Hi. We took this last piece, was the shortest segment out done in my book. Of
course, you, you may have shorter segments by design in the way you have chosen to
break up the learning. So, a quick question. Let's try to figure this out. I
have two, two, two, questions here. What are the growth rate of the policy? And
I'll give you a hint, and actually we did it together. Is that, if I'm not
reinvesting anything, the growth rate is zero. So if I'm reinvesting 70%, it has to
be a function of that 70%. And for convenience, we are going to do it on an
ongoing basis. But the, deeper question is, what will happen to the share price?
And here is the tragedy of the world. And let me just now spend some time. Growth
here is greater than zero. In fact, it is equal to b times ROI and it was seven%.
Let me first tell you, if you grow at seven% any business, forever you have
arrived, you know, it's, it's not possible. It's not possible. You can grow
very fast for a short period of time but after that, you've got to slow down and
that's, the main reason is, the competition. I mean that's why we have
laws that monopoly, if you're really good at what you do, you tend to become a
monopolist. But sometimes, in fact I would say, many times, you become a monopolist
by actually screwing the customer. So I just want you to recognize that seven%
growth is really, really difficult. Now, people see this and say, what will happen
to price? So, suppose we are standing today. What was the price already? 50
bucks, no growth. The generic answer to this is, price will go up because of this,
and the answer's wrong. I don't know, you, you, probably most of you are very young
to know about cholesterol, right? So, turns out, there is two types of
cholesterol. First, everybody thought cholesterol was bad. No. There's a good
cholesterol, and there's a bad cholesterol. Unfortunately, though there
is good growth, there is bad growth too. So let's look at the scenario, okay? So,
what will the pricing be? New price. Dev one over r minus g. I'll firs t do the
formula, and show you the numbers and then I'll tear it apart and tell you what the
heck is going on. And the tearing apart is not difficult, okay? So what is the first
dividend? Remember, how much of this, how much of the cash flow. Free cash flow was
how much in the first year? Six bucks. How much of it did you take and put back in
the firm to create this growth? To create this growth, how much of this did you
take? 70%. You cannot therefore have dividend two of six bucks anymore. So, you
see the trade off? For growth to occur you have to give up something. You, who's you?
You're the shareholder, right? I mean. So what is 30% of six bucks? 1.8 And I'm not,
this is not magic, right? So, 70%. So, one minus b times six I believe is 1.8, right?
So what have we done? You have, and this is true of any growth. You'd be willing to
give up some dividend next year for some exciting things the firm is planning to
do, but what is the r of the firm? Nothing to do with the firm. We are in the same
business, or in want to. And what is the g? .07. What's the answer to this? You can
do this in your head, and that's the easy part..12 minus .07 is what? .05. Dividing
anything by .05 is what? Multiplying it by? Twenty. So the answer to this is $36.
Look at what's happened. The stock price has plummeted to 36. I want to take this
opportunity to explain two things. The main thing I want to explain is, growth
and the earnings is being generated by investing in what? You should be able to
guess. Investing in ideas that are going to earn how much rate of return. Look at
the rate of return built into my formula, into my plan. Ten%. But what is the
opportunity cost of capital? In other words, what are other people in this
business already earning and capable of earning? Twelve%. So, what is true?
Remember, IRR conceptually is not a problem. So let's say IRR. In this case,
it'll work because the cash flows are well behaved. There's no long term, short term.
It's one problem, everything is perpetuity. So IRR, should be greater than
R. What's true here? My IRR is ten%, my R is what? Twelve%. So actually, I'm
throwing money on negative equity projects. So why the heck am I growing?
What is compelling me to grow? Does this happen in the real world? I would say,
yes. Many times, not by design, you make mistakes. But many times, perhaps by
design. And the reason is quite straightforward. The firm is long lived,
the stock is long lived, but the management is short lived by definition.
There's a conflict. Remember I said people use IRR? What projects will you pick?
Projects focused just on the ROI. And you say, oh, ten% is great and you try to go
after it, and generate cash flows that grow. But, having cash flows grow in the
short term is not necessarily value generation. You want to grow cash flows,
but by investing in ideas that are really powerful. That's the first lesson. The
second lesson is, how come today as soon as you announce this, the price drops by
fourteen bucks, which is what? 28%. Fourteen on fifty is a 28% stock price
drop. Do you see such changes in the stock market? Sure. They bounce all over the
place. But this example assumes what? That people know what's going on, that those
are the analysts, and have the courage to kinda dig through the numbers and say, you
know what? If you do this plan, the price will drop for $fourteen. Why? Because the
plan is not value generating, it's quite the opposite. So the reason I'm bringing
up this example is that we are focused actually, fundamentally, on the wrong
thing that's growing. Growth in your assets is what it's all about. That's how
value is generated. Not by growing just your cash flows, okay? So let me continue
now and give you one more example, and then you'll understand what's going on.
Growth scenario two. There is Microsoft that suddenly emerges with a different
alternative growth policy. Always in, obviously in the real world though the two
things can happen simultaneously. But I'm giving you a sense of what are the two
directions growth policy could take. So what's scenario n umber two? Scenario
number two does two things. It says, we are going to grow but we are going to ploy
back 50%. Okay, what was the plow back rate in the first? 70%. And, I have my
ideas are going to earn fourteen%. So the first question is, what is the growth rate
of this policy? And if you bear with me, and as I said, regardless of whether I
take a break or not, you've got to understand this. So, take a break if you
want to, but the growth rate is not tough to do. What is g? Gv now requires some
reinvestment, and that's all, already a fraction and then some ROI. Look, I have
been a little naughty. What's the growth rate? .5 times fourteen%. The growth rate
is what? Seven%. You see why I have been naughty? There is no difference in the
growth rates of the two examples and that's we are fixated on, okay? That's
what we are fixated on, everybody is fixated on growth rate of cash flows. Now
tell me in this case, is it good news or bad news? And you should tell me what
would happen to the shared price. Directionally, and why. You just have to
think very simple. What is your rate of return on these new ideas? Fourteen%. What
is the competition earning? Twelve%. What's going to happen to the stock price
as soon as you make this announcement and people actually believe you can deliver?
Stock price will go up. Why? Because you're, in this scenario, without problems
of IRR are comparison not reasonable, fourteen%, where is greater than twelve%.
Let's do the actual price, okay? So, I'm going to go on to the next page and just
right, next slide, and just give you a sense final of what's going on. Okay. So,
my dividend one is now what? 50% of six bucks in the first period. Why? Because I
am plowing back only 50%, so how much am I left with? 50%, which is three bucks. What
is my growth? Seven%. What is my r? Twelve%. Remember, little r you can't
touch, you can't touch this. That's another MC Hammer thing. You shouldn't
touch your financing to figure out a value of your project, and you cannot touch r, r
belongs to the world , right? It's not yours. Okay? So, anyway, so what is t he
PNOT now? Div one over r minus g, which is equal to three bucks over good old .07,
which is also equal to 60 bucks. So what has happened to stock price. It's gone up
from how much to how much. Before this announcement, it was 50, now it's 60. A
twenty%, ten, sorry, ten over 50. Yep, that's right. A twenty% increase in stock
price which is phenomenal. What does that twenty% reflect? A continued strategy of
picking great projects, right? That's what built in for simplicity in this model. Can
you have a growth strategy that lasts for a little bit? Yes, that's the real world.
But this is simply to show you that this is good growth. Why? Because it's actually
generating value. Remember the value is in the stock price not in the cash flow. Two
very different things. You can hurt your stock price by growing in your cash flows
if you grow the wrong way as in the first example. I hope this has been useful to
you. I want to just wrap this all up, and then we'll take a break and go on the
website again. So I want to now emphasize some issues. Emphasis on growth is on the
wrong thing, it's on the flow. Why is that? I think it's a function of simply
the fact that our horizons are too short. And people call this Myopia, people call
this selfishness, whatever. I think it's simple fact that we have an agency
problem, and anybody I talk to agrees that's very tough to measure but it's all
over the place. What does that mean? That we manage wealth creation for our
shareholders who are all over the world now. And many are not even participating,
cannot even participate. And the we, the managers, and that's why I love teaching
at a business school is because we have, things are changing and people are
becoming aware of this. That we, without even knowing it, leave alone cheating,
have a much shorter horizon and we try to worry about the short run. And what
policies would you prefer if your salary is based on the short term? I'm not saying
you should, many people do. If, so, if you're ethical, you look for the long run.
And then, I'm sorry I us e that word but, yeah. Good people care about the long run.
And the reason is not because they're good people, because they recognize they're
looking for an entity that's longer than them. However, the pressures are growth,
growth, growth and flow wrong. Could be good or bad, I just told you. And it's
very simple to figure out how good or bad. But in reality, it can be difficult
because firms do tend to be, in spite of all assumptions, kind of black boxes. And
it's tough to get all this information and many times you make bad decisions and grow
bad. I'm more worried about the systematic growth focus on cash flows. Now, thus is
the real world, is this only corporations? That's the part which I am not sure about,
and I disagree with in the public debate. Is that yes, corporations grow, have a
focus. But, look at our government. Look at the whole nation. What do you read in
the press every day? Growth in what? Gnp. Now, is GNP a stock out of flow. Gnp is a
flow. It's like the dividend or cash flow of the, all the companies, all the people
added together. Why are we so hung up on it? It's okay to want to grow, but not at
the expense of depleting value. So you can have a binge by putting a straw inside the
Earth, right? And grow really fast. But then you'll come to a point where there's
nowhere to go. So that's the point. Is that, don't be so focused on flow. Sorry
I'm, I'm, because the value creation is not easy. And on top of it, if there's any
perverse incentives or whatever to grow the flow, you can make really bad
decisions. So as I said, it doesn't apply to just companies. It applies to nations,
and it applies to the whole world. I hope you like this. We're going to take a break
and go and I'll show you the fascinating world of how real even stocks are even
though they have not a IOU in my book. There's an open ended invitation to invest
your money and hopefully earn something in the future. Let's take a break, come back,
do some websites an d that'll be this week. Pleasure talking to you.