Tuesday, February 26, 2019

Collins, Turning the Flywheel

Turning the Flywheel: Why Some Companies Build Momentum … and Others Don’t (HarperBusiness, 2019) is a short (40-page) monograph intended to accompany Jim Collins’s iconic bestseller Good to Great, published back in 2001. I never read Good to Great, so I can attest that Turning the Flywheel stands proudly on its own.

Underlying the success of the flywheel as a business principle are two concepts known to every investor: momentum and compounding. As Collins writes, “Never underestimate the power of a great flywheel, especially when it builds compounding momentum over a very long time.”

What exactly is a business flywheel? In the case of Amazon, it goes something like this (imagine these steps laid out in a circle): lower prices on more offerings, increase customer visits, attract third-party sellers, expand the store and extend distribution, grow revenues per fixed costs. “Push the flywheel; accelerate momentum. Then repeat.” Or, with Vanguard, offer lower-cost mutual funds, deliver superior long-term returns for clients, build strong client loyalty, grow assets under management, generate economies of scale—and repeat. Notice, Collins writes, “how each component in the Vanguard flywheel isn’t merely a ‘next action step on a list’ but almost an inevitable consequence of the step that came before.”

The flywheel isn’t just for CEOs. Anyone can use this model to propel a venture, for example, in education or medicine—or, for that matter, in trading. The point is that once you identify the right components of the flywheel, and once you have all these components performing at a high level, you must then keep cranking. “The big winners are those who take a flywheel from ten turns to a billion turns rather than crank through ten turns, start over with a new flywheel, push it to ten turns, only to divert energy into yet another flywheel, then another and another. When you reach a hundred turns on a flywheel, go for a thousand turns, then ten thousand, then a million, then ten million, and keep going until (and unless) you make a conscious decision to abandon that flywheel. Exit definitively or renew obsessively, but never—ever—neglect your flywheel.”

In 2017, Forbes selected Collins as one of the 100 Greatest Living Business Minds. Turning the Flywheel justifies that accolade.

Sunday, February 17, 2019

Gannon, Tailored Wealth Management

Niall J. Gannon, of the Gannon Group at Morgan Stanley, is a financial advisor for high net worth and ultra high net worth individuals and families. And yet Tailored Wealth Management: Exploring the Cause and Effect of Financial Success (Palgrave Macmillan) is applicable to all investors, at any stage of their lives. It addresses three pillars of wealth: identifying and building it, managing it, and deploying it. As such, the book can be read as a wealth life plan.

Among the most original parts of the book is an updated version of a paper Gannon co-authored with Scott Seibert in 2006. It has been re-titled “Forecasting Long-Term Portfolio Returns: The Efficient Valuation Hypothesis.” The paper’s hypothesis is that “much of the long-term (20-year rolling periods) variability in stocks can be explained by the beginning-of-period earnings yield (the inverse of the starting P/E ratio).” For the 42 rolling 20-year periods beginning on January 1, 1957, with the inception of the S&P 500, the paper shows that the earnings yield accurately predicted the minimum expected return 95% of the time. In the two instances in which the hypothesis failed (1958-1977 and 1989-2008), the disparity was less than 1%. It is noteworthy that the highest observed earnings yield of 13.7%, in 1975, produced a 14.33% annualized return and the lowest earnings yield of 4.54%, in 1998, produced a 7.1% annualized return. Gannon concludes that “the use of earnings yield as a minimum expected return produces a more informed comparison of the future return potential of equities versus fixed income than the application of the theory of mean reversion or the Efficient Market Hypothesis.”

Gannon looks at the effect of taxes on equity returns and tries to compare stock and bond returns on a net basis. He contends that “the notion that stocks outperform fixed income over time … is false when examining net returns over specific periods.”

Tailored Wealth Management is a valuable book both for financial advisors and DIY investors. Most of it is easy-to-read text, with the occasional case study thrown in to illustrate the pillars of wealth. But it includes just enough quantitative research to whet the appetite of anyone who is trying to plan his or her financial well-being for the long run.