Another way out of the Ponzi scheme

I have questioned the value of owning shares in a company, if the shareholder has no share of the profits, e.g. when the company pays no dividends. I noted that with young and promising companies one argument is that they need to reinvest in themselves to continue to innovate and grow, but that the expectation is that their revenues and profits will thereby increase, so that one day they will pay dividends to shareholders.

Ponzi aka "Charles Bianchi" under arrest circa 1910

There is another way out of the Ponzi scheme of buy low-sell high marshmallow stocks. In a posting a couple years ago, I mentioned that about a decade ago I had bought shares in Ben & Jerry's. Within a year, the company was bought by Unilever, and shareholders were paid out in cash, rather than in stock of the purchasing company. We doubled our investment, and thus shared directly in the boon for Ben & Jerry's. But then, B&J had been paying dividends I believe, and certainly Unilever was at the time and continues to this day. With a present-day P/E ratio of around 17, Unilever (UN) pays a dividend of 3.75%. Not too shabby in today's market. [And just for the curious, I currently own no shares of Unilever.]

Without selling your seemingly worthless shares of some high-flying company which can't deign to share the profits with its shareholders to some sucker at a higher price than you paid, you could hold out the hope that some other firm will eye the company whose shares you hold and pay a premium to swallow up their holdings and market share.

Perhaps Yelp is simply a takeover target, and that $1.5B in market cap will be just a tasty morsel, tempting some giant to swoop in and pay off shareholders to the tune of $3.0B for the chance to turn a profit where Yelp has yet to succeed. Alas, there aren't many companies or countries out there willing or able to gobble up Amazon, Google, or Apple. So, Ponzi it remains.

[I noted last week that I was aiming for a 40% allocation of personal investments in stocks. I've modified that target to 51%. But the sell off of shares continues. Current stock holdings tally: 72% and falling.]

Wasserman's Choice: Avarice or Control?

The Kauffman foundation is promoting new books that they've funded on the topics of entrepreneurship and innovation. Among them is "The Founder's Dilemmas" by Noam Wasserman. I linked to find details, in hopes that I could download a sample on my Kindle. On Amazon's website, I was deceived by the lack of details into purchasing an inexpensive download of a Harvard Business Review article of the same title (only singular) by the same author. I guess I should have checked the page count (9 vs. 448 for the book).

In any case, I read the article, reinforcing my view that I am not among the target audience for Harvard Business Review. A few highlights from the article:

Most entrepreneurs want to make pots of money and run the show.

... you must choose between money and power.

... entrepreneurs as a class make only as much money as they could have if they had been employees. In fact, entrepreneurs make less, if you account for the higher risk. What's more, in my experience, founders often make decisions that conflict with the wealth-maximization principle.

... There is, of course, another factor motivating entrepreneurs along with the desire to become wealthy: the drive to create and lead an organization.

... Entrepreneurs face a choice, at every step, between making money and managing their ventures.

And on it goes. According to Wasserman, there are only two notable motivations for entrepreneurs, making money and having power. I don't know about you, but I don't list avarice and control among my top priorities. That doesn't mean that I've taken an oath of poverty and weakness, it's simply that as far as striking my top motivations to being an entrepreneur, Wasserman and HBR shoot wide of the mark.

What are my priorities and motivations? If I had to choose two they would be: freedom and accomplishment. I seek the freedom to pursue my interests, and the knowledge that the work I engage in will have a meaningful impact on society. But freedom is not quite the same thing as control, and accomplishment is surely not the same as wealth. Now I believe these are not mutually exclusive, but if I have a choice between power and a sense of accomplishment, or between wealth and freedom, my decisions would be easy.

But there's more to it than that. Just what entrepreneurs is he talking about? After completing my PhD, I spent about three years full-time just trying to get a faculty position, which in the best of circumstances would have garnered me an income of $45-60k/year (possibly less), would have required me to serve on numerous committees, and at least for the first several years would have left me little freedom to choose what classes I would teach. Suffice it to say, I earn more as an entrepreneur than those prospects offered (and multiples of the $15k gross I was earning as an adjunct), along with freedom and a sense of accomplishment. And I've been honored with creating meaningful jobs for others to boot.

Wasserman presents a false dichotomy: if I am willing to accept the prospect that someone else might be better poised to lead my firm to commercialization and profitability, then I must be motivated to be rich; and if I prefer to lead the company myself, then I prefer to be king. Truth is, the choices I make along the way will likely be guided by those twin motivations of freedom and accomplishment. And I'm okay with that.

Good Advice: The 5 Qualities of Remarkable Bosses

Check out Jeff Haden's article in Inc. on The 5 Qualities of Remarkable Bosses. All solid advice. I'd say his second point "Deal with problems immediately" should be expanded--"Deal with most things immediately". Now, that doesn't mean allow other people's priorities to become your own, but the less you put off, the more will be cleared off your desk, and the less there will be to distract you. As a correlate, anything that you don't deal with within a week, should likely be set aside, marked read, archved, or what have you. If you think of it again in a month, deal with it then; if not, let it go, it's not that important.

A few months ago, I made a tough decision to fire an employee for the first time. Haden's third point "Rescue your worst employee" is out of sync with the common line that as an entrepreneur you never lament firing someone too soon. Haden's point is that it serves you, the employee, and the business well to work on mentoring and coaching, with the concession that "sometimes it won't work out" but "the effort is its own reward."

In the case a few months ago, I had an employee who'd been with the firm for nearly two years. He's a likable guy, smart, funny, pleasant. But he just wasn't delivering. In fact, problems had emerged almost from the start of his employment. Did I wait too long to fire him? I don't think so. He made contributions to the company, albeit far less than he was capable of, and the experience taught me a great deal about mentoring and leadership, and what to expect from employees, and how to ask for it.

I'd like to think that I am a stronger entrepreneur for having worked with him, the company has grown, and that believe it or not the former employee gained both valuable experience and increased self-knowledge. It's like breaking up with a lover after a couple years. You don't have to regret the time and energy expended in order to understand that the time has come to an end.


As Carole King sang:

There'll be good times again for me and you
But we just can't stay together, don't you feel it, too
Still I'm glad for what we had and how I once loved you

I think it's important as entrepreneurs not to forget our humanity. I like Haden's view that we should always remember from whence we came, and be gracious.

Fetish: Stocks as Collectibles

News this week: Yelp IPOs. Friday's close was $24.58, 59.9 million shares outstanding, giving the company a market capitalization of $1.5 billion. In eight years, I hear, they have yet to turn a profit. So, what on earth are people buying? Shares...

Google sells for $621.25 a share, maket cap of $202 billion.
Apple sells for $545.18 a share, market cap of $508 billion.
Amazon sells for $179.30 a share, market cap of $81.6 billion.

What is the value of those shares? What exactly do you own, when you own shares of Google or Apple, Amazon or Yelp? Each one is worth one ticket to an arena with 59 million, 300 million, or 900 million entries. That's 3,000-45,000 Madison Square Gardens! One vote in an ocean of votes. That's ownership I suppose. What other benefit do you receive? You don't share directly in the profits. They pay no dividends.

Price earnings ratio is often quoted as a means to value shares, with 15 x earnings being a conservative target.

• Apple at a P/E of 15.53 is pretty close
• Google with a P/E of 20.89 is only slightly worse
• Amazon's P/E of 130.60 is rather extraordinary

You can think of it like interest in a savings account. If the companies paid out 100% of their profits as dividends, it would take you 15.53 years to double your purchase price of Apple shares; 20.89 years to double your investment in Google, or a whopping 130.6 years to get out what you paid for a share of Amazon. To put that in perspective, a P/E of 15, with 100% of earnings paid out in dividends would be roughly the equivalent of earning about 5% compound interest on savings, quite attractive in today's market.

But then, that assumes 100% of earnings are paid in dividends, not normally the case. Or it assumes that the earnings will increase dramatically over time, and thus the dividends paid will likewise increase. But in many cases, 0% is paid out in dividends, leaving a shareholder with no direct benefit from owning the shares. Unless these companies at some point begin paying dividends, shareholders' potential benefit only accrues upon selling the shares. Your sole means to profit from owning these shares lies in your ability to sell those shares to someone else at a higher price than you paid. Someone else who would likewise have no ability to share directly in the profits of the company. What is that like? Let's see:

Say it's 1988: Cabbage Patch Kids have been around for a decade. You buy a dozen or so, as collectibles. $15 a pop, leave them in their packaging, with the hope that a few years later, you'll be able to sell them for $25 or $50 or $100 each!

What's the difference? To be honest, I can't see any. To be more direct:

A share's value must be the present value of all future dividends--otherwise stockmarkets would be a giant Ponzi scheme.

--The Economist, March 7, 2009

In the dot.com boom the argument was that young, hot, technology companies were forging new territory, and should be allowed to reinvest in their own growth, which down the road would be translated into profits for the shareholders. But then, Google, founded 1998 is already 14 years old; Amazon founded in 1995 is 17; and Apple, with its origins in the Bicentennial is solidly within Generation X at 36 years old. Just when do you expect they will start paying dividends?

And if never, are you really willing to continue participating in a Ponzi scheme?

For my part, I have every intention to reduce our vesting in the market, which currently stands at about 80%, down to about 40%, strongly preferencing those stocks and mutual funds that currently pay dividends, or whose young companies represent an innovation I believe in (like Tesla Motors). What will I do with the remainder? I think I'll invest in my own current business or start a new one. I was never much one for Cabbage Patch dolls.