As I
mentioned in a previous article, it is relatively simple to spot an issue with
stock reputation. Quantifying it is much more difficult. Nevertheless, it is
not impossible. By analyzing 5 specific criteria for a company over a long
enough period of time, I believe stock reputation can be precisely measured.
Share price behavior
The historical
share price behavior of a company points to its reputation with its
shareholders. Movements up and down reflect investors’ disappointments,
surprises and fears. They show both their nervousness and confidence level.
Also, by analyzing this behavior, stock reputation can be measured and rated. In
order to accurately measure this, two analyses need to be performed.
First, erratic
daily share price movements need to be identified and counted to determine
their proportion over the period of time. An erratic movement can be spotted
when, during a trading day, the share price materially deviates from the stock
market. Ideally, each erratic movement should be analyzed and explained (announcement,
market fact, etc), but in this case, the statistical measurement is what is
important. The goal is to determine historic risks and the probability of facing
an erratic share price movement for an investor.
Second, the
maximum deviation magnitude of a share price compared to its average trend needs
to be measured. A share price which deviates, one way or another, regularly and
significantly from its trend (the 200-day moving average, for example)
represents an important risk for investors. To the contrary, it is safer to
invest in companies that do not deviate from their trend.
Shareholder value focus
Shareholder
value and share price focus is the second criteria to measure stock reputation.
It is largely related to Corporate Governance. Officially, this is the company’s
management team’s first priority. In reality, however, this is not always the
case. Many CEOs simply do the minimum asked by investors. The main reason for
this is that they do not have to report to investors but rather to friendly and
complacent board members who do not specifically represent shareholders. CEOs
typically only take care of shareholders when their position depends directly on
them and when they are strongly incentivized by share price performance. Also,
this criteria needs to be measured at three levels.
First, the
focus on shareholder value has to come from the board. To rate this, the best
approach is to count the proportion of board members representing a major
shareholder. As a matter of fact, a board member representing directly one key
shareholder (a founding family or a reference shareholder) will always give
priority to shareholder value and will pressure management in case of bad share
price performance. A “professional“ board member may have other priorities. Similarly,
a board structure, where the roles of chairman and CEO would be separate, will be
positive to the rating. A CEO with an underperforming share price would be more
at risk in this configuration. Note that this rating should be reduced in two
cases. One is when the CEO is also the main shareholder of the company and
cannot be fired following a poor share price performance. The other case is
when the board member represents a public shareholder. Shareholder value is
never governments’ first priority.
Second, shareholder
value focus needs to be determined at the top management level. The way to do
that is to measure the number and the proportion of shares (and stock options)
owned by the CEO and management team. As a matter of fact, the first priority
of a CEO is to keep its job and then generally to maximize revenue. A
management team, which is highly incentivized by share price performance, is
most likely to listen to investors.
Third, this
issue needs to be analyzed at the level of Investor Relations. All things being
equal, intensive IR work impacts stock reputation. To measure these actions,
the best is to measure the time dedicated by management (CEO and CFO) to
investors (results, roadshows, conferences, investor days…). The CEO’s
dedicated time should be, of course, overweight compared to the CFO’s.
Shareholder structure quality
The quality
of the shareholder register is the third criteria to rate stock reputation. Indeed,
the more prestigious and the more loyal the shareholder base, the better it is
for the company’s reputation on the stock market. Beyond share price
performance, fund managers from large institutional asset managers have to
justify their choices internally to their investment committees and externally
to their clients. A long-term investment in a company with a good reputation will
always be easier to justify compared to an investment in an unknown or risky
one. To measure the quality of the shareholder structure, two analyses need to
be performed.
First, the
proportion of long term and large institutional funds managers within the free float
need to be identified and measured. That should of course take into account pension
funds and sovereign wealth funds that are particularly long-term shareholders.
The greater percentage of these types of investor in the register, the better
it will be for stock reputation.
Second, the
shareholder loyalty needs to be measured. For that, over the reference period, the
best is to determine the proportion of main shareholders that have remained in
the register and those that have exited. Loyalty is always a great indicator of
good stock reputation.
Equity story communication
Communication
is, of course, important to stock reputation. It is qualitative but can be
analyzed and measured with precision and rigor. Indeed, beyond valuation
multiples and profitability prospects, fund managers invest in a company with a
story and a promise of shareholder value creation: the equity story. This has
to be explained in detail and communicated extensively in a fully transparency
manner in order to create confidence. This communication is critical for stock
reputation, and therefore, needs to be analyzed and rated. To do so, the quality
and effectiveness of communication (website, annual reports, investor
presentations…) needs to be measured based on the 5 key components of the equity
story.
First, the
business model and the key profit drivers have to be explained and formerly disclosed.
The quality and detail of those explanations, as well as the way in which they
are communicated will determine the rating. Indeed, a lack of transparency or
missing information will create doubt with investors and negatively impact
stock reputation.
Second, the
strategy – with targets – has to be properly explained and communicated. These also
need to be rated. Often companies are hesitant to communicate on strategy
because they fear they are providing confidential (or valuable) information to their
competitors. This is a bad excuse. Companies are generally well aware of the
strategies of their competitors, and good communication on strategy is not aimed
at disclosing company secrets, but rather to explain main initiatives in order
for investors to better understand the direction that the company is taking.
Third, the capital
allocation– including the dividend policy – needs to be formerly disclosed and
explained. A cash allocation policy and its communication are critical to
investors as this explains investment priorities and returns that they could
expect. That will determine the rating.
Fourth,
results and performance have to be properly communicated and the quality of
this communication needs to be rated. A company reporting detailed results
every quarter, giving guidance, roadshowing extensively and taking conference
calls to make sure that investors well understood results will be definitively
more trusted than a company communicating limited information on its
performance only twice a year.
Fifth,
communication needs to be rated in its coherence. For example, a company that
highlights specific profit drivers in its business model but communicates on
other drivers in its quarterly results will lose credibility with investors.
Equally, too much inconsequential information will alienate investors and will
also negatively impact stock reputation. More broadly, the coherence should
reflect on the equity story and permit to build the right financial model.
Consistency
It is
critical to communicate on strategy and targets, but actually realizing this
strategy and achieving targets is even more critical for stock reputation. Say
what you do and do what you say. A profit warning or an M&A deal not in line
with strategy will always be disastrous for credibility and stock reputation.
Similarly, reporting changes and restatements will negatively impact visibility
and investor confidence. Also, to be rated, consistency has to be analyzed at
three levels.
Consistency
in strategy is the first thing to rate. To determine this, it is necessary to
review all press releases, transcripts and interviews to spot possible
initiatives or announcements that are not in line with the strategy. Only one
major inconsistency is enough to destroy stock reputation.
The
achievement of targets and guidance represent the second level of consistency
analysis. This can be also rated through a review of historical results
announcements. A profit warning will of course strongly impact reputation but
systematically better results than guidance is also not a positive. This raises
investor expectations and increases disappointment risk for the day the company
will only make its guidance.
Reporting
consistency is the last factor to analyze and rate. To do so, once again, a
detailed review of results publications needs to be done in order to spot
presentation, reporting and accounting changes. Even when they are justified,
reporting changes negatively impact visibility, the understanding of results
and consequently, stock reputation.
