Putting a “Hook” into Your IR Message

In the music business, received wisdom is that a song needs a “hook” if it’s going to be a number one hit.  In other words, a song has to have a memorable thought, idea or catch phrase so that listeners will remember it.  The idea translates well into much of what we do in investor relations.

Yesterday Robin Tooms of Savage Brands and I put on a Webinar entitled, “Attracting Investors with a Strong Financial Brand".  For me, it was an opportunity to step back and think about some of the more strategic aspects of investor relations. In IR we are often consumed with the tactical issues; the latest earnings release, the next investor conference, the endless minutia of analysts’ questions and the like, and we fail to put things in a framework that help investors understand what our companies are all about.  Thinking of your company as a financial brand helps to put your company in a context where many of the things your firm does fall into place and help explain one another. 

Some companies have such strong cultures that their financial brand is easy to see. The example I spoke about on the Webinar was Wal-Mart.  Everything Wal-Mart does is predicated on delivering the lowest possible price to their customer.  Their philosophy is simple – if you deliver low prices to customers, they will shop in your stores in large numbers and you’ll make lots of money.  Once an investor understands that this low price philosophy permeates everything that Wal-Mart does, they have a much better understanding, not only of the financial implications (gross profit margins low, SG&A even lower), but also how Wal-Mart gets there through its relationships with suppliers, cost containment and even their passionate anti-union stance. 

Sometimes it’s not quite as obvious and it takes a little thinking about how you should be positioning the “brand”.  When I was at Walgreens, the stereotype of the company was that it was just a drugstore chain, which as all the analysts knew was vulnerable to: (pick one, depending on the decade) combination supermarkets/drugstores, deep discount drug stores and Wal-Mart and hence could not possibly be competitive on price. In addition, nobody could understand why the company was building so many stores so close together, as there were already plenty of drug stores in America in retail shopping centers.  (As an aside, allow me to add that Wall Street analysts are notoriously bad at strategic thinking about companies.  Companies that allow Wall Street to set their strategic agendas are almost certainly doomed, as they will be buffeted by the latest trends taught in business schools unrelated to the hard facts of the marketplace and the company’s underlying culture. (See my post, “When Culture Meets Financial Theory” from September 24, 2008.)  It’s even worse than when the company brings in a bunch of consultants to help set the future course of the company.)  The response, or “brand message” to all of this was simple: Walgreens sells two things – healthcare and convenience.  When put into that context, much of what Walgreens was doing became more understandable.  The competitive response to the various retail formats, all of them big box retailers, was to be more convenient.  This explained why price, which Wal-Mart has used so effectively on most competitors, was not as effective on Walgreens, because Wal-Mart, with their giant stores, just wasn’t convenient.  It also explained why Walgreens was building so many stores – you needed to be close to the customers in order to be convenient.  And it explained why Walgreens wasn’t buying a lot of the existing drug stores, as those stores sat back in shopping centers right next to the supermarkets and were not as convenient as the new stores Walgreens was building on busy street corners.  The list goes on, but I think you get the idea.  Walgreens stated what made it unique and used it to explain many aspects of its operations and philosophy. 

We operate in a time when our message to investors is at risk of becoming ever more fragmented as the means of delivering it proliferate.  Think about Twitter – how do you convey a coherent message in 144 characters or less?  Either that or we run the risk of becoming increasingly bland as Reg. FD forces companies to be relentlessly on message.  If you can go beyond the tactical considerations of what the regulations require to be disclosed and whether or not something is material to provide a coherent context to your company – a financial brand – you will help your company and increase your value to investors. 

Either that, or you’ll be ready for a career in marketing…

The Curious Effect of Falling Stock Prices on Diluted EPS

As I’ve watched companies report earnings for the quarter that ended September 30^th, I’ve noticed a strange phenomenon – companies are getting help to their Diluted Earnings Per Share line from falling stock prices.  It’s no secret that the stock market has been brutal over the course of the past six months, and company equity values have taken a beating.  But there has been one small side benefit to the decline in stock prices.  Of course, companies won’t come out and tell you what it is.  You have to be a pretty savvy investor and know your way around a company’s financials in order to figure it out. 

Here’s how it works:  many companies have issued a large number of options over the last decade and have a large number of options that go into the diluted earnings per share calculation.  To grossly oversimplify things, the more options a company has outstanding and the deeper they are in the money, the greater the number of shares in the denominator for purposes of calculating diluted (as opposed to basic) earnings per share.  So far, so good, as long as the stock price moves in a smooth fashion.  However, when you get a steep drop in the stock price, many of a company’s options go under water.  When an option’s exercise price is above the fair market value of the stock, the options are excluded from the diluted earnings per share calculation, and they are anti-dilutive.  (This sounds to me suspiciously like anti-matter, but I don’t think accountants are that imaginative.) The result is that companies with large numbers of stock options and steep price drops in the stock price wind up with fewer fully diluted shares in their diluted EPS calculation and hence a higher diluted EPS number.  Good luck getting them to fess up to that however, they do their best to bury the calculations deep in the 10K or 10Q.

Sometimes the numbers can be startling.  A few years back Microsoft had 649 million shares excluded from the calculation of diluted EPS because they were anti-dilutive.  Talk about a big overhang on EPS if the stock price ever recovers.  More usually, the anti-dilutive effect is smaller, say one or two cents per share in each quarter.  The point here is two-fold: first, in Wall Street’s eyes, one or two pennies per share per quarter is a lot; when companies miss by that much, they get punished; and second, this is a non-operational benefit that companies are getting due to the bear market.  Companies are quick to tell you when non-operational issues hurt the EPS line, so why do they stay so quiet when it runs in their favor?

Finally, as long as I’m on my soapbox, where have all the highly paid Wall Street analysts been on this issue?  I have not seen a single analyst report that mentions this.  So here’s some advice to all my sell side friends – when diluted and basic EPS suddenly start looking the same where in previous years diluted was lower than basic, the company is probably getting some non-operational help from anti-dilutive options. Things aren’t as good as they seem.

Now, just like anti-matter coming into contact with matter, I will disappear.