Investing Blog

If Private Equity Ran the World's Businesses by Jordan at Investing Blog

To learn more about the relationship between martial arts and personal finance please read The Martial Artist's Guide to Investing.

Subscribe to our RSS feed to stay up to date or follow us on Twitter or Facebook.

On the day that several deals are being done including a $5.3 billion move by one of the biggest private equity firms, KKR, it’s probably about time I show my appreciation for the world of private markets.

They say that the stock markets are plagued with CEOs, CFOs, and other corporate executives who focus on the quarter and not the company as each quarter, investors re-evaluate companies that may have been around for a century or more.

Let’s break down the absurdity. Ninety days is equivalent to 270 shifts, or 2160 hours. From one quarter to the next, some companies will be open for business only 63-67 days. In this amount of time, the strategies of CEOs are judged, investors evaluate the future for the company, and creditors consider the safety of their loans.

Really, when you get down to it, corporate America isn’t opaque at all. Instead, it’s far too out in the open. Executives have to show that they’re doing what they can to grow a business every quarter. What if you were reviewed in your job every 90 days? It would seem like nothing even happened since the last evaluation, wouldn’t it?

To further exacerbate the problems, C-level executives are compensated mostly with stock options. As you’re probably well aware, a rising stock price isn’t always indicative of a healthy company, nor the ability for current strategies to propel a company into the future.

Information Inefficiency

More information should make markets more free, more prosperous, and more efficient. In the context of the current market system we have, then this is absolutely the case. Obviously, I can’t discount the fact that the stock markets allow anyone to be a business owner. Nor can I discount the limited barriers to entry in accessing this market, and that everyone has the right to see the books. That’s good stuff.

But there seems to be a problem, and private equity, in my opinion, is the solution.

Unlike other investors, private equity funds are the happy go lucky firms that come in and snap up companies for the long haul. They value brands, margins, cashflow and industry where traders are thinking RSI, MACD, candlestick patterns and tomorrow’s earnings call.

It shouldn’t come to a surprise to anyone that so many companies go from public to private then back to public. Private equity firms have an advantage that no one else has, they can come in, boost profits with either top or bottomline growth, and rake in the money when the net income is sold at a PE of 10-15. A company with a $1 billion net change in earnings is a company that can be sold at a profit of $10-20 billion on its next IPO.

When private equity comes to town it snaps up a company and often, but not always, they make huge changes. Executives may be replaced, and whole divisions may be erased or spun off. When new people come in, there are no sacred cows. That R&D drain of an “investment” that was supposed to bring $100 million in cashflow a decade ago but wouldn’t be touched by anyone at the top is a goner. That overvalued asset that brings in zero cash is on its way to the local pawn shop. There is no excuse for inefficiency.

Private equity firms, to me, are like the management consultants that are actually worth something. Where a “management consultant” with a Harvard MBA is at best an automated, but costly rubberstamp, private equity actually makes a splash.

Sometimes I feel like the markets are too fast, but thanks to the often under-appreciated and spectacularly boring-at-face-value world of private equity, I can get a little calm in crazy markets.

About Jordan

Jordan is the web master of www.investingblog.org, a site dedicated to skillful investing, news and recent trends. You can read the original article here.

Return to the Investing Blog section

Read The Martial Artist's Guide to Investing

Return to the Martial Arts Insight Home Page