0:16

So a quick question.

Â Let's try to figure this out.

Â I have two questions here.

Â What is the growth rate of the policy?

Â And that gave you a hint, and actually we did it together [LAUGH].

Â Is that if I'm not reinvesting anything, the growth rate is 0.

Â If I'm reinvesting 70%, it has to be a function of that 70% and for

Â convenience, we're going to do it on an ongoing basis.

Â 1:10

It's not possible, it's not possible.

Â You can grow very fast for a short period of time.

Â But after that you gotta slow down, and the main reason is competition.

Â I mean, that's why we have laws that if you're really good at what you do you

Â tend to become a monopolist but sometimes, in fact, I would say many times,

Â you become a monopolist by actually screwing the customer.

Â 1:36

So I just want you to recognize that 7% growth is really, really difficult.

Â Now people see this and say, what will happen to price?

Â So suppose we are standing today, what was the price already?

Â 50 bucks, no growth.

Â 1:55

The generic answer to this is price will go

Â up because of this and the answer is wrong.

Â I don't know,

Â probably most of you are very young to know about cholesterol, right?

Â So turns out there is two types of cholesterol.

Â First, everybody thought cholesterol is bad.

Â No, there's a good cholesterol and there's a bad cholesterol.

Â 3:10

To create this growth how much of this did you take?

Â 70%.

Â You cannot, therefore, have dividend to of 6 bucks anymore, so you see the trade-off?

Â For growth to occur, you have to give up something.

Â Who's you?

Â You are the shareholder, right?

Â I mean.

Â So what is 30% of 6 bucks?

Â 1.8.

Â And I'm not, this is not magic, right?

Â 3:37

So 70%, so 1 minus b times 6, I believe is 1.8.

Â Right?

Â So what have you done?

Â You have, and this is true of any growth, you will be willing to give up

Â some dividend next year for some exciting things the firm is planning to do.

Â But what is the r of the firm?

Â 3:57

Nothing to do with the firm.

Â We are in the same business, 0.12.

Â And what is the g?

Â 0.07.

Â What's the answer to this?

Â You can do this in your head, and that's the easy part.

Â 0.12 minus 0.07 is what?

Â 0.05.

Â Dividing anything by 0.05 is what?

Â Multiplying it by 20.

Â 4:33

The stock price has plummeted to 36.

Â I want to take this opportunity to explain two things.

Â The main thing I want to explain is growth in

Â the earnings is being generated by investing in what?

Â You should be able to guess.

Â Investing in ideas that are going to earn how much rate of return?

Â Look at the rate of return built into my formula, into my plan, 10%.

Â But what is the opportunity cost of capital?

Â In other words, what are other people in this business already earning and

Â capable of earning?

Â 12%.

Â So what is true?

Â Remember, IRR conceptually is not a problem.

Â So, let's say IRR,

Â in this case it will work because the cash flows are well behaved.

Â There's no long term, short term.

Â It's one problem.

Â Everything is perpetuity.

Â So IRR should be greater than r.

Â What's true here?

Â My IRR is 10%.

Â My r is what?

Â 12%.

Â So actually, I'm throwing money on negative NPP projects.

Â 5:57

Many times, not by design,

Â you make mistakes, but many times perhaps by design.

Â And the reason is quite straightforward.

Â The firm is long lived.

Â The stock is long lived, but the management is short lived by definition.

Â There's a conflict.

Â Remember I said people use IRR?

Â 6:26

And you say, oh, 10% is great and you try to go after it and

Â generate cash flows that grow, but

Â having cash flows grow in the short term is not necessarily value generation.

Â You want to grow cash flows, but

Â by investing in ideas that are really powerful.

Â 6:45

That's the first lesson.

Â The second lesson is, how come today as soon as you announced this,

Â the price dropped by 14 bucks, which is what?

Â 28%, 14 on 50 is a 28% stock price drop.

Â Do you see such changes in the stock market?

Â Sure.

Â They bounce all over the place.

Â But this example assumes what?

Â That people know what's going on, that those are the analysts, and

Â have the courage to kind of dig through the numbers and say, you know what?

Â If you do this plan, the price will drop $14.

Â Why? Because the plan is not value generating,

Â it's quite the opposite.

Â 7:22

So the reason I'm bringing up this example is that we are focused actually

Â fundamentally, on the wrong thing that's growing.

Â Growth in your assets is what it's all about.

Â That's how value is generated, not by growing just your cash flows.

Â Okay?

Â So let me continue now and give you one more example, and

Â then you'll understand what's going on.

Â 7:53

There's a Macrosoft that suddenly emerges with the different alternative

Â growth policy.

Â Obviously in the real world, the two things can't happen simultaneously.

Â But I'm giving you a sense of what are the two directions growth policy could take.

Â So what's scenario number two?

Â Scenario number two does two things.

Â It says we are going to grow, but we are going to plow back 50%.

Â Okay.

Â What was the plow back rate in the first?

Â 70%.

Â And I have my ideas are going to earn 14%.

Â So the first question is, what is the growth rate of this policy?

Â 8:34

And if you bear with me, and as I said, regardless of whether I take a break or

Â not, you've got to understand this.

Â So take a break if you want to, but the growth rate is not tough to do.

Â 8:50

G, we know, requires some reinvestment.

Â And that's already a fraction.

Â And then some ROI.

Â Look, I've been a little naughty.

Â What's the growth rate?

Â 0.50 times 14%.

Â The growth rate is what?

Â 7%.

Â You see why I have been naughty?

Â There's no difference in the growth rates of the two examples.

Â And that's what we are fixated on.

Â 9:22

Okay.

Â That's what we are fixated on.

Â Everybody is fixated on growth rate of cash flows.

Â Now tell me, in this case is it good news or bad news?

Â And you should tell me what will happen to the share price, directionally and why.

Â You just have to think very simple.

Â What is your rate of return on this new ideas?

Â 14%.

Â What is the competition earning?

Â 12%.

Â What's going to happen to the stock price as soon as you make this announcement, and

Â people actually believe you can deliver?

Â 10:00

Stock price will go up, why?

Â Because in this scenario with our problems of IRR, r compares enough reasonable.

Â 14%, where it's greater than 12%.

Â Let's do the actual price, okay?

Â So, I'm going to go on to the next page on this right next slide and

Â just give you a sense, finally, of what's going on.

Â Okay.

Â So my dividend 1 is now what?

Â 50% of $6 in the first period.

Â Why?

Â Because I am plowing back only 50%.

Â So how much am I left with?

Â 50% which is $3.

Â What is my growth?

Â 7%.

Â What is my little r?

Â 12%.

Â Remember little r, you can't touch.

Â You can't touch this, that's another MC Hammer thing.

Â 11:05

You should touch your financing to figure out the value of your project and

Â you cannot touch r.

Â R belongs to the world.

Â [LAUGH] It's not yours.

Â Okay, so anyway, so what is the p naught now?

Â Div 1 over r minus g, which is equal

Â to $3 over good old 0.07,

Â which is also equal to $60.

Â 11:33

So what has happened to stock price?

Â It's gone up from how much to how much?

Â Before this announcement it was 50, now it's 60.

Â A 20%, 10, sorry, 10 over 50, yeah that's right.

Â A 20% increase in stock price which is phenomenal.

Â What does that 20% reflect?

Â A continued strategy of picking great projects.

Â Right, that's what's built in for simplicity in this model.

Â Can you have a growth strategy that lasts for a little bit?

Â Yes, that's the real world.

Â But this is simply to show you that this is good growth.

Â Why?

Â Because it's actually generating value.

Â Remember the value is in the stock price, not in the cash flow.

Â 12:49

Why is that?

Â I think it's a function of simply the fact that our horizons are too short.

Â And people call this myopia, people call this selfishness, whatever.

Â I think it's simple fact that we have an agency problem.

Â And anybody I talk to agrees that it's very tough to measure but

Â it's all over the place.

Â What does that mean?

Â That we manage wealth creation for

Â our shareholders who are all over the world now, and

Â many are not even participating, cannot even participate, and we, the managers.

Â And that's why I love teaching at a business school is because we are,

Â things are changing and people are becoming aware of this.

Â That we, without even knowing it leave alone cheating,

Â have a much shorter horizon.

Â And we try to worry about the short run.

Â And what policies will you prefer if your salary is based on the short run?

Â I'm not saying you should, many people do.

Â So if you're ethical, you look for the long run.

Â And I'm sorry I'm use that word, but yeah, good people care about the long run.

Â And the reason is, not because they are good people,

Â because they recognize they're working for an entity that's longer than that.

Â However, the pressures are growth, growth, growth, and flow wrong.

Â 14:15

Could be good or bad.

Â I just told you, and it's very simple to figure out how good or bad.

Â But in reality it can be difficult, because firms do tend to be,

Â in spite of all our assumptions, kind of black boxes.

Â 14:30

And it's tough to get all this information.

Â And many times you make bad decisions and grow bad.

Â I'm more worried about the systematic growth focus on cashflows.

Â Now this in the real world, is this only corporations?

Â 14:48

That's the part which I'm not sure about, and I disagree with in the public debate,

Â is that yes, corporations grow, have a focus, but look at our government.

Â Look at the whole nation.

Â What do you read in the press everyday?

Â Growth and what?

Â 15:24

So you can have a binge by putting a straw inside the Earth, right?

Â And grow really fast.

Â But then you come to a point, where there is nowhere to go.

Â So that's the point is that don't be so focused on the flow.

Â Sorry I'm, because the value creation is not easy.

Â And on top of it, if there is perverse incentives or

Â whatever to grow the flow you can make really bad decisions.

Â