The firm value
What drives a business? The only rational reason for a business to continue as a going concern is to continue to earn a fair rate of return on its capital in order that the capital providers are not let down. If this were not to happen, the business is meant to fail and will be better dead than alive.
What drives return on capital? It is the combination of nature of business itself and invested capital. If a fundamentally economical business is provided with adequate capital it will be a good deal. This is true at least for the foreseeable future as opposed to infinite time.
Capital, growth and return on capital will influence the firm's value.
Growth can come either through efficiency in current operations, although with a limited power, or it can, and more likely, come from reinvestment. Without reinvestment, no business can continue to grow for long. However, growth requires reinvestments to continue to earn return on capital similar (good) to, if not better than, the business currently earning. If not, this additional capital will not add value, or worse, might destroy value. That is why just physical growth does not matter.
The technology business
What about technology companies? What about a technology company earning very high return on capital?
Growth for this business should come in just the same manner as to any other business. However, the key difference is that technology business is never a sustainable business. This means (even) for a truly wonderful technology, there will be periods of high growth followed by lower yet decent growth, and then followed by sudden or slow death depending on the extent and impact of the competition and change in technology.
The key driver for the technology business is innovation. As long as this business, with its wonderful technology, continues to innovate, it will experience growth. Nevertheless, the high return will attract competition and this will bring down the return initially (that is, slower growth) and then ultimately will evaporate all excess returns or even bring about its fall. Research In Motion and Nokia should be able to vouch on this based on their bitter direct experience.
For a technology business which has experienced, say, a decade of growth, it is absolutely crucial to innovate even for its sheer existence. There is one problem though: for any business it will be very difficult to innovate until eternity; innovations cannot come every year.
Apple
Apple is a case in point. With ridiculously high return on capital (don't even try to calculate), crazy amount of excess cash (it's really crazy), and a history of extensive growth and innovation, now it is at crossroads. It must innovate or perish by its own standards.
Given its past records and investor expectations, it will be extremely difficult for Apple to replicate. Too many smart phones and tabs have been floating around and many more to come from competition.
The Samsungs are dominating; the Sonys, the Microsofts and the Googles are giving more for less to consumers; there are many other players in the market; and the RIMs and the Nokias are not giving up (don't ask why).
Sooner or later this will deepen the price and volume war, and lead to an eventual loss of market share. It will be foolish for investors to think that that pile of cash is going to produce miraculous returns. From now on, Apple needs to innovate simply to exist, i.e. to maintain its market (scope for growth has become limited).
Extraordinaire
In this situation, what better way than to do something that has never been done in such doses in the past? It is time for Apple to return that cash to where it belongs; to its shareholders.
But then
While an extra-large cash dividend or stock-buyback is unlikely from the management, it will be interesting to see how the story unfolds into the future.
Since a high ego usually hurts, management will be well advised and shareholders will be well off if a rational decision is taken.
But then you never know...there could be an i-computer, i-tv, i-kitchenware, i-anything..
The contrast
Check out some samples: Apple witll hit 1650 and Law of limits - what do you think?
The insight
You see, since I am extremely good with hindsight, I should very well be able to tell you in a few years time.
What drives a business? The only rational reason for a business to continue as a going concern is to continue to earn a fair rate of return on its capital in order that the capital providers are not let down. If this were not to happen, the business is meant to fail and will be better dead than alive.
What drives return on capital? It is the combination of nature of business itself and invested capital. If a fundamentally economical business is provided with adequate capital it will be a good deal. This is true at least for the foreseeable future as opposed to infinite time.
Capital, growth and return on capital will influence the firm's value.
Growth can come either through efficiency in current operations, although with a limited power, or it can, and more likely, come from reinvestment. Without reinvestment, no business can continue to grow for long. However, growth requires reinvestments to continue to earn return on capital similar (good) to, if not better than, the business currently earning. If not, this additional capital will not add value, or worse, might destroy value. That is why just physical growth does not matter.
The technology business
What about technology companies? What about a technology company earning very high return on capital?
Growth for this business should come in just the same manner as to any other business. However, the key difference is that technology business is never a sustainable business. This means (even) for a truly wonderful technology, there will be periods of high growth followed by lower yet decent growth, and then followed by sudden or slow death depending on the extent and impact of the competition and change in technology.
The key driver for the technology business is innovation. As long as this business, with its wonderful technology, continues to innovate, it will experience growth. Nevertheless, the high return will attract competition and this will bring down the return initially (that is, slower growth) and then ultimately will evaporate all excess returns or even bring about its fall. Research In Motion and Nokia should be able to vouch on this based on their bitter direct experience.
For a technology business which has experienced, say, a decade of growth, it is absolutely crucial to innovate even for its sheer existence. There is one problem though: for any business it will be very difficult to innovate until eternity; innovations cannot come every year.
Apple
Apple is a case in point. With ridiculously high return on capital (don't even try to calculate), crazy amount of excess cash (it's really crazy), and a history of extensive growth and innovation, now it is at crossroads. It must innovate or perish by its own standards.
Given its past records and investor expectations, it will be extremely difficult for Apple to replicate. Too many smart phones and tabs have been floating around and many more to come from competition.
The Samsungs are dominating; the Sonys, the Microsofts and the Googles are giving more for less to consumers; there are many other players in the market; and the RIMs and the Nokias are not giving up (don't ask why).
Sooner or later this will deepen the price and volume war, and lead to an eventual loss of market share. It will be foolish for investors to think that that pile of cash is going to produce miraculous returns. From now on, Apple needs to innovate simply to exist, i.e. to maintain its market (scope for growth has become limited).
Extraordinaire
In this situation, what better way than to do something that has never been done in such doses in the past? It is time for Apple to return that cash to where it belongs; to its shareholders.
But then
While an extra-large cash dividend or stock-buyback is unlikely from the management, it will be interesting to see how the story unfolds into the future.
Since a high ego usually hurts, management will be well advised and shareholders will be well off if a rational decision is taken.
But then you never know...there could be an i-computer, i-tv, i-kitchenware, i-anything..
The contrast
Check out some samples: Apple witll hit 1650 and Law of limits - what do you think?
The insight
You see, since I am extremely good with hindsight, I should very well be able to tell you in a few years time.
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