Monday, May 18, 2009

Helping Filter Out the Noise

One of my favorite sayings about Wall Street is: “Over the short term, the market is a popularity contest, while over the long term the market is a discounting machine”.  What this means is that on a day-to-day basis stock prices react to all sorts of noise in the system, whether it’s fears about swine flu or the current political mood of the country, while over the long term stock prices tend to reflect the market’s view of the value of the company’s stream of future cash flows, the intrinsic value of the company.

Fayez Sarofim, one of the great long-term investors of the last fifty years, puts another spin on this.  He says, “Nervous energy is a great destroyer of wealth”, and illustrates the statement with the chart I’ve reproduced below.  

Assuming that a firm’s value rises over time (we are, after all, talking about well run firms here), an investor can potentially lose a lot of money by buying or selling based upon the latest short-term market reactions.  The patient, well-disciplined long-term investor can avoid those pitfalls and the associated trading costs that accompany them by focusing on the intrinsic value of the company.

The holy grail of investor relations is the patient, long-term investor who sees the value of management’s longer-term investments in the business and is willing to let them play out over time.  Unfortunately, in investor relations we spend 95% of our time responding to the other investors, so that’s where I’m going to direct my remarks.  One of the jobs of good investor relations is to engage in the IR version of damage control – responding to the market gyrations and the concern du jour; the large rises and drops represented by the dotted line in the graph.  Good investor relations seeks to squeeze out the volatility of the ups and downs of the market concerns by giving investors a full and complete picture of the company’s intrinsic value so that market value can more closely match intrinsic value. 

This means several things:  First, providing clarity to the numbers.  Mandated disclosure filings are good at telling investors what happened, but less good at explaining why they happened.  A good investor relations officer will fill in the gaps.  Secondly, investor relations can provide context to what is going on.  Many analysts following companies today don’t have a long history covering the company, whereas management has usually been there a long time.  Providing historical context can be very helpful. 

Here’s a case in point:  Recently, Walgreens has announced that it is testing a program to reduce the product assortment in its stores.  The thought process is that by reducing clutter on the store shelves, the company can more prominently feature key items and sales will go up, even though there are fewer items in the store.  Not surprisingly, this assertion has met with some skepticism in the investing community.  Yet Walgreens has an example in its own recent past that proves their thesis.  Back in the early 1990’s Walgreens reduced the number of newspaper advertisements it was running from two per week to one.  Everyone (including company management) thought that sales would go down, but instead, sales increased because better items and ads resulted from the reduced clutter.  If Walgreens were to provide such context to investors, it could mitigate some of the doubts being voiced (you will never eliminate them entirely – this is, after all, Wall Street we’re talking about).

Third, and as important as the other two items combined, good investor relations dampens volatility by providing credibility for the company.  This comes in a variety of forms, whether it’s access to management, consistency and even-handedness in how, when and where disclosure is accomplished or doing what the company says it will do, to name a few.  Every IR officer that has been around for a while has experienced situations where the stock suddenly plunges (or, less frequently, rises) and their ability to say much is severely constrained by the circumstances.   If you have credibility, investors will tend to give you the benefit of the doubt and give less credence to the rumors swirling about.

So that’s it in a nutshell:  lessen the noise, squeeze out the volatility and get your market value in line with your intrinsic value.  Simple, eh?


Rob Berick said...

John: great post - you hit on a number of important points.

Would you agree that one of the ways you squeeze out the noise is to craft a truly differentiated value proposition (read: IR messaging) that directly addresses the holy grail investors' primary needs, as well as the elephants in the room?

John Palizza said...


If you think about the the marketing component of IR- segment, target and positioning-the differentiated value proposition comes at the end of the process, when you know you're talking to someone whose investing style and values are aligned with your company's characteristics, although some of the message has to be built in earlier in the process, so that the investor can find you.