Guest “WTF?” by David Middleton
A couple of days ago Charles forwarded me a reader request for commentary on the recent decision to dump ExxonMobil from the Dow Jones Industrial Average. The reader specifically mentioned me, possibly because I’ve been a geophysicist/geologist in the oil & gas industry since 1981.
I replied that it’ll either be a very brief, “This sucks!” Or a longer diatribe about the idiocy of ESG “investing”… I was preparing to go the latter route, particularly after Charles forwarded me a peer-reviewed paper, outlining the idiocy of ESG “investing”… Then I decided that the best way to ridicule The Wall Street Journal was to simply explain what they did.
First: A Few Questions Answered
WTF is ESG “Investing”?
What Are Environmental, Social, and Governance (ESG) Criteria?
Environmental, social and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.
ESG “investing” is virtue signalling with your own money… Or, virtue signalling with OPM (other people’s money) that you manage (See Larry Fink & Blackrock).
What is the Dow Jones Industrial Average?
What Is the Dow Jones Industrial Average (DJIA)?
The Dow Jones Industrial Average (DJIA), also known as the Dow 30, is a stock market index that tracks 30 large, publicly-owned blue chip companies trading on the New York Stock Exchange (NYSE) and the NASDAQ. The Dow Jones is named after Charles Dow, who created the index back in 1896 along with his business partner Edward Jones.1 When reporters on television networks say the phrase “The market is up today,” they are generally referring to the Dow.
The DJIA is the second oldest U.S. market index; it is second to the Dow Jones Transportation Average.1 The DJIA was designed to serve as a proxy for the health of the broader U.S. economy.
[…]
When the index initially launched in 1896, it included only 12 companies. Those companies were primarily part of the industrial sector,1 including companies in the railroad, cotton, gas, sugar, tobacco, and oil industry and was in fact a spin-off of the Dow Jones Transportation Average, making the DJIA the second oldest stock market index in the United States. In the early 20th century, the performance of industrial companies was typically tied to the overall growth rate in the economy. As a result, the relationship between the Dow’s performance and that of the economy was cemented. Even today, for many investors a strong-performing Dow equals a strong economy (while a weak-performing Dow likely indicates a slowing economy).
As the economy changes over time, so does the composition of the index. The Dow typically makes changes when a company becomes less relevant to the current trends of the economy, or when a broader economic shift occurs and a change in the composition of the index needs to be made to reflect it.
[…]
The DJIA is based on stock prices rather than market capitalization. So, stock splits tend to force lineup changes.
The DJIA was supposed to be representative of the industrial sector of the US economy. This is why it used to be referred to as the “30 industrials.” There was a time when The Nightly Business Report would report on all of the indices (industrials, utilities, transportation).
Who decides what companies make up the DJIA?
Today, the DJIA is a benchmark that tracks American stocks that are considered to be the leaders of the economy and are on the Nasdaq and NYSE. The DJIA covers 30 large-cap companies, which are subjectively picked by the editors of The Wall Street Journal.
Over the years, companies in the index have been changed to ensure the index stays current in its measure of the U.S. economy. In fact, none of the initial companies included in the average remain, with General Electric holding the longest tenure, 110 years.
The people who decide what news gets published decide which companies are on the DJIA,
What did The Wall Street Journal Do?
Gratuitous pop culture reference
They basically traded Babe Ruth to the New York Yankees in order to fund a Broadway musical production.
In all, Ruth had played six seasons with the Red Sox, leading them to three World Series victories. On the mound, Ruth pitched a total of 29 2/3 scoreless World Series innings, setting a new league record that would stand for 43 years. He was fresh off a sensational 1919 season, having broken the major league home run record with 29 and led the American League with 114 runs-batted-in and 103 runs. In addition to playing more than 100 games in left field, he also went 9-5 as a pitcher. With his prodigious hitting, pitching and fielding skills, Ruth had surpassed the great Ty Cobb as baseball’s biggest attraction.
Despite Ruth’s performance, the Red Sox stumbled to a 66-71 record in 1919, finishing at sixth place in the American League. New ownership took control of the club, and in early January, owner Harry Frazee made the decision to sell Ruth to the Yankees for $125,000 in cash and some $300,000 in loans (which Frazee reportedly used to finance his Broadway production interests).
[…]
The deal paid off–in spades–for New York, as Ruth went on to smash his own home run record in 1920, hitting 54 home runs. He connected for 59 homers in 1921, dominating the game and increasing Yankee revenues to the point that the team was able to leave the Polo Grounds (shared with the New York Giants baseball team) and build Yankee Stadium, which opened in 1923 and became known as “the house that Ruth built.” Throughout the rest of the 20th century, the legacy of Frazee’s lopsided trade continued to hover over major league baseball, as the Yankees won 39 AL pennants and 26 World Series titles and the Red Sox went 86 years without a World Series win. In 2004, the Sox finally shook the “Curse of the Bambino,” coming from behind to beat the Yankees in the AL Championship and beating the St. Louis Cardinals to win their first Series since 1918.
What actually happened?
Apple recently announced a four for one stock split. This effectively reduced the tech sector’s representation on the DJIA, necessitating the replacement of some industrial companies with tech companies.
Apple’s 4-1 stock split, will reduce the DJIA’s tech representation, as a result, the team at S&P Dow Jones Indices announced late Monday, noting the new members will help “offset that reduction” and better reflect modern industries.
In one of the worst trades in DJIA history, Pfizer (a company that actually makes things) was traded for AmGen (a biotechnology company), Raytheon (a company that helps keep us free) was swapped for Honeywell (I think they make air filters and thermostats) and ExxonMobil (produces the energy that is needed to do everything) was effectively traded for a player to be named later (Salesforce ???).
What does Salesforce do?
Company Description
salesforce.com, inc. engages in the design and development of cloud-based enterprise software for customer relationship management. Its solutions include sales force automation, customer service and support, marketing automation, digital commerce, community management, collaboration, industry-specific solutions, and salesforce platform. The firm also provides guidance, support, training, and advisory services. The company was founded by Marc Russell Benioff, Parker Harris, David Moellenhoff, and Frank Dominguez in February 1999 and is headquartered in San Francisco, CA.
Allow me to rephrase the question: WTF is Salesforce? That was as helpful as reading the plot synopsis of The Matrix. At this point, I’m getting a 1999 déjà vu feeling… all over again.
This move left Chevron as the only oil company in the DJIA.
Why pick Chevron over ExxonMobil?
ExxonMobil (XOM) had been a component of the DJIA for 98 years, going back to when it was Standard Oil of New Jersey. From 1999-2008, ExxonMobil was the only oil company in the DJIA. Chevron, which was dropped in 1999 and added back in in 2008, will now be the only oil company in the DJIA. 1999 was the height of the dot.com bubble… A bubble that began to burst in 2000. At the time, we used to joke that if we announced that instead of drilling actual oil & gas wells, we would drill virtual oil & gas wells, our stock price would go through the roof… And the DJIA is all about stock price. This is why Chevron stays in, and ExxonMobil gets the boot.
Chevron has arguably been more fiscally disciplined than ExxonMobil since the 2014-2016 crash. Although, if not for Occidental breaking up Chevron’s acquisition of Anadarko Petroleum last year, things would be different. Chevron was set to acquire Anadarko for $33 billion last year, when Occidental made a $38 billion offer to Anadarko. Chevron refused to increase its offer and received a $1 billion break-up fee. Occidental paid a premium for Anadarko about a year before oil prices crashed. Chevron’s initial offer to Anadarko would have been cash flow positive within 1 year at $65/bbl. Chevron clearly won by losing. Chevron was then able to acquire Noble Energy at a discount after oil prices crashed in a deal that will be cash flow positive at current prices.
Predictably, CNN had a whacked out take on this…
Exxon was the world’s largest company in 2013. Now it’s being kicked out of the Dow
Updated 3:01 PM ET, Tue August 25, 2020
[…]
Exxon’s Tesla problem
Yet even if Guyana turns out to be a win for Exxon, the company faces an uphill battle because of the climate crisis.Exxon is the best-known company in the fossil fuels industry at a time when investors would prefer to bet on solar, wind and Tesla (TSLA).Although European oil companies including BP (BP) and Total (TOT) have aggressively invested on renewable energy and set bold emissions targets, Exxon’s efforts have been far more muted.”It’s a PR problem for energy companies,” said Ben Cook, portfolio manager at Hennessey BP Energy Fund. “You can either part of the solution or be seen as part of the problem.”
[…]
Note to Matt: There is no “climate crisis”… Even if there was a “climate crisis,” Chevron would be facing the same “uphill battle.”
So… If The Wall Street Journal editors needed to keep one oil company in the DJIA, Chevron was probably the right choice… But… NOT “because of the climate crisis.”
What does Babe Ruth have to do with this?
By now, I’m hoping that a tech-savvy commentator has already explained to me what it is that Salesforce actually does… Because this really is looking like trading Babe Ruth to fund a stage production of No,No, Nanette.
ExxonMobil closed at $39.94 on Monday. The current quarterly dividend is $0.87/share (a nearly 9% yield). Salesforce closed at $272.65 and pays no dividend. Let’s look at what the DJIA is supposed to be again:
The Dow Jones Industrial Average (DJIA), also known as the Dow 30, is a stock market index that tracks 30 large, publicly-owned blue chip companies trading on the New York Stock Exchange (NYSE) and the NASDAQ.
What does “blue chip” mean?
What Is a Blue Chip?
A blue chip is a nationally recognized, well-established, and financially sound company. Blue chips generally sell high-quality, widely accepted products and services. Blue chip companies are known to weather downturns and operate profitably in the face of adverse economic conditions, which helps to contribute to their long record of stable and reliable growth.
Granted, ExxonMobil’s (XOM) stock price has taken a beating since it was the largest company in the world in 2013; while Salesforce’s (CRM) stock price is booming (or bubbling)… But the stock price doesn’t really tell you much about the actual businesses.
XOM Income and Cash Flow vs CRM Income and Cash Flow
| Income/Cash Flow | ExxonMobil | Salesforce | |
| 2019 (billions) | XOM | CRM | XOM/CRM |
| Sales Revenue | $ 256.00 | $ 13.28 | 19.3 |
| Gross Income | $ 54.92 | $ 8.86 | 6.2 |
| Pre-tax Income | $ 20.06 | $ 0.98 | 20.4 |
| Net Income | $ 14.36 | $ 1.11 | 12.9 |
| EBITDA | $ 30.76 | $ 2.16 | 14.2 |
| Net Operating Cash Flow | $ 29.72 | $ 3.40 | 8.7 |
| Free Cash Flow | $ 5.36 | $ 2.80 | 1.9 |
XOM Profitability vs CRM Profitability
| Profitability | XOM | CRM | XOM/CRM |
| Gross Margin | 21.45 | 68.05 | 0.32 |
| Operating Margin | 4.6 | 2.94 | 1.56 |
| Pretax Margin | 7.83 | 4.13 | 1.90 |
| Net Margin | 5.6 | 0.74 | 7.57 |
| Return on Assets | 4.05 | 0.29 | 13.97 |
| Return on Equity | 7.48 | 0.51 | 14.67 |
| Return on Total Capital | 4.82 | 1.7 | 2.84 |
| Return on Invested Capital | 6.59 | 0.43 | 15.33 |
ExxonMobil clobbers Salesforce in every income, cash flow and profitability metric except “gross margin” and “free cash flow.” Salesforce’s gross margin is about three times that of ExxonMobil because it apparently doesn’t cost very much to make whatever is made in the “cloud.” However, ExxonMobil’s operating, pretax and net margins are all much higher than Salesforce. This is due to Salesforce having a much higher SG&A expense (63% of revenue) than ExxonMobil (5% of revenue).
What Is Selling, General & Administrative Expense (SG&A)?
Selling, general and administrative expense (SG&A) is reported on the income statement as the sum of all direct and indirect selling expenses and all general and administrative expenses (G&A) of a company. SG&A, also known as SGA, includes all the costs not directly tied to making a product or performing a service. That is, SG&A includes the costs to sell and deliver products and services and the costs to manage the company.
In the oil & gas industry, companies with high SG&A’s are generally considered poorly managed.
ExxonMobil’s operating cash flow is about 9 times that of Salesforce, but their free cash flow is only twice as large. My guess is that whatever Salesforce pays its people to make in the “cloud” doesn’t require much capital. Free cash flow can be simplistically defined as operating cash flow minus capital expenditures. If ExxonMobil drilled wells in the cloud instead of the Earth, they could practically eliminate capital expenditures.
XOM Valuation vs CRM Valuation
Basically, lower valuations indicate that a company’s stock price is under-valued and higher valuations indicate that a company’s stock price is over-valued.
XOM Efficiency vs CRM Efficiency
| Efficiency | XOM | CRM | XOM/CRM |
| Revenue/Employee | $ 3,417,824 | $ 348,939 | 9.79 |
| Income Per Employee | $ 191,455 | $ 2,571 | 74.47 |
| Receivables Turnover | 9.91 | 2.96 | 3.35 |
| Total Asset Turnover | 0.72 | 0.4 | 1.80 |
When it comes to the bottom line, the typical ExxonMobil employee is about 75 times as productive as the typical Salesforce employee… Maybe Salesforce is into renewable energy?
To make a long story, short
ExxonMobil was dumped from the DJIA… Because climate change… Because Apple’s four for one stock split.
Disclaimer
The author has a vested interest in the oil & gas industry. He has been employed for nearly 40 years by oil companies you probably never heard of. The opinions expressed in this post are solely those of the author and in no way meant to be taken as the editorial opinion of Watts Up With That? This post should not be construed as investment advice… I don’t do that. I do not currently directly own stock in ExxonMobil or Salesforce. I have owned ExxonMobil stock in the past, but I still don’t know what Salesforce does. Any and all sarcasm was purely intentional.
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September 2, 2020 at 04:07AM