Creating True Value

The obvious problem with earnings is that actual financial results are always a lagging indicator. They provide considerable insight into past performance, but little insight into whether a change in financial performance — and investment outcomes — is lurking just around the corner.

The more serious problem is that earnings can be ‘gamed’ so easily and successfully (though not indefinitely). Companies can temporarily boost profits/earnings in ways that mask, and even sap, their long-term prospects. Inevitably there comes a day of reckoning. Investors are left holding the bag. Beyond these practical issues, a narrow preoccupation with earnings flows from a flawed conception that the purpose of business is to make money. God’s intent is something larger and better. He intends business to create value and blessing for humankind. Companies who do this well achieve earnings that grow attractively and sustainably.

Eventide invests in companies who we believe are especially good at all of this — companies who are exemplary at creating the value and blessing God intends through business and, as a consequence, at achieving the attractive, sustainable returns that come as a reward.

Moral/ethical fund managers believe that the products of certain companies make them morally, or socially, inappropriate investments. Put simply, they believe these companies provide products that cause harm and should, therefore, be considered ‘bad’ companies — and off limits for investing.

‘Socially-responsible’ managers tend to exclude companies whose products/practices do significant environmental or social harm, e.g., a strip-mining company, or an armaments firm. ‘Morally-responsible’ managers, typically operating from a Christian perspective, characteristically exclude companies involved in abortion, companies who pointedly support gay marriage efforts, and traditional ‘vice’ industries like gambling, pornography, tobacco and alcohol. Note, however, that once the moral/social managers apply their respective exclusionary filters, they then join with conventional fund managers in focusing the bulk of their investment decision process on earnings.

Eventide is sympathetic to the ‘responsible investing’ viewpoint, but would offer three critiques:

• The ‘avoid companies who cause harm’ perspective is good, but the exclusionary filters approach falls well short of weeding out all the companies who do harm. So, for example, no ‘responsible investing’ filters were excluding Countrywide Financial or Bear Stearns in 2008, yet these firms and others were operating predatory business models that caused great harm to many. Not coincidentally, their investors were harmed badly as well.
• Simply articulating what one won’t invest in falls well short of a thoughtful, coherent investment strategy. The problem is analogous to equating the Bible to a list of proscribed behaviors. The Bible does proscribe behaviors, of course, but only as a step toward helping people embrace something higher — love as their overarching guide and purpose. Similarly, thoughtful Biblical investing involves not merely avoiding ‘bad’ companies, but actively joining with companies whose products and practices best accomplish the good God intends through business.
• As noted previously with respect to conventional investment managers, a narrow focus on earnings reflects a flawed conception of the purpose of business. God’s primary intent is that businesses create (various sorts of) value and blessing for humankind. A preoccupation with earnings implies the opposite idea — that creating value for customers and society is a secondary priority, simply a means to the real end of business, making money. Such a conception subverts God’s intent and regularly leads business people, and investors, astray.

Eventide Investing Objectives:

• Flowing from a Biblical understanding that business is divinely intended to create value and blessing for the world, Eventide rejects a narrow focus on earnings as the basis for investment decisions. Rather, we seek to support companies who best fulfill God’s purpose, i.e., who truly create the great value and blessing that God intends through business — and achieve the attractive, sustainable returns that come as a reward.
• Eventide agrees with the viewpoint of moral/ethical fund managers that the products and practices of some companies cause harm — and, therefore, should be avoided by responsible (and prudent) investors. But we take issue with a limited ‘exclusionary filters’ approach because it fails to identify many of the companies whose business models bring harm rather than blessing (note on the Eventide Investment Assessment spectrum the many more ‘bad’ companies to avoid once ‘harm’ is more thoroughly and thoughtfully assessed).
• We also believe that a ‘do no harm’ orientation toward investing falls well short of what responsible investors really desire, and woefully short of investing’s great potential for good in the world. By way of analogy, the medical ethics dictum that is often inaccurately quoted as ‘do no harm,’ in fact says ‘first, do no harm.’ In other words, ‘do no harm’ is simply the starting point for medical practice, not the end point. Fortunately for all of us, doctors don’t stop at avoiding harm; instead they strive to practice their profession in ways that magnify and maximize blessing. Nor should investors believe that doing no harm is an adequate guide for good, much less biblical, investing. Rather, truly wise investors will seek out and support companies whose products and practices create great value and blessing. In doing so, they help bring about a better world, and they benefit from the God-blessed returns that come as a reward.

An Additional Thought:

In the broad middle of the Eventide Investment Assessment spectrum, thoughtful viewers may question how accurately one can really assess where a company should rank and, in particular, how easy it is to precisely distinguish the ‘Poor’ companies from the less ‘Bad’ companies. We agree. We happily leave to others the unrewarding task of determining which mediocre companies may be slightly better, or worse, than others. Eventide has a higher and more rewarding goal. We strive to identify and invest in the standout companies — the ones in the highest echelons of value creation and blessing. These companies wonderfully fulfill God’s purpose for business and, in the process, create attractive, sustainable value for investors as well.

Notes on the 360 Assessment Framework:

• Just to be clear, Eventide does not currently create a 360 Impact Map for companies. Rather, the 360 Assessment is meant to convey, simply and visually, our philosophical framework for evaluating companies as investment candidates. Companies, through their products and practices, impact several distinct constituencies, or stakeholders, comprising: Customers, Employees, their Supply Chain, (Host) Communities, the natural Environment, and Society at large. In each case, the impact may be for good, or it may be for harm, and to varying degrees. Eventide believes that responsible -- and wise -- investing requires looking at the entirety of these impacts. In total, these impacts reveal the true nature of a given company’s value creation (or extraction) model.
• The majority of companies tend to fall in the broad middle range of impacts (ie, around the neutral or “0” range). They create little or no outright harm, fortunately, but neither do they create substantial good (blessing).
• Some companies, of course, create egregious harm, e.g., a tobacco company whose product kills its customers, or a subprime mortgage company who blithely promotes re-fi products to people who, all too often, lose their homes as a result. Companies whose products or practices extract value are, in various ways, acting exploitively — they are making money by taking rather than serving. Scripture labels this “plunder,” and makes clear that a severe day of reckoning is always in the offing. But even for investors without an expressly biblical, or ethical, perspective, the problem with plunder as a business model is that it works really well . . . until it doesn’t. So, for example, robbing banks offers a lucrative economic opportunity: short work hours and high income — until it suddenly, emphatically stops working when one is caught or shot. The same is true for businesses that extract value. Economic returns can be quite attractive, temporarily. But plunder is inherently an unsustainable endeavor and unwary investors end up paying a high price for their part in the plunder process.
• Fortunately, there are companies who are the polar opposite. They make attractive — and sustainable — returns precisely because they create great value for the customers and other constituencies they serve. The 360 Assessment framework serves as a guide to help us identify and invest in these companies. Eventide believes this is truly ‘better investing . . . for a better world.’

The first question the 360 Assessment brings to mind for many investors is ‘why aren’t shareholders represented on the 360 Impact Map?’ After all, aren’t shareholders at least one of the important constituencies that business should serve? Very good question. The answer is slightly subtle — and terrifically important. First off, we want to make clear that shareholders should appropriately expect to benefit from their ownership investments. Part of the ‘magic’ of capitalism is its ability to funnel self-interested capital to business through public ownership.

But here’s the slightly subtle part: when business pursues directly its own/shareholders’ financial betterment, its actual ability to deliver shareholder gain deteriorates. When, instead, business focuses on creating value for others, its ability to deliver sustainable, long-term earnings grows attractively.

Roger Martin, dean of the University of Toronto business school, discusses this thoroughly and empirically in his excellent book, Fixing the Game. His conclusion: pursuit of shareholder value maximization doesn’t maximize shareholder value. Even on its own terms, pursuing shareholder value directly doesn’t work.

Why is that? To quote Steve Denning, a business author and Forbes columnist who writes regularly on this topic: “A [direct, priority] focus on maximizing shareholder value leads firms to do things that detract from maximizing long-term shareholder value, such as favoring cost-cutting over innovation . . .pursuing ‘bad profits’ that destroy brand equity, and excessive C-suite compensation”. The result can be seen in the disastrously declining ROA and ROIC over the last four decades (the same time period during which ‘maximizing shareholder value’ became the prevailing paradigm for many corporations) in large US firms as documented by Deloitte’s Shift Index.

Fred Reichheld, a Fellow at Bain & Company and founder of their Loyalty Practice Group, discusses much the same idea in his seminal book, The Ultimate Question, published in 2006 by the Harvard Business School Press. His comprehensively empirical conclusion: companies who prioritize creating customer value, and treat profits and shareholder return as a byproduct, achieve decidedly superior growth and profitability versus companies who focus directly on financial return.

The Eventide Business 360 Assessment reflects, and extends, that same understanding. When business serves well its customers, and its other constituencies, it prospers attractively and sustainably. But when its focus turns inward, when it seeks first to serve its own/shareholders’ financial interests, it loses its ability to make money by creating value for others. In fact, it begins to move from value creation toward value extraction — and starts a slow slide toward toxicity.

For readers of Scripture, this should all have a familiar ring. Jesus famously says in the Gospels, “Whoever wants to save his life will lose it, but whoever loses his life for me will find it.” Jesus here gives insight into the fundamental contrast between the way the people of ‘this world’ understand life and its dynamics versus the way God understands life and the way he has, in fact, structured its operational dynamics.

Paraphrasing broadly, Jesus says, “I know that you have an instinctive bias toward your own happiness, and a belief that pursuing your (seeming) self-interest is the surest, most direct way to that happiness. But don’t be misled, that pathway actually leads to ruin. Fulfillment, happiness, prosperity all lie in the opposite direction. Seek first to serve others. You will be a blessing to them and will find — counterintuitively, and by God’s grace — your own life richly blessed as a result. Service, not selfishness, is the true pathway to life and blessing.”

So, is profitability/earnings important? Absolutely. Can a business serve its own and its shareholders’ interests well by prioritizing the pursuit of profits/earnings? Absolutely not. The Eventide Business 360 Assessment, therefore, focuses on the constituencies business is called to serve directly. When business does that well, its shareholders are blessed in turn.