Economics 101

I thought I'd toss in an economics 101 primer for any of our new friends from US New & World Report or NAM who happen to stumble by after reading the article on the state of American manufacturing.  As background, you ought to read the article from CNN letting the world know that the leeches and bottom dwellers who make their living on Wall Street pulled down an average of almost $300K last year each.  That's not what the big boys at the top made - that's the average for everybody who claims to work in the securities business on Wall Street.

I know that numbers can be kind of grueling, but please bear with me for a moment.  Toyota has a market cap - its value on Wall Street - of 184 Billion dollars.  They make money by the dump truck load, every year, without fail, and they do it as a result of the most phenomenal manufacturing focus and capability the world has ever seen.  418,400 shares of their stock were traded today and, over the last year, the value of a share of Toyota has been $105 plus or minus 18%.  With me so far?

On the other side of the coin we have GM.  Their market cap is a puny $18 Billion - 90% less than Toyota.  By comparison, they are a mom and pop outfit.  As amazing as it may seem, this nickel and dime outfit had 7,256,200 shares of their stock traded today - 17 times as many stock trades as Toyota.  GM's stock has bounced around its mean by 31% up or down over the last year.  On tenth the value, 17 times the trading volume, nearly twice the stock price volatility

Did you catch the difference?  Toyota manufacturers very well, very methodically, very predictably, and is boringly consistent.  GM is out of control, jerking factories up and down selling subsidiaries, rolling out press releases, strategic plans and model ideas.  Who knows what they might do next?  Whatever they do, it will happen before the end of the quarter when Wall Street next passes judgment on them.

The boys and girls who made $300K apiece love GM because they make money when you trade.  It really doesn't matter whether you buy or sell, or whether GM makes money or not.  As long as GM is volatile, Wall Street make money.  They can't make any money on Toyota, however.  Even though Toyota is ten times as valuable and infinitely more profitable, their stability makes it impossible for Wall Street to make any money on them.  With their stability, there is almost no chance of a wild short term swing in stock price, so you can only make money on Toyota stock if you buy it and hang on fro the long steady upward climb everyone knows they will make.  GM, on the other hand, might go up or down by a huge amount - maybe even tomorrow - so a short term trader just might get rich on them. 

17 times as many stock trades means Wall Street made 17 times as much money on GM than they did on Toyota today.  Warren Buffet has often pointed out this scam perpetuated by Wall Street.  If you invest $100 in stock, and trade it for some other stock every quarter, and each time you buy and sell you pay a total of 4% commission, your initial $100 has dropped down to $85.  You have to get a 15% return on your investment just to break even.  The Wall Street folks, of course make out like the bandits they are - to the tune of $300K a year, in fact, on the strength of all those commissions - and you put enormous pressure on GM to do something spectacular and immediate so you can get that 15% back and then some.

You don't put that pressure on, of course, because you can't.  But there are plenty of hustlers and shysters like Kirk Kerkorian around to do it for you.  While the stoic guys running Toyota sit in Tokyo as stone faced as the Buddha when quarter ends come and go, American execs go crazy doing whatever it takes to keep their stock rolling to satisfy you and the Kerkorians of the world who only make money on the short term churning and rolling of the stock market.  Toyota, on the other hand, could care less if you buy or sell their stock today - they are going to keep on doing what they do no matter what you do or what Wall Street says.

Of course, the execs are willing participants in the Wall Street fiasco.  Their compensation is tied to short term stock prices.  At the end of the year, four months before Ford and GM went into junk bond status, Bill Ford collected $10 million and Rick Wagoner put $5 million in his pocket - all from stock options.  Hundreds have played it a little too sharp lately, prompting the Feds to start hunting stock option back-daters down and throwing them in jail.

Manufacturing is a long term proposition.  A transformation from traditional manufacturing to lean takes five years for a decent sized company. No problem for the guys at Toyota who snicker up their sleeves at American execs and Wall Street.  No way for American publicly traded companies ruled by Wall Street.

The solution is pretty simple.  Ross Perot pushed it in 1992.  Put a sliding scale on capital gains taxes.  100% tax for the gain on any stock sold within a year of buying it - dropping down to zero in five or six years.  That would bring the trading and churning to an immediate halt.  Folks like Kerkorian would have to find a new shell game to play, and people who plow money into companies would be more concerned with the long haul - putting their dough into outfits willing to sign up for that five year journey to Toyota-like excellence.

But that would also gut the bank accounts of the bottom feeders on the Street.  With every Republican in Washington in their hip pockets, and 2/3 of the Democrats, that ain't gonna happen in our lifetime.  And that's why public companies don't become lean.  Wall Street doesn't make any money on lean manufacturing. The public companies play the Wall Street churning game and outsource instead. 

Comments

[Mark Jaeger]

Bill comments:

"While the stoic guys running Toyota sit in Tokyo as stone faced as the Buddha when quarter ends come and go"

My recollection is that Toyota's executive offices are in Toyota City (known until 1959 as Koromo) in the Aichi Prefecture about an hour from the "big city" of Nagoya.

Regardless of which place the Board meets, we have confidence that they are focused on the long haul, not the next quarterly statement. Stability, in the form of Standard Work, forms a cornerstone to the Toyota Production System. Without stability, kaizen is impossible, because any delta in results might otherwise arise from variation rather than measurable improvement. Likewise, seeking stability in the financial markets implies the ability to improve Toyota market capitalization through controlled experimentation (with PDCA applied).

[Bill Waddell]

You're right, Mark. I had the mood right - stoic and stone faced as the Buddha - but I put them in the wrong town.

[Costikyan Jarvis]

Great post and another example of why family owned manufacturing firms are the way to go. We have the long term vision that is required to support our customers and employees. Only problem is that we have to reduce investments to pay punitive estate taxes - if only those people in Washington would understand that the money spent on estate taxes would be better spent on creating and protecting jobs!

[Joe Cappello]

What always struck me about Toyota is their overall attitude toward work. Lean is merely an indicator of a greater belief that work is all about commitment and attentiveness to the task at hand. It is as though work is not just what they do during the hours they show up at work but a reflection of something much deeper. It’s more than being focused; it’s an intrinsic belief that their is something noble, perhaps even spiritual in the individual’s work and his/her relentless pursuit of “perfection” as proclaimed in the doctrine of TPS.

[Costikyan Jarvis]

An interesting article about stock options and CEO was written on the front page of the C section in the Wall Street Journal dated 10/18/06.

Verizon is moving several of their executive's compensation packages from stock performance to "attaining certain strategic objectives".

Now the amounts may not be justified, but the concept is great. Verizon has decided that they want fiber optics to every house and they are willing to suffer short term erosion in profit to achieve this goal. They also seem to have the vision to align their senior executive's compensation to customer related issues (new products and services) versus Wall Street related issues (stock price). The Verizon spokesman is quoted saying "it's a provision to make sure we do the right thing for the long-term health of the company".

Now what would happen is GM's management's pay was based on customer satisfaction surveys?

[Barry "aka the Hillbilly"]

I saw the cnn article also Bill.

I was thinking about it when your Economics 101 post showed up. It did a good job of putting all the pieces together, nice work !

I can't add much to what you have said. It pretty well says it all. I will add a little bit. It comes from Roger Lowenstein's Introduction to "Buffett-The Making of an American Capitalist". Here is the short quote.

'As an investor, Buffett eschewed the use of leverage, futures, dynamic hedging, modern portfolio analysis, and all of the esoteric strategies developed by academics. Unlike the modern portfolio manager, whose mind-set is that of a trader, Buffett risked his capital on the long term growth of a few select businesses. In this, he resembled the magnates of a previous age, such as J.P. Morgan, Sr.

But the secretive Morgan was a Wall Street Archetype, Buffett a plainspoken Midwesterner, was its antithesis. He was famous for quipping that it was the bankers "who should have been wearing the ski masks" or that, as he said to a friend who had been offered a job in finance, "you won't encounter much traffic taking the high road on Wall Street."'

I guess the only thing I would do to that quote is to throw the Brokers in with the Bankers.

I think in some ways what Warren has done and what Toyota has done has some similarities. They both recognized what Value really is and is not. They both didn't mind what everyone else was doing. They had the belief that they were right in their thinking and they stuck to their guns for a very long time. Nobody paid much attention to them for a very long time. Everyone was too busy reading the analysts Quarterly consensus reports I suppose.

It might even be that Toyota has a higher overall rate of Wealth creation over the last 50 years than Warren. That in itself would be quite a feat. I think Toyota's Market Cap is larger than Berkshires currently. And they did it based upon their convictions !