Ethical Investing
Jason Kuznicki on Nov 28th 2005
As my husband and I work on our stock portfolio, I’m envisioning a number of posts on personal finance. As usual, the comments are open, and I look forward to hearing from you. Do you want more posts like this one? Fewer? None? Be sure to let me know if you have an opinion. (Note that nothing you read here should be mistaken for professional advice, either. I am doing this quite by the seat of my pants, and for the purpose of self-education as much as anything else. Feel free to tell me that I’m all wet if you want, and, if you explain yourself, perhaps I’ll learn something.)
Today I particularly enjoyed this article from The Motley Fool, and I think that absolutely everyone should read it. Here is just a taste; the article overflows with similar insights:
Socially responsible investing falls closest to my heart concerning environmental issues. (I am an environmental engineer by trade, holding a master’s degree in the discipline, and I have nearly a decade of industrial practice.) In the interests of being somewhat provocative, if all investors were to adhere to rigid environmental protection criteria as a screening tool, then there are no companies that would be worthy of our investment dollars. The reason: Commerce always affects (read: harms) the environment. Of course, environmental harm is a bit of a slippery slope, and experts rarely agree on what is harmful…
Perhaps I’ll come off as an unabashed capitalist and proponent of a “let the market decide” line of thinking, but the most environmentally friendly solution may also be the most business-friendly. My former employer was an emitter (a nicer word than “polluter”) of a particular carcinogenic degreasing solvent. It was the second-largest polluter … err emitter … of this substance in Canada in the late 1990s. As the lead engineer on the project, my team and I developed a new process that completely eliminated the use of the chemical from our facility. Quantifying only the savings from chemical purchases and hazardous waste disposal (and there were also productivity and health and safety gains), the project paid for itself in just about four years.
Were our emissions causing environmental harm? Yes, in my opinion. Yet the government regulation in force at the time allowed for 10 times the emissions we were pumping into the air. But it was in our self-interest to implement the project. You see, pollution indicates an inefficient process. That inefficiency has a cost. Competitive businesses profit by driving down costs and earning greater returns on capital.
Of course, the inefficiencies inherent in spilling valuable chemicals around may still be outweighed by the benefits to the polluter, a phenomenon known as a negative externality. Still, the underlying point is correct: It’s not as though companies ever want to be wasteful. The proper way to care for the environment, then, is to make certain that property rights claims are enforceable and that transaction costs in pursuing them are low (for more on this, see the Coase Theorem).
Another paradox of ethical investing emerges when we look at companies that many people consider unethical. Take cigarette maker Altria (formerly Philip Morris). Quite often, investors avoid this stock not for fear of future lawsuits — but because they simply do not wish to be associated with the evil trade in cigarettes.
Yet the market consequences are quite the opposite of what these non-investors probably intend. Rather than punishing the unscrupulous buyers of Altria stock, the large numbers of people staying away from it over the long term means that Altria is a great bargain. Avoiding the company’s stock actually rewards those who buy it.
To understand why, it’s important to recall that stocks generally make invstors money in one of two ways, through share price increases and the payment of dividends. If the share price goes too high, too small an expected dividend return can often drag it back down to earth; conversely, if the share price is too low, more investors will snap up the stock with the intent of gaining a relatively larger dividend, driving the price back up. This equilibrium is a bit depressed in Altria’s case, since a number of investors view accepting its dividend money as unethical. As a result, Altria’s current dividend payment is 4.4% per year, which all by itself compares quite favorably with money market funds. The picture is even brighter for the long-term investor: Over the last twenty years, annual return has been a hefty 21.5%. With enemies like these, who needs friends?
The article’s conclusion speaks to this point as well:
Perhaps it’s cold-hearted, but the purpose of investing is to make as much money as possible. Shunning a particular company’s shares arguably has little effect on the ethical stance of that company, because the money paid for shares doesn’t land in their coffers anyway, but rather into the pocket of the person you bought them from. It may just be more effective to use your ethical discretionary dollars in your direct purchases of cars, food, or other leisure good and activities. So-called distasteful businesses like online gaming, debt collection, or death care are doing well because there is strong end-user demand. Directly affecting that demand will do more to put your own personal ethics into action than buying or selling a stock.
In other words, you do more good by urging your friends, as I do, that they ought not to smoke. Of course, it also doesn’t hurt — and could very well make you a bundle — to bet that they will ignore your advice.
Filed in The Boardroom
Sorry but I think you’re wrong…
Despite the fact that buying stock puts the money in the hands of the person who owned it before you, the stock’s value is based upon the perceived value of that stock–which is affected by the rate at which it is sold, held and traded. How long is it at a stable price? How many shares outstanding? What are the profit projections met by this company? Unless you are a day trader, the more useful concept is are you going to manage this stock for the long term? Are you going to invest in a company that plays the zero-sum game of no dividends or are you going to invest in something that earns you money over time and provides an income stream of its own?
While spending habits may have a larger effect, you as a stock holder also have the not unreasonable ability to address company officials on a completely different level. You get to be the Angry or Happy stock holder. You of all people should know the strength of a well placed letter. ;P
As far as ethical investing, by investing in companies that are not involved in either venture, angel or structured capital investments, you’re already making a mistake in ethical transactionism–you’re supporting the zero-sum game of companies striving to out-perform themselves until they crunch in on themselves or defile the market. If you instead invest in companies that build other companies, you at least support the 80% of companies that actually make more jobs, make more money and eventually make more businesses. As it stands, you’d just be playing a consistent black jack system unless the companies you invested in were actually making new businesses–regardless of how you play, you’ll consistently build your potfolio, but only at the expense of the eventual damage done to the company to satusfy ever harder to attain profit goals. Dell for instance, makes billions of dollars. So many dollars in fact that to make a 1% increase in market share would be a feat beyond measure, but it is expected. Their solution? They shed jobs, they cut corners, and slowly but surely they implode, until some fall guy takes two or three quarters of poor growth in the form of a golden parachute, and then the next guy in line takes an enormous bonus when he sets the system back to rights. Lather, Rinse, repeat, until eventually the company and its industry beg or are forced into regulation that cripples or enthrones some ignoble quality.
Invest in companies that at the very least turn corners. Don’t play the economic Bipolar disorder companies in your portfolio.
Jason —
I’m not sure I follow some of the things you’ve said.
While it may satisfy some ethical investors to see Altria’s stock price remain low, price is not the only way that companies reward their stockholders. A low-priced but profitable company tends to pay big dividends, so the money ends up with the unethical investors either way. I can’t say the trade-off works perfectly, but it’s certainly real. In general, you punish no one by refusing to buy a stock; if the unethical activity makes money, it makes money whether or not you take a cut of it after the transaction is over.
(Not that I think smoking is unethical — While I do think it’s dangerous and unwise, I also understand that many people have different levels of acceptable risk in life. I have no serious problem with financing the risks of others, particularly when they are this well-known.)
You do make a very good point, however, when you note the shareholders’ ability to write to management. With Altria, though, I doubt you can convince them to give up cigarettes!
As to your complaint with Dell, I’m not sure I understand it. A 1% increase in market share is a quite reasonable hope for the company: In 2004, Dell commanded 17.9% percent of the worldwide PC market, up 1.2% from 2003. A few points here or there is certainly possible. What we can’t expect is for Dell to grow at the rate that it has for the past twenty years — If it did, it would be larger than the planet. The same is true with many other successful “growth” stocks; by the time you know about them, most of the opportunity for enormous profit is gone.
Now, some investors may demand growth of the type you seem to fear, and I would agree that this is irrational. A fool and his money, though, are soon parted, and if a corporation wants to reward the long-term shareholders, it will not try to satisfy investors like these. The best strategy would be to find companies that are in it for the long haul and to buy them when they are cheap. If Dell keeps delivering respectable profit numbers without taking the giant risks you imply, then eventually growth investors will drift away, while value investors like me will come in and buy the cheap stock for the dividend it pays. Dell may already be getting close to this point — its P/E is a reasonable 23.37, for instance, and its stock price is near a 1-year low.
[I also note that several times you invoke a "zero-sum game," though I'm not sure that the concept applies here, at least as properly defined. Likewise with golden parachute. A greater precision will help you get your points across in the future.]
Let me straighten this out. There are two zero-sum games. 1, investing in companies that do not pay Dividends for the long haul. 2, investing in companies that do not invest in other companies for their goods, services and developments. You actually restated what I said, on the first game, so I guess we agree there.
To rephrase what I said above and clearly state what i think even you agree to, this is one of my chief assumptions: by buying the other guy’s stock, you do add value and thus influence the stock price of a company. You’re a piece of the confidence in that stock. The stock price’s stability actually leads to a company’s credit score when it does things like borrow money from banks to cover various needs.
Now to Dell:
How can Dell continue to gain 1% or more of market share?
If they maintain or gain on their current market share, but the overall market shrinks, causing a net gain of zero in profits over their last quarter, despite a projection of a 1% increase, what will probably happen to their stock shares? Do you think they lost money or simply missed a growth forecast?
The spin doctors of investment houses will usually consider it a “loss” having bet on significant gains. They’ll post to their sources and their financial partners to sell the stock short, devaluing the commodity for another day when the hidden advantage of the profits within the company recover.
The short term investors will walk away because their money might not be “doing them anything.” when in reality, making 11 billion dollars a year isn’t shabby at all!
What has Dell done in the past to insure their profits continue to outstrip projections?
In 2000 they fired and then outsourced. When they got a a bloody nose over outsourcing, and the unfriendly (accented) service, they shifted around and hired talent “after” the consistency in their market share growth turned around rough numbers on their projected profits. They also played shell games with divisions. Suddenly resellers felt a crunch about 2 years ago, when Dell refused to offer them better prices than their online stores. You couldn’t even squeak volume discounts out of some of the sales reps. The secret? The divisions shuffled loss around and played politics internally. Despite making the company millions, the perception was that resellers took a percentage of online sales. Now Dell is investing in programs to regain their lost resellers. Come Back to Dell letters abound.
When companies like Adelphia, Enron, and WorldCom came to similar situations, they simply lied or juggled the books to hide poor earnings, which sometimes weren’t all that poor–Enron and WorldCon of course actually being pretty bad through out. They just weren’t astronomical or even close to the horizons they’d posted before. When they got really greedy, they even posted losses as gains. This juggling act of capital does not “improve” the economy, as companies traded on the stock market produce the lowest percentage of jobs.
Small businesses not appearing on the stock market make 2/3rds of all jobs, despite the stock market representing 60-80% of the available capital. The more people with jobs, the more people with retirement accounts, the more market increasing investing that occurs(the largest growth sector in stock market investment is actually in retirement accounts). There’s a weakness here though. With a lion’s share of investment, the Stock Market is outperformed by private enterprise in the elemental tasks of creating producst and services, making jobs, and making money through methods other than stock valuation. Small, fast mobile companies make more money from their tiny market shares in comparison to their costs. They don’t have to play games with adding zeros to CEO salaries, instead adding those zeroes to payroll, marketing, research and design.
Back to Dell. When big companies start losing credibility in the stock market, they shed jobs, trim corners, and make sacrifices. If they consistently lose, they fire senior management and send them away with giant golden parachutes of cash and stock, and roll in new management just before they’re about to turn a corner or financial difficulty to gain a small break in the expectations of forecst and delivery. Many companies actually have a clear plan for turning their profits around before they even do the political spin job. When profits return to numbers or territory these large companies have already owned, the stock price jumps, bonuses are passed out, and a large company continues to draw in people to pay for their stock.
Marrying to this system(investing in giant companies or blue chips), can be a consistent system for profitable returns, but with every market downturn, you may be the first to miss a turn of the market, and see your shares lose value before you can leave. If instead you consistently invest in funds that invest in small business and enterprise every single quarter, you meet two objectives:
1. you directly influence the investment into the growth of the economy. New companies spend their investments on new employees, and any fund on the stock market, makes their bets extremely well, usually choosing companies that have projected profits in excess of their investment needs. In short, you invest in the future, not the eventual juggling game of large companies that seem to eventually reach point of limited frontiers.
2. You gain the ethical satisfaction of investing in growth, not just profit through juggling act.
Jason –
You write,
Again, these aren’t zero-sum games. In example 1, a company may pay no dividends, yet still return a profit or a loss to investors depending on the changes in its stock price. These are real changes, just like profits or losses from dividends, and they do not represent a zero-sum game. In example 2, a company’s bottom line does not necessarily depend — even in the long term — on its investment in other companies. All that is required is to trade with other companies or individuals to mutual advantage.
A good example of this is Procter & Gamble, which, if I recall correctly, is one of the world’s leading suppliers of caffeine. P&G gets this caffeine from being one of the world’s leading producers of decaffeinated coffee, and they sell the leftover caffeine to soft drink companies. Neither company has to buy stock in the other one for both to benefit in the exchange: P&G doesn’t make caffeinated soft drinks, and caffeine is cheaper to extract than to synthesize. Both make a profit on the deal.
Regarding Dell, forgive me, but it does seem you’ve moved the goalposts a bit.
When you stated that a 1% increase in market share would be a disaster for Dell, I did not realize that what you really meant was a 1% increase in market share combined with disappointing profit numbers that brought on bad business decisions and short-sighted management. These last two things are the real disaster.
Even then, a few rough quarters isn’t going to be the end of the world for a solid, well-known company like Dell. Just look at GM, for instance: Their stock price is in the toilet, but a lot of people think that right now is exactly the time to buy (Google GM and Kirk Kerkorian, for instance). Good companies die hard.
As to Dell’s specific business practices, I can’t really say whether they were ethical, wise, or even justified. It’s not a company I follow all that closely. I doubt, however, that they are at all so bad as Enron or WorldCom.
And as to small businesses versus blue chips in general, I certainly agree that investing in the right small company can be very profitable. Dell, Gateway, Microsoft, and most of the other biggies all started out as one- or two-person ventures; investors who bought in back then have made the biggest profits of anyone in the market.
The trouble, though, is determining just which of the thousands of small companies will be the next Microsoft. For every big winner, there are hundreds and hundreds of companies that struggle along for a while, profit some, lose some, and then fail. My heart goes out to these ventures, and I know that they are the engine of economic progress, but if I were to invest in them, I would personally need a lot better guarantee of safety than this.
Investing isn’t just about shooting for the moon; it’s also about keeping a relatively secure nest egg for emergencies, a steady income, and easy liquidity. Each investor is going to value these goals differently, and not all of them can be satisfied at once: The already-wealthy venture capitalist won’t mind shelling out ten million on a company that might fail a year from now, provided that he stands, say, a one-in-fifty chance of a hundredfold profit.
That deal looks much less attractive to me, however, since I would regret the loss much more than I would value the profit: I’ve got big plans for my money later on, and I can’t stand the thought of losing it all. My long-term plans (buying a house and raising a family) would be ruined, and I can’t accept that risk.
Becase the risk is too high, it’s a lot more likely I’ll pick a stock like Bank of America, which makes lots of loans to small businesses instead. Banks absorb the loss, spread out the profit, and often do quite well for their safety-minded investors.
Another advantage I gain is liquidity: Altria won’t even notice when I sell my tiny handful of shares a year from now — but the micro-cap startup company would have to fold if the venture capitalist wanted his ten million back.
Finally, I think it’s quite unfounded to suggest that blue chip stocks only make their profits through a juggling act. There have certainly been some spectacular examples of mismanagment lately, but to suggest that all companies beyond a certain size will behave in the same way is unwarranted.
(And I should probably be scrupulous about disclosure here, too: I own a smallish number of shares in Bank of America, Altria, and Procter & Gamble. And absolutely none of the above is intended to serve as advice, professional or otherwise.)
“The already-wealthy venture capitalist won’t mind shelling out ten million on a company that might fail a year from now, provided that he stands, say, a one-in-fifty chance of a hundredfold profit.”
The already wealth venture capitalist does not invest in a company without a profit model in place. He swoops in and buys cash crunched companies that need only investment to meet their internal demands. Companies that do this appear on the Stock market, like Aventure and others. In no way am I asking you to do other than invest in the stock market, I’m just suggesting that if you’re looking for an ethical way to spend your money, investing in companies that create jobs faster is as easy as investing in the companies that invest in them directly. You protect your money in other companies.
“Finally, I think it’s quite unfounded to suggest that blue chip stocks only make their profits through a juggling act. There have certainly been some spectacular examples of mismanagment lately, but to suggest that all companies beyond a certain size will behave in the same way is unwarranted.”
Name a company in the fortune 500 that hasn’t “down-sized”?
Now name one that hasn’t outsourced?
Name one that doesn’t receive government subsidies(From Coke to Microsoft they all partake)?
Name a Blue-chip that isn’t a fortune 500… (there may be a few I’m not sure)
How many employees do they have compared to the rest of corporate and private company America?
How many zeroes have been added to the family income versus the average income of CEO’s for fortune 500’s in the last 30 years? The answers are zero and three respectively.
You know how we can have jobless recoveries? We can fail to invest in the companies that actually create jobs.
A venture capitalist would be foolish to decline a 1-in-50 chance of a hundredfold profit; this in itself is a “profit model.” The trouble lies in sorting out the real ones from the false ones, and I don’t have the ability to do this with thousands of small companies in my spare time. I also can’t afford the risk, while someone with much more money to spare certainly could.
As to investing in companies that produce jobs, I don’t dispute that most new jobs come from small businesses. Whether the jobs-per-dollar ratio is better in small companies or large ones, I admit I have no idea, and this seems the more relevant statistic for the investor who wants to make a difference here. It’s an interesting question and one I’ve never seen raised before. I will have to search and see what I find.
Lastly, about the list of awful things Fortune 500 companies have done, I have to say that many of them simply aren’t awful: When I spoke of “juggling,” (and when you spoke of it earlier), I thought you meant the sort of fraud perpetrated by WorldCom and Enron, not the things you mentioned.
I simply don’t have a problem with outsourcing or downsizing, even while it certainly has made my own life more difficult (for example, I could be living the easy life as a translator if only most translation jobs weren’t outsourced to India). I understand, though, that the net benefit to everyone is greater when businesses pursue these sorts of comparative advantages, and so I console myself for the loss of this opportunity by realizing how outsourcing means relatively cheaper goods and services for everyone. On CEO salaries, I can only imagine that if you are right, and that if this really is so bad an abuse as you say, some company will come along and save a bundle by paying their CEO less. Until then, I have to conclude that good talent is hard to find, and that the market tends strongly to be right about these sorts of things.
On government subsidies, I completely agree that this is wrong. The place to begin with that, though, is the government. I’ve complained loudly about corporate welfare many times on this blog, so I don’t think I’m being inconsistent here.
Real Quick:
“A venture capitalist would be foolish to decline a 1-in-50 chance of a hundredfold profit; this in itself is a “profit model.”… I don’t have the ability to do this with thousands of small companies in my spare time. I also can’t afford the risk, while someone with much more money to spare certainly could. ”
I’m not suggesting risking money. I’m suggesting investing in publiclly traded firms that specialize in venture capital investment. You don’t need to know how to do it, you need your money to do the worfor you and pay a company that has experience doing it. Buy their stock instead of companies like RJR or P&G. Or heck, just put some of your money into it. As it stands, investment capital is actually drying up. Interest rates are rising, home ownership is down another 2.9%, and these are the only two areas where small business owners can find capital reasonably, outside of the Angel investor or lottery ticket.
My original argument remains that your purchase of stock is a tool of influence and that I felt your dismissal of it as a tool was wrong. I don’t think I’ve managed to get back to that given limited time.
It seems to me that investing is a financial activity engaged in to make money. Any other consideration is a distraction.
Please don’t say “seat of my pants” and “all wet” in the same paragraph!
I presumed that it invoked… falling in a puddle.
What were you thinking?