Mauboussin: What You See and What You Get
The latest from Michael Mauboussin, Chief Investment Strategist of Legg Mason Capital Management (LMCM): What You See and What You Get
A number of significant corporate finance activities present the opportunity for divergence between earnings growth and value creation. These include mergers and acquisitions, share buybacks, and capital projects funded with internally generated cash flow. Given the nearly obsessive focus on earnings at a lot of companies, investors are well served to be very diligent and critical in assessing a company’s capital allocation actions and processes.
. . . one large technology company spent nearly $7.1 billion on research and development—certainly a form of investment—and only $2.3 billion on capital expenditures. This company is most certainly making healthy investments in its business, but most of those investments are reflected on the income statement as an expense, versus on the balance sheet as an asset.
The ongoing shift to an intangible-based economy renders earnings even less useful. Intangible-based companies consistently have higher cash flow-to-earnings ratios than their tangible-based peers.
See also GaveKal’s ‘platform company‘ argument.
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