Wednesday, February 5, 2014

THE BUSINESS OF BUILDING BUSINESSES



It’s that time of the year again when businesses tally up their numbers to determine whether they had a successful year or not.

The time when bonuses and dividends will be doled out if it has been a good year – sometimes even when it has been a bad year. Or when the shareholders may have to dig painfully into their pockets to prop up their ailing businesses or wind them up all together.

Counter intuitive as it sounds the latter decision is probably easier to make than the former.
If your business is behaving like a black hole consuming prodigious amounts of money with no return in sight, the decision to shut it down can be forced upon you.

On the other hand if your business is doing well, the temptation to give your executives healthy bonuses and award yourselves big dividends is not an easy one to resist, which may very well come back to haunt you one day.

 During a recent end-of-year meeting – thankfully in a business that has maintained its good health through these economic hard times, the dilemma arose, whether to continue with business as usual – dish out the dividends or suspend a pay out and retain more of the earnings to shore up the value of the company.
  
 The need to beef up our balance sheet was in anticipation of a new regulatory regime the company was soon to come under.

At the bottom of it, the dilemma is really between instant versus delayed gratification.

Do you pay a dividend now, which will be consumed by the shareholders or not and grow the company’s value, which is a long term benefit to the shareholder anyway.

US billionaire investor Warren Buffett has only paid a dividend once in his fifty years at the helm of multi-billion dollar conglomerate Berkshire Hathaway. He argues that his shareholders are better off leaving their money in the company, whose shares have grown on average by 20% a year in value for the last half decade or doubled in price every four years.

Essentially he is saying by forgoing your dividends now I can make the money grow over the long term better than you can if you tried. There are very few people who would argue with that.
Imagine you own a corner shop. You have made record profits this year but then the environment is such as to cause you some concern – a weak economy, potential competitors and shifting customer allegiance. In the midst of the festive season the temptation to reward yourself for a year well done would be overwhelming but when you have licked your fingers clean from the merry making you may find a business tottering on the brink of disaster.

Taking the long term view, scaling back on your fun and games and girding your business’ loins for the New Year would be the prudent thing to do. While easier said than done that is the discipline that makes for businesses that are built to last.

I think it is safe to say, in trying to decide what causes businesses to fail or thrive at its basic level it is how the company’s shareholders and management handle the issue of instant versus delayed gratification. Everything else is detail.

The aforementioned Buffett who has made his fortune investing in companies since he was 11, has a very simple way of telling which investments are good or not.

Through long experience Buffett, 83, has learnt to look for companies, which show consistent growth in their net value – the extent to which the companies assets are larger than its liabilities. If this figure keeps growing year-in, year-out the probabilities are high that the share price will soon mirror this growth in company value.

The growth in assets is the most manifest sign of delayed gratification, a virtue we will do very well to cultivate in our businesses and personal lives.

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