David Trainer in Praise of Slow GDP Growth

There’s an interesting argument to be made about why a slow-growth recovery can actually be beneficial, despite the fact that we can’t seem to get above stall speed and out of the rut.

The great thing about this sluggishness return to normal, according to David Trainer of New Constructs, is that the reallocation of capital is much smarter and more deliberate this time around. By forcing business owners and investors to be more disciplined in their decision-making processes, less bad ideas or expensive deals get funded, foolish projects aren’t pursued and mistakes from the last cycle are not repeated.

Here’s Trainer’s explanation, via WealthManagement.com:

Slow rebound in GDP means businesses are allocating capital more efficiently. 

It also means capital is not being redeployed into the same businesses from which it was most recently taken. Usually, the first businesses to die in tough times are the worst, ie lowest ROIC. Too often after recent recessions, capital is redeployed into the businesses from which it was most recently taken and GDP is able to bounce back quickly. I do not think that is happening this time. Slow growth and slower rates of corporate investment (corporate cash balances are near all times highs) suggest businesses are being more deliberate and careful about how they spend money. Being slow and careful to spend is smart capital allocation, which lays the groundwork for higher ROICs and productivity gains in the future.

Oracle Corporation (ORCL) is a great example of a company that has grown more deliberate and more efficient with its use of capital in recent years. From 2004 to 2008, Oracle significantly increased its capital stock, increasing invested capital from $530 million to $28.4 billion. In return for that massive capital increase, ORCL barely even doubled its net operating profit after tax (NOPAT) over that same time frame, driving down ROIC from almost 400% to 23.5%. Now, that 400% ROIC was obviously unsustainable, and decreasing returns were always going to accompany the new investment required for Oracle to grow. However, the rapid rate of growth in investment and decline in returns suggests that Oracle, spurred on by the free-spending corporate culture of the mid-2000’s, was neither careful nor efficient with its capital during this time period.

Since 2008, the metrics on Oracle tell a very different story. With just 30% growth in invested capital over the past four years, Oracle has nearly doubled its NOPAT. Oracle’sROIC is up to 32% and has risen every year since 2008. Accumulated asset write-downs totaling barely 1% of net assets attests to the minimal amount of capital Oracle wastes. If one looks only at profits, the past four years look very similar to the preceding four. However, a closer look reveals that the growth of 2004-2008 was driven by a massive capital spending, while the growth from 2008-2012 has been driven by increasing efficiency.

Good food for thought – although most of us would probably prefer the more reckless old school 5% growth rate by now 🙂


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