Cost of complexity

I've been listening to Aswath Damodaran's valuation class online, which has been very informative. Near the end of Lecture 10, Professor Damodaran suggests an interesting adjustment to "punish" companies for having complex structures that are hard to understand and analyze. The argument goes the more complex a company is, the more places it can hide information about itself and the more likely some of those details will turn out to be bad news. The professor suggests counting the number of pages in a companies 10-K as a simple way to measure complexity.

I sort of assume my companies are more transparent than their peers, but I didn't have any way of measuring that. Now I do. Here are my core holdings with the first competitor I thought of for reference:

Company        Pages
-------        -----
Oracle         103
Canon (20-F)   122
Select Comfort  72
Berkshire       84
Alberto         99   
Sally           99
Marblehead      71+38F

SAP (20-F)     121+70F+1S
HP             152
Tempur-Pedic    48+30F
Citigroup      180
P&G             23
Regis          117
Sallie Mae     118+84F+12A

I don't know how to treat the extra pages (F-38, A-12 and so on), but my sense is that these are a sign of even more complexity than regular pages. Proctor & Gamble walk away with the prize in this group, but overall, the companies I own are objectively less complicated than the ones I don't. I had actually picked Citigroup as a foil to Berkshire because I expected it to have over a thousand pages. Perhaps that number includes all the supplementary documents that I don't plan on even opening. I only included the main 10-K.

One other reason to use this sort of test is that if a company's filings are too long or complicated, chances are you won't read it. My Alberto-Culver investment relied on that principle, since I hoped as few people as possible would have worked though the sum-of-the-parts valuation and I could buy in at a low price. Now that I've bought, I hope the Sally reports at least are going to become more clear and simple so that other investors can begin to appreciate the company's true worth. And since insiders have had these same goals, I'm pretty sure my wish will be granted.

The business of beauty

It's been a while since I wrote about Sally Beauty, but there were two stories that I thought were worth reading. First is a story from Forbes on starting a salon business. Sally got a mention as a supplier of salons, but what was more interesting to me was the advice to adopt a Whole Foods approach to employees. "In the salon world, the most precious resources are stylists, so keeping them around and happy is critical." The article suggested emulating Whole Foods' training program.

On a related note, Regis is dropping out of the beauty school business by merging most of its schools with Empire Education Group. The press release has more information including the suggestion that the need for IT investment was the reason for the merger. As you might recall, Regis was initially interested in buying Sally Beauty, but was rejected at the last moment because of operating weakness.

It seems to me that while the beauty salon industry as a whole resists consolidation, the supporting industries are successfully consolidating. Beauty schools and salon product distributors benefit from economies of scale, but salons themselves rely to a large extent on the services of talented stylists. Since talented stylists know they are an important part of the success of a salon, they demand a larger slice of the profits. There are dozens of professions with this dynamic including chefs, athletes, programmers, artists of all types, and so on. But unlike other professions, it's difficult for individual stylists to scale their work—they can only cut one head of hair at a time.