Romney is Right: Culture is the Difference

By Jonathan Yates - August 10, 2012 | Tickers: XOM, ITW, INTC, MSFT, TRV | 0 Comments

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Mitt Romney was right: Culture is the difference.

That is applicable for the economic success of a country or the failure of a company.  Investors should look for publicly traded companies that have a culture of enhancing shareholder value through superior total returns.  While there are many factors to consider, the most important is for firms to be profitable with superior returns-on-equity, high dividends and low, if any debt.  Prominent among these companies are Exxon-Mobil (NYSE: XOM), Microsoft Corporation (NASDAQ: MSFT), The Travelers Corporation (NYSE: TRV), Intel Corporation (NASDAQ: INTC), and Illinois Tool Works (NYSE: ITW).

The success of the culture of a company is ultimately demonstrated in its bottom line, the profit margin.  That is what it is all about: there in no other reason to have an initial public offering unless a company aspires to be profitable enough to attract enough enough investors so that the share price will rise.  This point was made very well in the play, "Other People's Money." 

In that play, Larry "The Liquidator" Garfield is pursuing New England Wire & Cable for the sole intent of making a profit by selling off its assets.  While Larry "The Liquidator" is as odious a figure as can be in the world of finance, he was always intent on maximizing the returns of his investors.  Andrew "Jorgy" Jorgenson, head of New England Wire & Cable, was more intent on honoring the memory and work of his father, who founded the company. 

The very moment that New England Wire & Cable went public and took "other people's money" was when the culture should have changed from honoring the founder to enhancing shareholder returns.  Jorgy did not adapt to that evolving culture imperative.  As a result, he suffered the tragic consequences of having other shareholders vote with "The Liquidator" in the struggle for the control and the destiny of New England Wire & Cable.  If the culture of New England Wire & Cable had emphasized shareholder returns rather than remaining a tribute to the founder, the ending would have been different and much happier for Jorgy.

At Microsoft, the high tech behemoth, that culture results in a profit margin of 23.02%.  For Intel, the margin is 22.73%.  Illinois Tool Works, a diversified machinery company, posts a profit margin of 10.64%.  The Traveler's Corporation has a profit margin of 8.84%.  The world's biggest oil company, Exxon-Mobil, has a profit margin of 8.28%.

Along with a high profit margin, a superior culture should lend itself to a high return-on-equity (ROE) for a company.  ROE directly measures the how well the company is performing in generating returns on the shareholders' equity (assets created by paid-in capital and retained earnings).   According to Foolsarus, the ROE "... is a profitability ratio. In most cases, businesses will be managed with the intention of maximizing its return on stockholder's equity."

The average ROE is around 15%.   For Microsoft, the ROE is 27.51%.  The ROE for Exxon-Mobil is 25.84%.  At Intel, the ROE is 25.42%.  Illinois Tool Works has a ROE of 18.79%.

One of the most important components of the culture of a company for an investor is that the profits are shared through a healthy dividend income.  According to legendary investor Jack Bogle, founder of Vanguard group and creator of the world's index mutual fund, in his book, Enough, dividend yield has accounted for over 40% of the historic return of an equity.  At present, the average dividend yield for a member of the Standard & Poor's 500 Index is around 2%.

Dispelling the myth that high tech firms do not pay dividends, the yield from chipmaker Intel is 3.38%. The insurance giant Traveler's provides its shareholders with dividend income at the rate of 2.88%.  Dividends flow from Microsoft at a 2.64% clip.  Exxon-Mobil pays a dividend of 2.58%.  At Illinois Tool Works, the dividend yield is 2.53%.

Another important part of the corporate culture is a sustainable dividend framework.  While the average dividend payout ratio, cash from earnings going to the shareholders, has been around 50% historically, each of these companies has a ratio far beneath that level.  Not only does that represent sound corporate management, it allows for dividend growth in the future and stock repurchase programs to enhance shareholder value.

Just as a culture that rewards its shareholders with dividend income is important, it is critical that a little of the cash flow goes to creditors.  Too much debt is crippling, particularly in the inevitable downturn.  In addition, heavy borrowing can distort the profit margin and ROE, in the short term.  For Exxon-Mobil, the debt-to-equity ratio is only 0.10.  Intel only has a debt-to-equity ratio of 0.15.  The debt-to-equity ratio for Microsoft is 0.18.  It is 0.25 for The Traveler's Corporation.  Illinois Tool Works has a debt-to-equity ratio of 0.49.

While each of these companies is in a different industry, all have a culture that values success as demonstrated by the strong profit margins and solid ROEs.  This bounty is shared with the owners of the company, no matter if it is a major institution or individual investor, with above average dividend income, from a modest payout ratio that allows for future growth from ample cash flow.  The low debt-to-equity ratios assure that the company capital goes to increasing operations to return for more profits in the future to reward shareholders rather than paying creditors.

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