Is the Horse Dead Yet?

This will be the last blog about “free lunches” and the supposed good deals they represent! The last item I will tackle are the BOGO concepts – some are Buy One Get One 50% off – some are the Buy One Get One free version.

There is not time to go into all of the differences and mechanics in one blog, so I am going to pick retail store merchandise. Margins on goods purchased by stores for re-sale range from 500% (and sometimes more) to 200% (and sometimes a bit less if a store chooses to carry what they term as a loss-leader). An average retailer mark-up is in the 300% + range. They use this because they know some items will be returned as defective and some will be returned but can be re-sold. Retailers also have to cover staffing, buildings, etc. – which are expensive!

In the ideal world, the many buyers working on behalf of the retailers will guess “correctly” about future styles and demand – and well-trained ones get pretty good at it – but no-one bats 1000. The next issues shipment JIT – Just In Time – the manner in which automakers try to function. When customer demand underperforms the buyers’ purchase assessment, inventory remains on hand or in a wharehouse. If JIT shipping is not an option, then very large amounts of wharehouse space is required – particularly for large appliances and furniture.

Wharehouses are a pure COST item – they never generate revenue and neither does product inventory sitting on a shelf.

So as in many things, timing is everything. When timing is off – whether demand or shipping, costs are incurred and many times, it is cheaper to sell of items – allegedly at “below cost” to clear mis-calculated consumer demand items or unplanned shipments – hence BOGO came along – but remember the average 300% markup – so even BOGO 50% gives the retailer a 225% markup net over 2 items – so they are still OK. BOGO 100% still gives a profit, although it is down to 150% net over 2 items.

The point is, sale costs – even 50% off – are built in to their initial costing of items – no-one can get fashion, demand and delivery 100% bang on the numbers – so “fudge factors” are included along the way. Sales that are 60% off are still not $$ losers for the retails – although much better pricing for consumers! Take an item costing $10.00 – the 300% markup places it on the shelves at $30.00, BOGO 50 results in 2 items sold for $45.00 against 2-item cost of $20 – they still have a markup of 225%. BOGO 100 results in 2 items sold for $30.00 versus a cost of $20 – markup is now $150%. An 60% discount takes the $30 item down to $12.00!

Keep all of this in mind when looking at the next big BOGO sales!

Investing Is Tough Stuff

By: Don Shaughnessy

Profit is a poor proxy for success and investors should not rely on the number without considering other facts.
Strangely a business can become bankrupt while it is profitable. This profit ambiguity causes problems for business owners, managers, policy makers and investors.
What do you mean by profit?
Suppose an incorporated business earns $1,000,000 using the tax rules and generally accepted accounting principles (GAAP) In Ontario, the tax bill would be $220,000 leaving $780,000 to invest. Clearly profitable!
BUT, only within the system of GAAP and taxation. In the real world, the result might well be very different.
Suppose the business must invest $1,500,000 to remain competitive in its industry, (same market share and same technology as the leaders in the industry.) Did it really make a profit or did it really lose $720,000?
The economic answer is it lost $720,000, and even that is not simple.
By investing the profits and borrowing, the business continues to exist and possibly a weak entrant in the industry will become weaker still and succumb. So the true long-term economic loss is actually somewhat smaller. Maybe a lot smaller and possibly not a loss at all. Some of the cash loss is an investment in future market share.
Management faces the task of deciding if they will survive long enough to benefit. Especially true if the government bails out the weak ones.
For those looking at profit alone, other expenses matter too. Marketing, advertising, R&D, employee training and more, pay off over long periods but have immediate cost. Good for tax expense but hard for the analysts to validate. Some other expenses, like pensions, have a visible price today but an unknowable future cost.
In both accounting and taxation, profit is not the result of facts but rather is the result of rules and opinions. Things like depreciation rate, inventory and product obsolescence, bad debts, investment rate to be earned on the pension fund, future technology effects and more.
As an investor, is there anything at all to be gleaned from the financial statements?
In most cases, it makes sense to pay attention to the management letter. I know a high performance fund manager who looks for the words challenge or challenging in that letter. If he sees either he throws the statement away. In his words, “I have only limited resources, so why would I invest with people who have challenges?”
When looking for an investment, use commons sense first. I like the product, I like management, I like the industry and so on. Then look at the numbers.
• “Cash is real, profit is opinion.” Or at least cash is more likely to be real because you go to jail if you fool with it. Not so much with profit.
• Look for dividends. They impose a discipline on management and the cash paid out reduces the homeless dollar problem. When management finds that problem, some pretty dodgy projects get funded.
• When things go wrong, quit quick. Holding losers and waiting for recovery is a losing tactic. The price of tulip bulbs, which peaked in Holland in February 1637, has, as yet, not returned to that high.
Good look!
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.