[PDF] FINANCE DENTREPRISE de Pierre Vernimmen

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10 everlasting truths in finance

Pascal Quiry

Moscow, April 22, 2010

www.vernimmen.com 2

1. Divorce is not allowed in the Risk-Return pair

www.vernimmen.comThe higher the return the higher the risk incurred. A higher return without a higher risk incurred is a mirage. Sad but compelling!

In %2001 2002 2003 2004 2005 2006 2007 2008 2009

Return on equity UBS

investment banking division6% 9% 25% 26% 29% 29% - 63% - 128%- 124% 3

2. Over the long term, ROCE converges towards WACC

www.vernimmen.comMichelin, the world leader in tyres.

Why? Competition

All the more time if it is a mature company.

2000 2002 2004 2006 2007 2008 2009

Return on capital employed 6% 7% 8% 7% 10% 5% 4%

Weighted average cost of capital 7% 7% 8% 7% 8% 10% 8% 4 www.vernimmen.com3. Debt does not create value per se

Except when:

• interest rates are negative after inflation (lenders are despoiled). See Europe and the USA in the

60s and the 70s.

• debt put pressure on managers to out-perform.

Source of value creation for LBOs.

5

4. Cash is king

www.vernimmen.com Because a company goes down if it is lacking cash. Because a liquidity crisis represents a unique opportunity to buy assets on the cheap.

Because cash is truth. Mr. Madoff would still be in business if he had not some minor cash issues end of 2008.

Because the easiest way to solve complex financial problems is to analyze them in term of cash flows. 6

5. EV / CE > 1 ROCE / WACC > 1

www.vernimmen.com The entreprise value (EV) of a company can only be higher than its capital employed (CE) if its return on capital employed is anticipated for several years to be higher than its weighted cost of capital (WACC).

W ACC ROCEEV / CE

A pple10% 318%44

L'O réal7%18%4

X 512%16%3

RBS11%- 3%0.8

7

6. Diversification

per se does not create value www.vernimmen.com• In most emerging markets, conglomerates are the rule of the game as financial markets are not well developped and conglomerates are a substitute for them (internal capital markets). • Diversified groups allow founding entrepreneurs / families to keep control and to diversify their wealth. • On a long-term basis a diversified group can only survive if it demonstrates that nobody can manage its assets better than itself: e.g., General Electric, Bouygues. Counter examples: Hanson, BTR, ITT, Gulf and Western,

Lagardère, etc.

8

7. WACC is only a function of the risk of operating assets

www.vernimmen.com• The weighted average cost of capital (WACC) is the weighted average cost of debt and equity, weighted by the respective share of debt and equity in the capital structure of the company.

• Increasing the debt weight whose cost is below that of the equity (because it is less riskly for investors) does NOT reduce the WACC.

• Most of the time it increases the ROE, and systematicaly the risk of the capital structure of the company.

• If debt had the power to reduce WACC, the most successful companies in the world would be debt loaded.

• Most of them are debt free: Apple, L'Oréal, BMW, etc. 9

8. Accounting is not finance

www.vernimmen.com• Finance does take into account the future and hence risk, contrary to accounting which limits itself to the past and the present and ignores risk. • Which means that indicators that seems to be financial but in fact come from accounting like Earnings Per Share (EPS), Return On Equity (ROE), can be manipulated: an increase in EPS or ROE does not necessarly translate into an increase in value if it is explained by an increase in the riskiness of the activity or the capital structure. 10

9. Beware of tax fascination

www.vernimmen.com• Taking financial decisions guided only by tax considerations is a recipe for disaster. For example keep on holding shares a few more months so as to get a tax break because the holding period would be long enough expose you to the risk of a market crash in the meantime. • Granted there are more pleasant things in life than paying taxes. • Better to take a financial decision and then try to optimize tax parameters. 11

10. The only efficient regulator for capitalism is crisis

www.vernimmen.com We are all human beings with feelings like hope and fear that regularly translate into booms and busts. There is nothing we can do about that.

There have always been crises in the past.

Paris Stock Exchange index since 1854 (dividends reinvested)

Source : Le Bris David et Hautcoeur Pierre-Cyrille.They will be there in the future too. Investors and managers need to keep that in

mind and act accordingly.

100 1 000 10 000 100 000 1 000 000

1854
18 58
18 63
1 868
1 872
1877
18 82
18 86
18 91
18 96
19 00 19 05 19 10 19 14 19 19 19 24
19 28
19 33
19 38
19 42
19 47
19 52
19 56
19 61
19 66
19 70
19 75
19 80
19 84
19 89
19 94
19 98
20 03 20 08

Logarithmic scale

1 313 306

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