MONEY stocks

How Microsoft Became a Market Darling, in Two Charts

Microsoft CEO Satya Nadella
Jim Young—Reuters Microsoft CEO Satya Nadella speaks at the Microsoft Ignite conference in Chicago, Illinois, May 4, 2015.

CEO Satya Nadella has turned an aging tech giant into one of the hottest stocks on the market.

On Tuesday, saw its shares skyrocket as rumors spread of a possible Microsoft acquisition. While Bloomberg has said no deal is imminent, a Salesforce sale would make a lot of sense for a company that has staged an improbable comeback through a newfound focus on cloud services. (Our sister publication made just that case a few days ago.)

When Satya Nadella was named Microsoft’s CEO on February 4, 2014, he was taking over an aging tech giant long known for muddled priorities and a fear of any internal innovation that could challenge the dominance of its Windows operating system. Since then, Nadella has given his company a clear objective—even killing off established but musty brands like Internet Explorer. As the Economist noted in April:

Mr. Nadella’s biggest achievement so far is that he has given Microsoft a coherent purpose in life, as it enters its fifth decade. He sums it up in two mottos. One is “mobile first, cloud first”: since these are where the growth is going to come from, all new products need to be developed for them. The other is “platforms and productivity”.

On the cloud side, Microsoft’s business has been flourishing. Profits from the cloud—that is, software and services available via the Internet—more than doubled in the past quarter, and revenue has increased to $6.3 billion.

Investors are liking the new clarity too. Microsoft’s stock price has surged under its new CEO. Since Nadella took the reins, Microsoft shares are up over 30%, 10 points ahead of the S&P. In comparison, Microsoft’s stock dropped nearly 12% during Ballmer’s tenure and underperformed the market.

Here’s Microsoft’s stock performance under Ballmer:

Microsoft’s share price growth compared to the S&P 500 while Steve Ballmer was CEO.

And here’s its performance since Nadella started:

ycharts_chart (1)

This magical-seeming recovery is still a short-run thing—we’re talking a bit more than year. But Wall Street seems to have Nadella’s back for now. Earlier today, the Wall Street Journal‘s “Heard on the Street” column praised the company’s cloud efforts and called its stock one of the cheapest ways to gain exposure to cloud business. Just a few hours later, as though to confirm the endorsement, shares jumped on merger news.

MONEY Small Business

New Ways to Invest in Small Businesses

Cafe owners
Getty Images

When nonprofessional investors are able to put money into small businesses, everyone can benefit.

I met with Paul on Tuesday. He is the CFO of a business start-up. He’s not sure if the next phase of his company’s financing is going to go through. Although he believes in the business model and the mission of the company, some days he thinks he won’t have a job in three weeks.

I met with David on Wednesday. While he’s a great saver and earns a decent buck, he isn’t wealthy. He wants to invest in small companies so much that we’ve set up a “fun money” account, which is 10% of his otherwise well-diversified, passively managed portfolio. “Fun money” is specifically set aside so that he can make individual investments he believes in.

Because of the way small business investing is structured in this country, the likelihood of Paul and David connecting has been infinitesimally small.

This drives me mad.

It’s not just these two who are missing out. Because small companies drive job and economic growth, the economy of the country loses when Paul and David don’t connect. And because the current system of funding is biased, some small businesses are a lot less likely to get funding despite their worthy ideas.

Recent developments could change all this.

To raise their initial start up money, small business owners typically first use their savings, and then appeal to their friends and family. Next, they go to banks. If they get big enough and have certain ambitions and contacts, they can get venture capital funding or private equity funding, which is what Paul was waiting on.

These sources of capital are all enhanced if you are affluent and well connected. Do your friends and family have extra money to invest in your business? Do you know anyone you can talk to at a bank? What about impressing people in the venture capital world? A lot of people with good ideas are shut out.

Enter the Internet. Raising money got a lot easier.

The Power of Reward Sites

With reward sites, startups with good ideas raise money in exchange for rewards.

Sesame, which opens doors remotely from smartphones, raised over $1.4 million on The reward here was a chance to order the device.

Then there is Lammily, Barbie’s realistically proportioned cousin, whose designer raised almost $500,000 through The reward for funding Lammily was the chance to pre-order the doll, and sticker packs with stretch marks, cellulite, freckles, and boo-boos.

The reward sites show that companies can raise large amounts of money through small contributions from a large number of people. Research suggests that reduces company funding gender bias by an order of magnitude and reduces geographic bias as well. Reward sites cater to consumers who love new products and want to support new ideas.

You may get first dibs on a cool new doll, but sending money to a reward site isn’t investing.

The Risks of Private Equity

Traditionally, to get private equity funding, you have to sell to accredited investors — the richest 1% of the population, roughly speaking.

Accredited investor regulations were set up in in the wake of the 1929 crash, when a lot of people got ripped off because they invested in dubious enterprises. The idea was that people with a high level of wealth are sophisticated enough to understand investment risk. Unfortunately, this leaves the Davids of the world — investors who are sophisticated but wealthy — shut out of these types of investments.

Private equity placements are not always a great deal. When I’ve looked into them for clients, I’ve concluded they are expensive, risky, and difficult to get out of, even if you die. The middlemen who offer these and the advisers who sell these seem to be the ones most likely to make money. The best deals I’ve looked at weren’t hawked by sales people or investment advisers, but came through clients’ friends and family.

The rise of Internet portals set up to connect small companies with accredited investors has the potential to cut down on intermediary costs. Still, the sector remains small.

In 2012, President Obama signed the JOBS act, which directed the Securities and Exchange Commission to devise rules opening up small business investing to non-accredited investors.

Some organizations didn’t wait for the SEC to issue the rules. Instead, they dusted off exemptions in the securities legislation that most of us have ignored for 80 years.

States Get Into the Act

Some states have picked up on crowdfunding to boost their economies. Terms vary, but generally investors are subject to investment limits and companies are subject to a cap on raising money. Each individual, for example, might be limited to investing $10,000; each company might be limited to raising $1 million. Both investor and company are generally required to reside in the state.

This is music to ears of people who want to invest locally. The first successful offering using this type of exemption was in Georgia in 2013, where Bohemian Guitars raised approximately $130,000 through

Other Exemptions

Village Power is another example of raising money using an exemption. This intermediary helps organizations set up and fund solar power projects. Village Power coaches their community partners to use an exemption in the SEC rules, which allows for up to 35 local, non-accredited investors.

New Rules Open Doors

New rules issued March 25 by the SEC removed a lot of the barriers for companies raising money and for non-accredited investors.

Companies will be able to raise up to $50 million. Non-accredited investors are welcome to invest, sometimes with limits — 10% of their net worth, say, or 10% of their net income.

Although Kickstarter has said that it won’t sell securities, other fundraising portals, such as Indiegogo, are looking into it.

And if all goes well, Paul, David, and I can start looking for the new opportunities in June of 2015.


Bridget Sullivan Mermel helps clients throughout the country with her comprehensive fee-only financial planning firm based in Chicago. She’s the author of the upcoming book More Money, More Meaning. Both a certified public accountant and a certified financial planner, she specializes in helping clients lower their tax burden with tax-smart investing.


How Twitter Tried to Convince Us That It’s Doing Really Well

The Twitter logo is shown at its corporate headquarters  in San Francisco
Robert Galbraith—Reuters

Stop falling for this tech bubble trick.

2014 was a very unprofitable year for Twitter TWITTER INC. TWTR 3.83% . The company reported a net loss of $578 million on $1.4 billion of revenue. Even the free cash flow, which benefits from adding back Twitter’s massive $632 million of stock-based compensation, was negative, a loss of $120 million. The fourth quarter was no different than the full year, with both net income and free cash flow soundly negative.

Despite these sobering numbers, Twitter recorded record quarterly profits, according to CEO Dick Costolo:

We closed out the year with our business advancing at a great pace. Revenue growth accelerated again for the full year, and we had record quarterly profits on an adjusted EBITDA basis.

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. Twitter’s adjusted EBITDA backs out another major expense: stock-based compensation. On an adjusted EBITDA basis, Twitter earned $141 million of profit in the fourth quarter, and $301 million of profit during the full year. Adjusted EBITDA nearly quadrupled in 2014.

If you look at the earnings reports of big, profitable technology companies, you’re unlikely to find EBITDA mentioned at all. I looked at the latest earnings releases for Microsoft, Apple, Intel, Cisco, Facebook, Qualcomm, Oracle, IBM, and Google. How many times do you think EBITDA was mentioned?

Not even once.

There’s a good reason for this: EBITDA is a mostly useless number. EBITDA was a popular metric during the dot-com boom of the late 90s, and I’m seeing it touted in an increasing number of earnings releases today, largely by unprofitable tech companies like Twitter.

A common argument for using EBITDA is that depreciation and amortization are non-cash expenses, and by backing those out, you get something that’s supposed to represent a company’s real cash flow. Warren Buffett, in his 2000 shareholder letter, pretty much kills this argument:

References to EBITDA make us shudder — does management think the tooth fairy pays for capital expenditures?

EBITDA accounts for the earnings generated by a company’s assets without accounting for the cost of those assets. Depreciation may not be a cash expense, but it is a real expense, and ignoring it produces a number that carries little meaning. Charlie Munger puts it best:

I think that, every time you see the word EBITDA, you should substitute the word “bullshit” earnings.

To see why EBITDA can be so misleading, let’s start a business.

The power of EBITDA

I’m going to start a fictional food truck business. I’ll buy one truck in the first year, then add an additional truck each following year. Each truck costs $50,000 and has a useful lifetime of five years, generating a $10,000 depreciation expense annually.

It turns out, I’m not very good at selling tacos out of a truck. Each food truck I own consistently generates $100,000 in annual revenue, but it costs $90,000 to operate, including food costs, wages, etc. Add in the depreciation expense, and my operating income per truck is zero.

No matter — I want to build a food truck empire. I borrow money each year from the bank to open a new food truck and replace any that need to be replaced, paying 6% interest. After 10 years, with 10 food trucks in operation, things are either going very well or very poorly, depending on which numbers you look at.

In year 10 of my food truck business, the company generated $1 million in revenue, a tenfold increase compared to the first year of operation. It was also a record year for profitability on an EBITDA basis. EBITDA came in at $100,000, 10% of revenue, and it has increased every single year. EBITDA also easily covers the $45,000 of annual interest payments.

That may sound great, but net income in year 10 was a loss of $45,000 thanks to the interest on all of those loans. Free cash flow is also negative, since I spent $50,000 expanding my food truck empire and another $50,000 replacing one of my existing trucks. The company is hemorrhaging cash and, unable to even pay the interest on its loans, is on the verge of bankruptcy.

Calculations and chart by author. Free cash flow ignores effects of changes in working capital, but including this would make free cash flow even more negative.

EBITDA has managed to make this unsustainable, money-losing company look like a success story. Not only does EBITDA ignore the cost of the food trucks, which are required to generate any revenue in the first place, it also ignores interest, which is a real cash expense. EBITDA is in no way equivalent to cash flow.

Putting lipstick on a pig

Twitter’s adjusted EBITDA not only excludes depreciation and amortization, which totaled $208 million during 2014, but it also excludes $632 million of stock-based compensation. More than 40% of Twitter’s expenses are completely ignored in an effort to produce a number that makes the company appear profitable.

A good rule of thumb for all investors to follow: Always question the numbers management wants you to see. Companies make up all sorts of non-GAAP, adjusted figures in an attempt to make things look better than they really are. Sometimes, these figures are perfectly reasonable. Other times, like in the case of Twitter’s magical adjusted EBITDA, they’re not.

As Warren Buffett said during the 2002 Berkshire Hathaway annual meeting:

People who use EBITDA are either trying to con you, or they’re conning themselves.

Remember that the next time you’re looking at an earnings report.

MONEY Warren Buffett

15 Things to Expect from Warren Buffett’s Annual “Woodstock for Capitalists”

Berkshire Hathaway CEO Warren Buffett talks to reporters while holding an ice cream at a trade show during the company's annual meeting in Omaha, Nebraska May 3, 2014. Warren Buffett's Berkshire Hathaway Inc on Friday said quarterly profit declined 4 percent, falling short of analyst forecasts, as earnings from insurance underwriting declined and bad weather disrupted shipping at its BNSF Railway unit.
Rick Wilking—Reuters

A look at what promises to be a memorable annual meeting.

Saturday is the day. That is, Saturday is the day.

That’s right, I’m talking about the Berkshire Hathaway BRKA 0% annual meeting, which brings tens of thousands of investors to Omaha to hear what CEO Warren Buffett and his brilliant co-pilot Charlie Munger have to say about Berkshire, the economy, the stock market, and… well, just about anything else under the sun.

There are certain things that Buffett-watchers can expect every year from the meeting, but every year’s meeting is a bit different. And this year promises to be particularly memorable, as it marks the 50-year anniversary of Buffett and Munger at the helm of Berkshire.

So what exactly should we expect from this year’s edition of the Woodstock for Capitalists? Let’s see…

1. What do you think about the stock market?

I’m guessing the question won’t come in quite that form, but there will be some question during the hours-long Q&A session with Buffett and Munger that gets to their views on the current state of the stock market. We can expect the response to be a combination of their traditional wisdom that emphasizes how investors are buying a piece of a business (not a piece of paper), that long-term ownership is the way to go, and that low-cost index funds are the best bet for many investors.

But this ain’t the normal mealy mouth corporate-speak annual meeting, so don’t be surprised if Buffett and Munger offer direct views on the state of the market. After all, in Berkshire’s annual letter in 1999, Buffett was very clear about his view that valuations were inflated:

Our reservations about the prices of securities we own apply also to the general level of equity prices. We have never attempted to forecast what the stock market is going to do in the next month or the next year, and we are not trying to do that now. But, as I point out in the enclosed article, equity investors currently seem wildly optimistic in their expectations about future returns.

And then, in the 2008 letter, he was equally clear about the bargains that he and Charlie were seeing:

Additionally, the market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market. This does not bother Charlie and me. Indeed, we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.

2. What’s up with that new number?

Buffett and Munger’s benchmark of choice for many years has been the change in Berkshire’s per-share book value versus the one-year change in the S&P 500 index. This year, a new number appeared on the first page of Berkshire’s letter: the one-year price change in Berkshire’s stock.

On the one hand, this shouldn’t be all that surprising. For years now, both Buffett and Munger (more so Munger), have explained that the changing nature of Berkshire’s business – that is, away from an insurance-heavy operation to a more diversified conglomerate – make the per-share book value calculus less meaningful.

In this year’s letter, Buffett noted that:

Market prices, let me stress, have their limitations in the short term. Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge.

At the same time, going by the “classic” benchmark, Berkshire has underperformed in five of the past six years. I’d be surprised if somebody didn’t try to call out the duo on the apparent convenient timing of the new performance gauge.

3. You bought what at Berkshire?

One thing that Berkshire investors that attend the meeting can expect every year is a cornucopia of Berkshire-subsidiary products on offer, from Dairy Queen Dilly Bars to NetJets private-jet leases. Seriously, Berkshire investors get their shop on. Here’s what Buffett had to say about last year’s Berkshire rendition of Supermarket Sweep:

Last year you did your part as a shopper, and most of our businesses racked up record sales. In a nine-hour period on Saturday, we sold 1,385 pairs of Justin boots (that’s a pair every 23 seconds), 13,440 pounds of See’s candy, 7,276 pairs of Wells Lamont work gloves and 10,000 bottles of Heinz ketchup.

My personal goal is to buy something that will make my wife say…”You bought what at Berkshire?”

4. Kraft…

Buffett likes his “elephant hunting” and he did some for Berkshire in late March. Pairing up once again with Brazilian private equity firm 3G Capital, Berkshire agreed to buy Kraft Foods for around $50 billion. The Economist was none too impressed with the deal, writing:

Warren Buffett says he likes to buy companies that are easy to understand and are performing well. His latest deal, the $50 billion acquisition of Kraft Foods that was announced on March 25th, passes only one of those tests.

The article continues to clarify that while Kraft’s business is easy enough to comprehend, its recent performance hasn’t been terribly tasty.

My fellow Fool Alex Dumortier wasn’t as pessimistic, noting the incredible success that 3G has already had with the last team-up acquisition, H.J. Heinz. To be fair, The Economist did note that 3G “is the closest thing the consumer-goods industry has to a miracle-worker.”

The bottom line, though, is that the price tag for Kraft wasn’t especially cheap and the business isn’t thriving, so a “what’s up with that” question is bound to come.

5. “I have nothing to add.”

Charlie Munger is famous for curtly quipping “I have nothing to add” during the meeting when… well, when he has nothing further to add. On our live chat we will be sure to let you know every time Munger delivers his well-known line.

And for a fun Berkshire-inspired game that even the kids can enjoy: Eat a See’s Candy (or two) for every “I have nothing to add.”

6. …but then, there’s plenty to add.

Though Munger’s “I have nothing to add” is well known, it’s likewise known that when he does have an opinion on something he’s not afraid to share it. We can certainly expect that there will be plenty of this during the meeting as well.

Charlie on ethanol (2008): “The policy of turning American corn into motor fuel is one of the dumbest ideas in the history of the world.”

Charlie on gold (in a 2012 CNBC interview): “Gold is a great thing to sew into your garments if you’re a Jewish family in Vienna in 1939, but I think civilized people don’t buy gold, they invest in productive businesses.”

7. So, um, what up with Clayton Homes?

When you’re as large as Berkshire, you’re bound to find yourself in the crosshairs of controversy. That’s doubly so when you’re run by a CEO who says things like “we can afford to lose money — even a lot of money. But we can’t afford to lose reputation — even a shred of reputation.”

In the past, Berkshire has come under fire in the annual meetings for the disruption of salmon spawning by a dam owned by Berkshire subsidiary Mid-American Energy, as well as its ownership of PetroChina stock, which a shareholder proposal described as “the dominant international player in Sudan’s oil sector.”

This year, the heat will likely come from concerns over Berkshire’s manufactured-housing company, Clayton Homes. In early April, The Seattle Times published an article titled “The mobile-home trap: How a Warren Buffett empire preys on the poor.” The article alleges that while Buffett rails against shady mortgage practices, the company that he owns – and praised in this year’s shareholder letter – is “trapping many buyers in loans they can’t afford and in homes that are almost impossible to sell or refinance.”

8. The Berkshire movie

Every year, the meeting begins with a movie. That’s right, a movie. Well, it’s really sort of half-movie and half-advertisement for Berkshire brands and holdings (Coca-Cola COCA-COLA COMPANY KO -0.19% and Geico always seems to have prominent placement). What the movie lacks in plot and clear structure, it makes up for in cheap laughs and cameos.

Who will pop up in this year’s iteration? I’ve got my fingers crossed for Left Shark.

9. Tell us more about this car thing

Could it be that Jay Leno now has an Omaha billionaire that he can talk cars with?

In early March, Berkshire closed on the acquisition of Van Tuyl Group — one of the U.S.’s largest auto dealerships — and promptly renamed the group Berkshire Hathaway Automotive. Prior to the acquisition, Van Tuyl reportedly had $9 billion in annual sales, but Buffett wants to see the new subsidiary grow further. In late March he went on CNBC and said:

We’ve heard from a lot of dealers and we’ll hear from more, I’m sure. I’d be very surprised if five years from now, we’re not a whole lot bigger.

Berkshire also purchased $560 million in Axalta stock from Carlyle Group. While Axalta is a diversified coatings business — which fits in with Berkshire’s vast industrial holdings — its primary market is transportation. Axalta holds the No .1 worldwide position in supplying coatings for auto-repair shops and is No.2 when it comes to manufacturers of cars and light trucks.

And lest we forget, it was just in 2011 that Berkshire coughed up $9 billion to buy Lubrizol.

What’s next for Buffett’s burgeoning auto-empire? I’d certainly be interested to hear what the Oracle sees ahead for the industry.

10. Zombies in Omaha

The crowd at the CenturyLink Center in Omaha is expected to top 40,000 this year for the 50thAnniversary meeting. Any shareholder can attend the meeting, but none can purchase preferred seating. What does that mean? The same as every year: Investors will line up bright (technically, it will still be dark) and early to try to secure the best seats and the best views of Buffett and Munger.

This means that if you happen to be in Omaha on the weekend of May 2, but aren’t part of the Berkshire hoopla, don’t fret, those aren’t actually zombies wandering around Farnam Street and Dodge, they’re just exhausted Berkshire investors.

11. Entschuldigung Herr Buffett, aber was ist nächste für Sie in Deutschland?

As the Geschäftsführer for The Fool’s German-language website (, I have a special interest in this one.

On February 20 of this year, Berkshire announced that it was acquiring German motorcycle-gear business Detlev Louis Motorrad. Buffett called the deal a “door opener” and crowed that “I like the fact that we have cracked the code in Germany.” Wie cool.

Buffett followed up with an interview with Handelsblatt, Germany’s answer to The Wall Street Journal. In the interview, Buffett said:

We are definitely interested in buying more German companies. Germany is a great market: lots of people, lots of purchasing power and Germans are productive. We also like the regulatory and legal framework.

I wholeheartedly agree and would be very interested to hear: Also dann, was jetzt Herr Buffett?(So then, what now Mr. Buffett?)

12. Just give us a hint

Every calendar quarter, large investors like Berkshire are required to deliver a so-called 13F filing to the Securities and Exchange Commission that shows their stock holdings. Berkshire last filed in mid-February, and we’ll likely see the next filing in mid-May – conveniently after the annual meeting.

In the last 13F filing, we found out that Berkshire had shed all of its holdings in ExxonMobil EXXONMOBIL CORPORATION XOM 4.02% – Buffett later explained to CNBC, “We thought we might have other uses for the money.”

Will there be any big moves this quarter? I doubt we’ll find out at the annual meeting, but that doesn’t mean that the question won’t be asked.

13. Run like the wind

If you’re a runner, you may be familiar with the Brooks running-shoe brand. If you’re a Berkshire shareholder you may know that Berkshire owns Brooks. But did you know that for the past couple of years Berkshire and Brooks have put on a 5k race the day after the Berkshire meeting?

The runners that come out for the “Invest in Yourself 5k” are no joke — last year’s male winner finished in a blazing 15:52. For the rest of us, it’s a matter of just trying to shake off a sleep deficit and an over-indulgence in See’s Candy. But, then again, what better way to burn of a few of those candy calories than by running a few miles?

Better still: Runners get a Berkshire-ized Brooks t-shirt and a finisher’s medal with Buffett’s smiling mug on it.

14. Want another question that won’t be answered?

Buffett’s successor: Who will it be? We won’t find out at the meeting, but it’s another “not to be answered” question that I expect to hear.

15. Oh right, the Berkshire business meeting

Believe it or not, sandwiched into all of the Buffett and Munger-y goodness of the Berkshire meeting and weekend is an actual business meeting. According to Berkshire’s annual meeting info, the business meeting will be held from 3:45 to 4:15 on the day of the meeting. In the years that I’ve attended the meeting, I can’t recall the business meeting lasting more than 10 minutes.

Then again, my perception of time by that point in the day has usually been compromised by the peanut brittle.

MONEY Fast Food

Why Chipotle Mexican Grill Going GMO-Free is Terrible News

Chipotle restaurant workers fill orders for customers on the day that the company announced it will only use non-GMO ingredients in its food on April 27, 2015 in Miami, Florida. The company announced, that the Denver-based chain would not use the GMO's, which is an organism whose genome has been altered via genetic engineering in the food served at Chipotle Mexican Grills.
Joe Raedle—Getty Images

Avoiding GMO foods might be a bad decision over the long run.

Some time ago, I wrote about the need for investors to adopt scientifically responsible investing practices. Apparently, Chipotle Mexican Grill CHIPOTLE MEXICAN GRILL INC. CMG -0.34% never read it.

On the quest to use “great ingredients,” Chipotle Mexican Grill removed from its menu most ingredients derived from genetically engineered crops. While “great” and “genetically engineered” aren’t mutually exclusive, the company’s press release and GMO website make emotional arguments to appeal to a loud minority of consumers and destroy its own logic in the process.

Truthfully, most customers will never taste the difference in ingredients or care to look into the company’s claims, but increased prices could unwind any perceived benefits in ridding the menu of genetically engineered ingredients. As could any public backlash from claims that don’t quite add up. All of that could negatively affect investors in the long run.

Will burritos become more expensive?

According to Chipotle Mexican Grill, the answer is an emotionally charged “no”:

While GMO advocates point to higher costs associated with producing non-GMO foods, Chipotle’s move to non-GMO ingredients did not result in significantly higher ingredient costs for the company, and it did not raise prices resulting from its move to non-GMO ingredients.

It helps to take a closer look at the ingredients that were replaced and exactly what they were replaced with. Given the prevalence of genetically engineered corn (94% of America’s harvest) and soy (93% of America’s harvest), it makes sense to either avoid corn and soy altogether, or find the 6% and 7%, respectively, that neglect to take advantage of biotech tools. Chipotle Mexican Grill elected to deploy a combination of those strategies. After all, it’s mighty difficult to make a flour tortilla without corn flour.

Here’s a breakdown of the new ingredients and those they replaced:

Old Ingredient New Ingredient Use
Corn flour (from genetically engineered corn) Corn flour (from non-genetically engineered corn) Tortillas
Soy oil (from genetically engineered soybean) Sunflower oil (no genetically engineered varieties exist) Frying chips and tortillas
Soy oil (from genetically engineered soybean) Rice bran oil (no genetically engineered rice varieties exist) Mixed into rice, used to fry vegetables
Soy oil (from genetically engineered soybean) Canola oil (from non-genetically engineered canola) Tortillas

So, will these ingredients be more expensive than their predecessors? It depends on the agricultural yield of the crops compared to genetically engineered corn and soy (the former would be lower), the cost of seeds (the latter will be higher), and the cost of inputs (the former will be higher). It’s a complex economic equation, although market prices do point to higher costs for Chipotle Mexican Grill.

In fact, The New York Times reports that using canola oil to make tortillas may result in “slightly higher” prices this year. The ability to pass costs to consumers should allow the company to keep margins relatively intact, but that may not last forever.

That leads us to ask: If the company could experience higher costs for its inputs, why did it decide to remove ingredients from genetically engineered crops?


Chipotle Mexican Grill launched a website to explain its rationale behind shunning biotech crops from its supply chain. Three reasons are listed:

  1. Scientists are still studying the long-term implications of GMOs.
  2. The cultivation of GMOs can damage the environment.
  3. Chipotle should be a place where people can eat food made with non-GMO ingredients.

The last reason is perfectly fine (although I would have chosen different language). Unfortunately, the logic doesn’t quite work out for the first two.

The company claims that there is no scientific consensus on the environmental and human health of cultivating and consuming biotech crops, citing a single petition signed by 300 scientists. A recent Pew research poll found 412 scientists that thought genetically engineered foods were “generally unsafe.” The only thing is, the other 3,336 scientists polled, representing 88% of the survey, said the opposite.

The company also said more independent studies are needed, since “most research was funded by companies that sell GMO seeds.” Yet, the Genetic Engineering Risk Atlas, a publicly funded non-profit, found that half of the studies on biotech crop safety randomly selected were independently funded.

The second claim is the most ridiculous. Chipotle Mexican Grill backs it up by calling out the overuse of pesticides, namely glyphosate, even calling attention to the World Health Organization’s recent designation as “probably carcinogenic to humans” (in the same category as emissions from frying oils and working as a barber). Why doesn’t this logic hold up?

It’s worth pointing out that “non-GMO” doesn’t mean “organic.” The sunflower, rice, and canola crops that contribute oils to the company’s new menu will still use pesticides and synthetic fertilizers, likely more than the crops they replaced. In some cases, that includes herbicide mixtures that use glyphosate. For instance, in California alone, over 222,000 acres of sunflower were treated with pesticides in 2012, including over 11,500 acres using some form of glyphosate.

It gets even more interesting. While the company was able to use canola oil instead of soy oil to make its flour tortillas, canola oil is a registered insecticide with the U.S. Environmental Protection Agency (link opens a PDF). In other words, this is a true statement: Chipotle Mexican Grill removed from its menu ingredients from genetically engineered crops to instead serve its customers an insecticide.

Of course, Chipotle Mexican Grill may be quick to point out that scientists state canola oil is safe for human consumption. And isn’t that exactly the point?

What does it mean for investors?

Investors may cheer the move by Chipotle Mexican Grill as an innovative step to respond to consumer concerns about food. But it could result in higher food prices for customers in short order. Perhaps the costs get passed along without any reduction in customer count, but costs can only be passed along for so long before people seek alternatives, and the company’s margins are negatively affected.

Additionally, rather than foster misinformation with emotional arguments to become the first fast food chain that avoids ingredients from genetically engineered crops, Chipotle Mexican Grill could have stood with science (like the Girl Scouts did) to position itself as a brand that provides a platform for a sensible middle ground for an even broader population. When the need for publicity trumps the need for making sound business decisions, I would hesitate to own shares.

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Amazon Investors Are Stuck in the 1990s

Lisa Werner—Getty Images

Are investors getting Amazon wrong?

Shares of AMAZON.COM INC. AMZN -1.1% soared over 14% last Friday following the release of its first quarter earnings report. While revenue came in slightly ahead of expectations, the primary source of excitement was new information about the growth and profitability of the Amazon Web Services cloud computing business.

Indeed, AWS revenue grew 49% year-over-year to $1.57 billion. This puts it on pace for annual revenue of more than $6 billion.

However, Amazon investors and analysts may be getting a little carried away about the profitability of AWS. Its apparently strong profit margin is being bolstered by a 1990s-era accounting trick that should have been laid to rest long ago.

The stock options expensing controversy

For decades, U.S. tech companies have used stock awards — primarily in the form of stock options — as a major part of their employee compensation. And for decades, they fought against including those stock awards as an expense in their official earnings statements.

Silicon Valley companies argued that since stock was not cash, it did not qualify as an expense. Economists almost universally derided this rationalization. Tech companies also claimed that it was difficult to value stock options. Economists retorted that models for valuing options have become quite sophisticated.

In 2004, the Financial Accounting Standards Board — which sets U.S. accounting and reporting standards — finally updated its generally accepted accounting principles to require the expensing of stock options. Thus, tech comapnies are now required to report GAAP earnings, including the cost of stock awards. But they have reacted by promoting the use of non-GAAP financial metrics that once again remove the cost of stock-based compensation.

Stock awards at Amazon

Amazon is one such tech company making heavy use of stock-based compensation. For the most part, it rewards employees with restricted share units — essentially stock with some restrictions on selling — rather than options. Valuing these RSUs is much more straightforward than valuing employee stock options, removing one major argument against expensing them.

Yet Amazon still puts non-GAAP financial measures — segment operating income and consolidated segment operating income (or CSOI) — front and center in its earnings releases. Conveniently, both metrics ignore stock compensation.

This has an enormous impact on reported profitability. In 2014, Amazon CSOI totaled $1.8 billion. But after deducting $1.5 billion in stock that it handed out to employees, as well as some other expenses it excludes from CSOI, the company actually lost money.

How this applies to AWS

Amazon broke out results for its Amazon Web Services segment for the first time in the recent earnings report. Investors were pleased to see that AWS operating income totaled $265 million on revenue of $1.57 billion, for a relatively robust 16.9% segment operating margin.

But segment operating income is not a very good measure of profitability, because this metric excludes stock-based compensation. For the full company, stock-based compensation reached $407 million last quarter. As a result, CSOI of $706 million was nearly three times its GAAP operating income of $255 million.

Since stock-based compensation is most prevalent in the tech industry, and AWS is the high-tech portion of Amazon, it seems reasonable to attribute a significant chunk of stock compensation expense to AWS.

As a rough estimate, suppose Amazon were to allocate its stock compensation expense according to each business segment’s proportion of CSOI. AWS segment operating income of $265 million represented 37.5% of first quarter CSOI. Allocating to AWS a proportionate chunk of the $407 million in stock-based compensation would have reduced its segment operating income to just $112 million, for a much more modest 7.2% segment margin.

Stock compensation is a real cost

By excluding stock-based compensation from its segment results, Amazon encourages investors to ignore a significant category of expenses, just as most 1990s-era tech titans did. But while stock-based compensation is a non-cash cost, it leads to shareholder dilution over time.

If Amazon eventually tries to offset that dilution through share buybacks, then it will become a very real cash cost. The number of common shares and underlying shares for stock awards has increased by 36 million in the past six years. At the current stock price, it would need to spend more than $15 billion on share buybacks to offset all of that dilution.

After adding back the cost of stock-based compensation, Amazon looks a whole lot less profitable. There may not be a single “best way” to allocate that cost across the different operating segments. But however it is divided up, profitability at AWS — and the company as a whole — looks much less impressive once stock compensation is accounted for.

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MONEY stocks

14 Simple Ways to Be a Smarter (and Richer) Investor

brain made out of gold bars
Hiroshi Watanabe—Getty Images

Picking stocks is hard—and you still might not beat throwing darts at the stock pages. Here some easier ways to get yourself an edge.

1. Don’t pay 33% of your money in fees. Mutual fund charges look small, but the cost of paying an extra 1% a year in fees is that you give up 33% of your potential wealth over the course of 40 years. An index fund like Schwab Total Stock Market SCHWAB TOTAL STOCK MARKET SWTSX -0.63% can keep your expenses below 0.1%, compared with over 1% for many stock funds.

2. Mix your own simple plan. Four very low-cost index funds, recommended in the Money 50, deliver all the world’s major markets. (See graphic below.) The more aggressive you are, the more you can tilt toward stocks.

Source: MONEY research

3. Or pick just one fund. You don’t have to be fancy to be an effective investor. A classic balanced mix (about 60% stocks/40% bonds) provides plenty of equities’ upside, with less pain during crashes. The Vanguard Wellington VANGUARD WELLINGTON INV VWELX -0.36% balanced fund has earned an annualized 8% over a decade.

4. Or hire a robo-adviser. Outside of a 401(k), if you want a plan that’s more tailored to you, web-based automated investment services can put you in a mix of low-cost index funds and then rebalance as you go. Betterment and Wealthfront stand out as low-cost options, charging 0.35% of assets or less.

5. Patch the holes in a 401(k). Many workplace plans offer at least an S&P 500 or total stock market index fund as a low cost option for buying U.S. stocks. But if your plan doesn’t offer good choices in other asset classes, such as bonds and foreign stocks, diversify elsewhere. Save enough to get the company match. Then fund an IRA, where you can choose which bond funds or foreign funds to go with.

6. While you’re at it, dump company stock. About $1 out of every $7 in 401(k)s is invested in employer shares. But your income is already tied to that company. Your retirement shouldn’t be too.

7. Pick an asset, any asset. You can get into trouble by being too clever by half. The average investor has barely beaten inflation in the past 20 years as a result of buying trendy assets high and selling low. Forget all that. As the chart below shows, you’re better off buying and holding almost any major asset class.

Sources: Bloomberg, Morningstar, DalbarNotes: Returns are through Dec. 31, 2013.

8. Be patient with funds. Some well-known bargain-minded funds, such as Dodge & Cox Stock DODGE & COX STOCK FUND DODGX -0.87% , have struggled this past year. That doesn’t mean you should flee. True value funds refuse to buy popular—read expensive—stocks, so they often lag in frothy times. But over the past 15 years, Dodge & Cox has outperformed its peers by 2.5 percentage points a year and the S&P by more than four points.

9. Be stingy with funds. Cheapskates know index funds aren’t their only options. Actively managed blue-chip stock funds with an expense ratio of 0.35% or less have returned 8.5% over the past decade. That’s 0.5 percentage point better annually than the S&P 500. A great option: Vanguard Equity-Income VANGUARD EQUITY INCOME INV VEIPX -0.46% , charging 0.29%, has outpaced the market’s gains by 3.5 points annually over the past 15 years.

10. Rebalance? Maybe not. Routinely resetting your stocks and bonds to their original levels “is a nice idea in theory,” says planner Phil Cook. But “if you rebalance too often, you can give up a lot of potential returns.” In your twenties and thirties, when you’re almost all in stocks, you can skip it. As you age, though, gradually increase the frequency of rebalancing to every few years.

11. Break up with your high-cost adviser. Stock and bond returns are expected to be muted in the coming decade, so cutting advisory fees—often 1% of assets—matters. Vanguard Personal Advisor Services charges just 0.3% of assets. Some tech-based services, such as Betterment and Wealthfront, charge even less.

12. Put your portfolios together… If you hold a third of your 401(k) in bonds, your mix may be riskier than you think if your spouse is 100% in stocks. Coordinating also improves your options. If your spouse’s plan has a better foreign fund, focus your international allocation there.

13. …and your assets in the right place. Once you’ve maxed out your IRAs and 401(k)s, use taxable accounts for the most tax-efficient investments in your mix. They include index and buy-and-hold equity funds that trade infrequently and generate few capital gains distributions.

14. Take a fresh look at a classic. You’ve now built up enough assets that advisers will be eager to sell you clever ideas to beat the market. Before you bite, read the 2015 edition of A Random Walk Down Wall Street. Burton Malkiel has updated his skeptical investment guide to take on the latest new flavor, “smart” ETFs. If a fund has a greater return, says Malkiel, it’s probably because it’s taking on more risk.

Adapted from “101 Ways to Build Wealth,” by Daniel Bortz, Kara Brandeisky, Paul J. Lim, and Taylor Tepper, which originally appeared in the May 2015 issue of MONEY magazine.

MONEY Warren Buffett

Was Warren Buffett Wrong About Google?

Warren Buffett, chief executive officer and chairman of Berkshire Hathaway Inc.
Brendan McDermid—Reuters Warren Buffett, chief executive officer and chairman of Berkshire Hathaway Inc.

Buffett and Munger may have been too optimistic about Google’s moat.

Warren Buffett and Charlie Munger have long gushed about Google’s GOOGLE INC. GOOG 0.11% dominance in Web search. Munger in 2009 said he had “probably never seen such a wide moat,” according to MarketWatch‘s reporting of Berkshire Hathaway’s BRK 0% shareholder meeting that year. At the same meeting, Buffett called Google’s business model “incredible” and intimated that he also believed the company had a sizable moat.

Six years later, Google’s once-impenetrable moat is showing signs of drying up. The company is struggling to maintain market share in Web search as the number of mobile apps and specialized search engines multiplies. Google needs fresh innovations to maintain its massive lead in search.

Google’s leaky moat

More than a decade after its initial public offering, Google is still dependent on its search-based advertising platform for the vast majority of its revenue. Over 68% of Google’s 2014 revenue came from advertisements served on its own websites (, YouTube, Google Finance, etc.), and its main search engine is still the crown jewel of the company.

Google is the undisputed leader in web search, but its moat may be narrowing. In January, Google’s U.S. market share slipped to below 75% for the first time StatCounter started tracking data in 2008. Compounding the problem, cost per click — what advertisers pay Google each time a user clicks on its search ads — has been declining for several quarters, falling 8% in the fourth quarter. Although the number of paid clicks is increasing, falling market share and cost per click are challenging Google’s growth expectations.

Internet in transition

Google’s main problem stems from the proliferation of new and better ways to search the Web. For instance, Web users increasingly employ specialized search engines, such as and Kayak, to search for certain information instead of using Google. As the Internet matures, niche search engines might direct more searches away from Google’s generalized system — turning Google’s recent market share struggles into a long-term secular trend.

The same trend toward specialized search engines is engulfing the mobile space as well. Users are increasingly turning to mobile apps like Yelp’s to make targeted searches. Yelp averaged 72 million monthly mobile unique visitors in the fourth quarter of 2014, up 37% from the year-ago quarter. Cumulative reviews grew 35% in 2014 to 71 million. While Google has responded to threats from Yelp with Google+ Local, it must continue to outmaneuver its competitors in order to maintain its mobile market share.

For now, Google maintains an outstanding 84% mobile market share, according toStatCounter. Mobile search now accounts for 29% of all search activity, according to a report by comScore,. which says smartphone searches grew 17% and tablet searches grew 28% in 2014, while desktop searches declined 1%. The increasing number of mobile searches is putting downward pressure on Google’s cost per click. Mobile ads are smaller and harder to fit on a screen than desktop search ads, thus making them a less profitable advertising avenue. As mobile searches ramp up, Google’s cost per click is declining — falling 10% in 2013 and 7% in 2014 for Google’s websites. This is the single biggest sign that Google’s moat might not be durable.

Was Buffett wrong?

Despite its challenges in mobile ad monetization, Google is still a strong and growing company. Paid clicks on Google websites increased 29% in 2014, more than offsetting its single-digit decline in cost per click and powering an 18% increase in advertising revenue.

However, investors shouldn’t let Google’s revenue growth mask its deteriorating cost-per-click numbers. If the metric continues to decline, Google’s profitability is sure to follow. This could be why Buffett hedged his stance at Berkshire’s 2012 annual shareholder meeting, telling investors, “I would not be at all surprised to see [Google] be worth a lot more money 10 years from now, but I would not buy [it]. I sure as hell wouldn’t short [it], either.”

Buffett knows Google has a powerful business model, but investors shouldn’t take its booming growth for granted. If Google fails to find a more profitable model for mobile search, long-term shareholders could be left holding a busted growth stock.



Humdrum ETFs Are Overtaking Racy Hedge Funds

Tortoise and the hare
Milo Winter—Blue Lantern Studio/Corbis

It's part of a gradual change in culture on Wall Street that's encouraging low costs and long-term thinking.

It’s like the investment world’s version of the race between the tortoise and the hare. And the hare is losing its lead.

Hedge funds, investment pools known for their exotic investment strategies and rich fees, have long been considered one of the raciest investments Wall Street has to offer, with $2.94 trillion invested globally as of the first quarter, according to researcher Hedge Fund Research.

Despite their mystique and popularity, though, hedge funds are about to be eclipsed by a far cheaper and less exclusive investment vehicle: exchange-traded funds.

According to ETF researcher ETFGI, exchange-traded funds — index funds that have become favorites of financial planners and mom and pop investors — have climbed to more than $2.93 trillion. ETFs could eclipse hedge funds as early as this summer, according to co-founder Debbie Fuhr.

In some ways the milestone is one that few people outside the money management business might notice or care about. But even if you don’t pay much attention to the pecking order on Wall Street, there’s reason to take notice.

The fact that ETFs have caught up with hedge funds reflects broader trends toward lower costs and a focus on long-term passive investing, both of which benefit small investors.

Exchange-traded funds, which first appeared in the 1990s and hit the $1 trillion mark following the financial crisis, have gained fans in large part because their ultra-low cost and hands-off investing style.

While there are many varieties of ETFs, the basic premise is built on the notion that investors get ahead not by picking individual stocks and securities but by simply owning big parts of the market.

Index mutual funds have been around for a long time. (Mutual funds control $30 trillion in assets globally, dwarfing both ETFs and hedge funds). But ETFs allow investors to trade funds like stocks, and they can be more tax efficient than mutual funds. Both ETFs and traditional index funds are known for ultra-low fees, sometimes less than 0.1% of assets invested. That means investors keep more of what they earn, and pay less to Wall Street.

Hedge funds by contrast exist for elaborate investment strategies. They are investment pools that in some ways resemble mutual funds, but they can’t call themselves that because they aren’t willing to follow SEC rules designed to protect less sophisticated investors.

Because of their special legal status, hedge funds aren’t allowed to accept investors with less than than $1 million in net worth, hence the air of wealth and exclusivity.

But hedge fund managers also enjoy a lot more freedom in how they invest, for instance, sometimes requiring shareholders to lock up money for months at a time or taking big positions in complex derivatives.

Hedge funds aren’t necessarily designed to be risky — they get their name from a strategy designed to offset not magnify market swings. But hedge fund investors do expect managers to deliver something the market cannot. Otherwise why pay the high fees? Hedge funds typically charge “two and twenty.” That is 2% of the amount invested each year, plus 20% of any gains above some benchmark. No that is not a typo.

Of course, hedge funds’ rich fees wouldn’t be a problem if they delivered rich investment returns. The industry has long relied on some fabulously successful examples to make its case. But critics have also suspected that, like the active mutual fund industry in its 1990s’ heyday, this could be a case of survivorship bias, with a few rags-to-riches stories distracting from more common stories of mediocre performance.

Hedge funds’ performance in recent years seems to be bearing that out. (By contrast ETFs, whose returns are typically tied to the stock market, have benefited from one of the longest bull markets in history.)

Why should you care if a bunch of rich guys blow their money chasing ephemeral investment returns? One reason, is you might be among them, even if you don’t know it. Pension funds are among the biggest hedge fund investors.

The good news: They too are embracing indexing, if not specifically through ETFs. Calpers, the giant California pension fund, said last year that it was dumping hedge funds, while also indexing more of its stock holdings.

Unlike ETFs, hedge funds — because they need to justify their rich fees — often suffer from short-term focus. In recent years, one popular strategy has been so-called “activist investing,” where a hedge fund buys a big stake in an underperforming company and demands changes.

While the stock market often rewards those moves in the short-term, many investors worry moves like cutting costs and skimping on research ultimately make those businesses weaker, hurting long-term investors. It’s no surprise then that one of activist investing’s most outspoken critics is BlackRock Inc. As the largest ETF provider, BlackRock represents the interests of millions of small investors.

And finally, there are those fees. The surging popularity of low-cost investments such as ETFs will inevitably focus more attention on fees, putting pressure on active investment managers — and even hedge funds themselves — to slash prices. And in the the end, that benefits everybody.

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