fallen below the dividend yield of the S&P 500. (Location 2969)

They began to resemble banks, just at the time when Spanish banks, with their expanding mortgage books and increasing exposure to property developers, were looking more like property companies. (Location 2995)

Marathon was always very suspicious of the property-fuelled Irish economic boom, in particular the incredible growth of that aggressive corporate and property development lender Anglo Irish [see above]. (Location 3046)

Marathon looks to invest in sectors where competition is declining and capital has been withdrawn, and where depressed investor expectations produce attractive valuations. (Location 3098)

Competition and capital are seemingly in retreat, and credit is being repriced. Investors have been put off by impenetrable balance sheets and by the complexity of new banking regulations (Basel III runs to thousands of pages). Then (Location 3100)

European bank assets have always been higher than in the US, since mortgages are generally kept on their balance sheets and European companies have limited access to the corporate bond market. (Location 3105)

McKinsey has estimated they will need to raise €1.1tn by 2021 to meet all the new regulatory requirements. One of the lessons from (bitter) experience of investing in banks in the US and UK is that when something as fundamental as the ultimate share count remains uncertain, the investment outcome is unpredictable. (Location 3112)

remain plagued by excessive numbers of banks – there are over 6,800 banks in Europe – and anachronistic structures. Even in Germany, that paragon of economic virtue, the banking landscape is littered with hundreds of unlisted local cooperative banks, savings banks (Sparkassen) and wholesale Landesbanken. As a result of this fragmentation, the German banking system generates little by way of profits. (Location 3120)

For investors in banks with stronger balance sheets, returns are likely to be restrained by weak lending growth and excessive competition. (Location 3125)

News that 10 per cent of British businesses are “zombies,” kept alive by ultra-loose monetary policy and the reluctance of lenders to write off bad loans, coincided with a report from the Bank of England suggesting that 5–7 per cent of outstanding mortgage debt was in various forms of forbearance. (Location 3133)

The poster child of this failure is the European auto industry, which appears incapable of reducing its capacity despite weak demand and dwindling exports to emerging markets (which have been busy boosting their own car production). (Location 3141)

Flag-carrier airlines, saddled with outdated employment contracts and national champion status, have suffered greatly from the growth of unencumbered low cost carriers. (Location 3158)

when stock market valuations fall to a fraction of replacement cost and a path opens up for dealing with the excess capacity. (Location 3166)

In the early 1990s, for example, our portfolios benefited from UK investments which survived the shake-out and prospered in the subsequent recovery, among them homebuilders (Taylor Woodrow), conglomerates (Trafalgar House) and advertisers (WPP). (Location 3169)

and banks prepared to prop up weak businesses for fear of crystallising losses, monetary policy looks very unlikely to precipitate a major reallocation of resources. (Location 3171)

supply side restructuring via industry consolidation also looks like a long-shot, especially as many European industries are already quite consolidated and face anti-trust barriers. (Location 3173)

Our European portfolios have undergone a gradual shift towards higher return on equity businesses over the last ten years or so. (Location 3176)

Lack of growth and overcapacity in mature industries would ordinarily require restructuring and consolidation, particularly as off-shoring is more prevalent in more basic, labour-intensive industries. (Location 3192)

In the emerging markets, the identification of “strategic industries” by Chinese politicians has led to excess capacity in various sectors, as diverse as solar and wind power, stainless steel, shipbuilding and telecommunications equipment. (Location 3198)

capital cycle analysis tends to be more effectively applied to industries which are largely domestic in nature or where the dominant players are inclined to Anglo-Saxon style capitalism (as is the case in the global beer industry). (Location 3201)

Fortunately, the capital cycle approach is well attuned to identifying superior Internet business models which can sustain high returns of capital. (Location 3206)

For the former, the investment case rests on whether competing capital can enter the sector and boost supply, eventually driving down industry returns. (Location 3212)

dominant businesses often become more powerful when they have well managed, proprietary assets. (Location 3213)

Namely, both high and low returns are likely to revert to the mean as valuation influences corporate behaviour and brings about shifts in the supply side. (Location 3216)

Over time, if capital is not flowing freely to its most productive use, aggregate returns on capital and economic growth will decline. (Location 3245)

In short, Japan’s long experiment with low rates has hardly been a positive one, with respect to either corporate profitability or the country’s ability to outgrow its debt burden. (Location 3252)

namely a weak economy, high leverage and the memory of a near catastrophic financial collapse in the rearview mirror. (Location 3257)

Mr. Piketty identifies the “central contradiction of capitalism” in the fact that the average rate of return on capital has tended to exceed the pace of output growth. (Location 3282)

In order to achieve higher returns, investors must take on a variety of additional risks. (Location 3286)

True, investors can earn 4.7 per cent on “high yield” corporate bonds, roughly a percentage point above nominal US GDP growth, which might appear to support the French economist’s argument. (Location 3289)

“We’re seeing a deterioration in lending standards and we are attentive to risks that can develop in this environment.” The Fed offered assurance that it is working with other regulators to “enhance compliance with previous guidance on issuance, pricing and underwriting standards.” (Location 3314)

In an age when risk-free assets yield little or nothing, the determination of the wealthy to earn somewhat more will, in due course, do more to restore equality than his proposed taxes. (Location 3320)

it is not surprising that very few investments have been made in mainland Chinese equities over the years. Many of these firms are state-controlled. (Location 3347)

The result has been excess capacity and low returns in a number of different sectors ranging from steel manufacturing to shipbuilding. (Location 3355)

Attending the firm’s recent IPO presentation, the audience of potential buyers seemed captivated by charts proudly boasting margins and returns on capital rising steadily for the past three years. (Location 3402)

Furthermore, the prospectus reveals that almost two-thirds of Sinotrans’ operating assets are to be leased from government-owned companies. (Location 3405)

Until our industry starts paying more attention to the protection of our clients’ capital, the emergence of one billion consumers is unlikely to deliver a positive investment (Location 3412)

Any IPO windfalls are likely to be frittered away in lending practices similar to those which led to the very bad debt problems now being resolved. (Location 3443)

The trouble is that Comba’s customers aren’t paying their bills on time. (Location 3458)

These customers are none other than the state-controlled publicly listed mobile telephone companies which, according to Comba’s executives, prefer to spend their money on buying assets from the government. (Location 3458)

Thus, the listed subsidiaries of SOEs are caught between the requirement to meet their liabilities and poor systemic profitability. (Location 3489)

Yet this growth appears to be resulting from increased inputs rather than improved productivity. (Location 3492)

Applying ever more factors of production allows China to meet the 10 per cent economic growth target, despite declining returns on assets. (Location 3494)

set up four asset management companies (AMCs) or “bad banks.” (Location 3517)

From time to time, the audience was treated to library footage of employees collectively high-fiving. (Location 3521)

Chief among these, apparently, was the opportunity for investors to gain exposure to that sexiest of investment classes, distressed assets. (Location 3523)

Favourable comparisons were drawn by the bankers between Cinda and one of the most respected of distressed asset investors, Oaktree Capital, (Location 3526)

As we often find in China, appearance and reality in Cinda’s case are far apart. (Location 3533)

Successful distressed investors tend to eschew leverage because of the uncertainty in magnitude and timing of returns. (Location 3536)

The two biggest and most important line items were RMB 33.5bn provided by the ministry of finance, and RMB 104bn coming from “market-orientated sources.” (Location 3540)

In short, Cinda’s funding costs are artificially low, possibly unsustainable, and given the company’s high leverage, the impact on profits of any normalisation of interest rates is likely to be significant. (Location 3545)

In other words, two-thirds of Cinda’s distressed book is exposed to Chinese real estate. (Location 3551)