ClarityBV Blog

Highly recommend the “Psychology of Intelligence Analysis.” (The entire work is available for free download from the CIA website, so take advantage of your tax dollars at work!)

Financial analysts will find “Part II–Tools for Thinking” of particular interest. A look at that section’s topics highlights many similarities in intelligence analysis and valuation analysis.

• Chapter 4: Strategies for Analytical Judgment: Transcending the Limits of Incomplete Information. “When intelligence analysts make thoughtful analytical judgments, how do they do it? In seeking answers to this question, this chapter discusses the strengths and limitations of situational logic, theory, comparison, and simple immersion in the data as strategies for the generation and evaluation of hypotheses. The final section discusses alternative strategies for choosing among hypotheses. One strategy too often used by intelligence analysts is described as “satisficing”–choosing the first hypothesis that appears good enough rather than carefully identifying all possible hypotheses and determining which is most consistent with the evidence.”

• Chapter 5: Do You Really Need More Information? “The difficulties associated with intelligence analysis are often attributed to the inadequacy of available information. Thus the US Intelligence Community invests heavily in improved intelligence collection systems while managers of analysis lament the comparatively small sums devoted to enhancing analytical resources, improving analytical methods, or gaining better understanding of the cognitive processes involved in making analytical judgments. This chapter questions the often-implicit assumption that lack of information is the principal obstacle to accurate intelligence judgments.”

• Chapter 6: Keeping an Open Mind. “Minds are like parachutes. They only function when they are open. After reviewing how and why thinking gets channeled into mental ruts, this chapter looks at mental tools to help analysts keep an open mind, question assumptions, see different perspectives, develop new ideas, and recognize when it is time to change their minds. A new idea is the beginning, not the end, of the creative process. It must jump over many hurdles before being embraced as an organizational product or solution. The organizational climate plays a crucial role in determining whether new ideas bubble to the surface or are suppressed.”

• Chapter 7: Structuring Analytical Problems. “This chapter discusses various structures for decomposing and externalizing complex analytical problems when we cannot keep all the relevant factors in the forefront of our consciousness at the same time. Decomposition means breaking a problem down into its component parts. Externalization means getting the problem out of our heads and into some visible form that we can work with.”

• Chapter 8: Analysis of Competing Hypotheses. “Analysis of competing hypotheses, sometimes abbreviated ACH, is a tool to aid judgment on important issues requiring careful weighing of alternative explanations or conclusions. It helps an analyst overcome, or at least minimize, some of the cognitive limitations that make prescient intelligence analysis so difficult to achieve.ACH is an eight-step procedure grounded in basic insights from cognitive psychology, decision analysis, and the scientific method. It is a surprisingly effective, proven process that helps analysts avoid common analytic pitfalls. Because of its thoroughness, it is particularly appropriate for controversial issues when analysts want to leave an audit trail to show what they considered and how they arrived at their judgment.”

Congrats to all my accountant friends kicking off a long weekend. I’ve been wondering though…

When will we implement staggered due dates, like many motor vehicle departments have implemented for registration renewals?

We’re deep in several auto dealership valuations at the moment. So, thought we’d share the following outlook for 2010. This is a summary pulled from the publicly traded dealership groups’ latest annual reports.

• Asbury Automotive Group, Inc. (ABG) “We expect the U.S. automotive retail market will experience a modest recovery in 2010, as we believe that the majority of automotive manufacturers have stabilized production levels in response to the economic slowdown and will focus on using a combination of vehicle pricing and financing incentive programs to increase demand in 2010, although no assurance can be provided in this regard.”
• AutoNation, Inc. (AN) “While we believe that new vehicle sales will gradually improve in 2010 as compared to 2009, we also believe that the automotive retail market will remain challenging and that the annual rate of new vehicle sales will remain depressed by historical standards in 2010. In addition, we expect that the decline in new vehicle sales over the past few years, which has led to a decline in the number of recent-model-year vehicles in operation, our primary service base, may have an adverse impact on our parts and service business for the next several years.”
• Group 1 Automotive Inc. (GPI) “Despite the recent economic downturn and resulting negative impact on our business, we remain optimistic about our business model and expect that, over the long term, industry sales will rebound, reflecting a significant level of pent-up demand.”
• Lithia Motors Inc. (LAD) “Our business is heavily dependent on consumer demand and preferences. The recent downturn in overall levels of consumer spending has materially and adversely affected our revenues. We expect this downturn to continue through at least 2010.”
• Penske Automotive Group, Inc. (PAG) “During 2009, there has been continued weakness in consumer confidence and spending in the markets in which we operate, which we believe has resulted in reduced customer traffic in our dealerships. While we have experienced increased vehicle sales and customer traffic in recent quarters, we expect our business to remain significantly impacted by difficult economic conditions in 2010.”
• Sonic Automotive Inc. (SAH) “Current industry analyst expectations for new vehicle sales volume in 2010 are between 11.0 and 12.0 million vehicles, a 5.8% to 15.4% increase from 2009. Changes in consumer confidence, availability of consumer financing or changes in the financial stability of the automotive manufacturers could cause 2010 industry results to vary.”

For those scoring at home, let’s call it…

• 3 cautiously optimistic (ABG, AN, and GPI)
• 2 pessimistic (LAD and PAG)
• 1 on the fence (SAH)

By now, most business appraisers are familiar with the pass-through entity tax debate. The issue is whether an S Corp. or similar “pass-through” entity is worth more than an equivalent C Corp. simply because of a tax election. (See for instance this presentation handout from 2003 by Mr. Mercer or simply do a search for “S Corp tax affect debate.”)

What I have not seen discussed often is the tax affect issue related to not-for-profit entities. Deals involving not-for-profits occur routinely in the health care industry. For instance, a study in 2008 referenced in this article indicated that 78% of hospital mergers and acquisitions involved non-profits as buyer, seller, or both.

Let’s say you were valuing a non-profit entity for financial reporting purposes (e.g. fair value standard) using a discounted net cash flow analysis. Would you apply an income tax effect to the net cash flow stream? Why or why not?

Rather than an either/or approach, what about using a weighted tax affect based on the probable market participants?

Using the hospital reference above, one might argue a 64% chance the buyer would be a non-profit (e.g. no tax affect) and a 36% chance the buyer would be a for-profit (e.g. a C Corp. or pass-through entity with some sort of tax affect). If non-profits have a lower hurdle rate due to tax status, it seems they would constitute the majority of buyers as appears to be the case in the hospital industry.

Of course, there are plenty of other reasons non-profits might have different hurdle rates or acquisition motives, but income taxes seem to be a material factor.