How to measure stock reputation

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.