Consider the empirical evidence:
❍ The insurance industry is attractive in theory only. In practice, insurance companies, as a rule, do not possess the underwriting dis- cipline required to generate low-cost float. And such is the com- modity-like nature of this business that slack pricing often ruins the profitability of every player in the game, preventing even disciplined underwriters from reinvesting in the business on a sound basis.
❍ Highly diversified firms are notoriously inefficient. At a human level they are difficult to manage and it is not readily apparent which divisions deserve to be funded and which do not—a process in which capital gets dissipated.
❍ Putting such a firm together by acquisition is sheer madness. The majority of mergers and acquisitions fail to deliver on the expecta- tions of those who engineer them. Prices paid are generally too high, the integration of the entities involved normally backfires, and capital value is destroyed in the process.
❍ Reinvesting 100% of a company’s cash in the enterprise is an exercise fraught with risk. In a competitive environment, managements face an enormous challenge to add value over and above that which their shareholders could earn elsewhere, to all of the cash their businesses generate. In fact, at the margin, managements generally earn the highest return on cash by giving it back to their share- holders.
❍ Leaving managers to their own devices can be dangerous: They habitually attend to their own selfish interests rather than comply- ing with the objectives set by the owners that employ them.
❍ Investing in the stock market is a losing proposition. In the sense that it discounts all known information into prices, it is efficient. Therefore, it should not be in the compass of one man to find stocks that do not fully reflect their attractive fundamentals in their valu- ations. Nor should he be able to do this on a consistent basis.
❍ Holding cash and other low-return assets acts as a dead weight when the target returns of a firm are substantially higher.
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