Money and Finance

Ed Chancellor on the capital cycle...

From his introduction to Capital Returns: Investing Through the Capital Cycle: A Money Manager's Reports 2002-15, which was released in hardcover today:

Typically, capital is attracted into high-return businesses and leaves when returns fall below the cost of capital. This process is not static, but cyclical – there is constant flux. The inflow of capital leads to new investment, which over time increases capacity in the sector and eventually pushes down returns. Conversely, when returns are low, capital exits and capacity is reduced; over time, then, profitability recovers. From the perspective of the wider economy, this cycle resembles Schumpeter’s process of “creative destruction” – as the function of the bust, which follows the boom, is to clear away the misallocation of capital that has occurred during the upswing.

The key to the “capital cycle” approach – the term Marathon uses to describe its investment analysis – is to understand how changes in the amount of capital employed within an industry are likely to impact upon future returns. Or put another way, capital cycle analysis looks at how the competitive position of a company is affected by changes in the industry’s supply side. In his book, Competitive Advantage, Professor Michael Porter of the Harvard Business School writes that the “essence of formulating competitive strategy is relating a company to its environment.” Porter famously described the “five forces” which impact on a firm’s competitive advantage: the bargaining power of suppliers and of buyers, the threat of substitution, the degree of rivalry among existing firms and the threat of new entrants. Capital cycle analysis is really about how competitive advantage changes over time, viewed from an investor’s perspective.

- More From Ed Chancellor On Focusing On Industry Supply...
From his introduction to Capital Returns: Investing Through the Capital Cycle: A Money Manager's Reports 2002-15: FOCUS ON SUPPLY RATHER THAN DEMAND Given that the future is uncertain, why should Marathon’s approach fare any better? The answer...

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From The Small-Cap Advantage: How Top Endowments and Foundations Turn Small Stocks into Big Returns:The truly exceptional business can operate with little capital. When U.S. securities markets function normally, most healthy businesses have no trouble...

- The Linkage Between Returns-on-capital And Competitive Advantage...
From The Small-Cap Advantage: How Top Endowments and Foundations Turn Small Stocks into Big Returns: The small-cap manager should attempt to understand the linkage between returns-on-capital and competitive advantage. The latter drives the former, but...

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- Edward Chancellor Quote
Via the book Capital Account: The turnaround of General Dynamics [from 1990-1993] and its dramatic share price performance illustrate two key aspects of the capital cycle approach to investment. First, shareholder returns are not necessarily determined...

Money and Finance