Wednesday, March 28, 2012

Moneyball for Investor Relations

I recently read Michael Lewis’ book Moneyball and was struck by some of the similarities between what it discusses and what commonly occurs in corporate investor relations. For those of you who may not have read the book or seen the movie, Moneyball is the story of Billy Beane, the general manager of the Oakland A’s baseball team who successfully positions his team to compete against teams with much larger payrolls than the Oakland A’s were able to afford. He does this by going against conventional wisdom and finding players that do not fit the establishment’s idea of what a professional ballplayer looks like but who contribute to winning in ways the establishment doesn’t value. In essence, the normal way of viewing these players allows their salaries to be mispriced in the marketplace and a general manager that appreciates this can assemble a winning team for considerably less money. (The football equivalent of this phenomena is Tim Tebow, who does not fit pro football’s concept of what a professional quarterback looks like or does. All he does is win yet the Denver Broncos seemingly couldn’t get rid of him fast enough.)
In investor relations, corporations are constantly applying conventional wisdom to their detriment, which in their case means that the value of their stock suffers. Take, for example, the following statement: “This is what the regulations require us to disclose, and therefore that’s all we are going to say”. This is what I call the regulatory mindset trap. The regulations describe the minimum disclosure requirements, but they don’t tell you to put it in context, or to make it intelligible. Anyone who has ever tried to parse through statements in annual reports dealing with deferred tax accounting or pension accounting can tell you that it is very difficult to make heads or tails of these sections without help from the company. In academic terms, when companies do this, they raise the cost of acquiring the information. This is because investors have to devote more resources towards understanding the information. Further, it also raises the specter of asymmetric information, that is, the information gap between what management knows and what it allows investors to know. Studies have shown that both increasing the cost of acquiring information and high information asymmetry will increase the cost of capital by lowering liquidity in the company’s shares.
Or consider the conventional wisdom that causes companies that take the position, “We simply report what we have done, and we leave it to the investors to figure out what our performance will look like in the future.” When you consider that the value of your company’s stock is equal to the sum of its future cash flows, discounted back to a present value (this is Finance 101), not discussing the future is obviously leaving off a critical piece of information. Investors will then make their own forecasts, whether a company helps them or not.  The forecasts then become harder to make and carry a greater degree of uncertainty without some input from the company. As a result, future values will be discounted to a greater degree, leading to lower stock prices.
So the investor relations thought for the week is that if you hear someone at your company say, “We can’t say that” or “We’ve never disclosed that”, question the conventional wisdom. Your stock could be mispriced simply because investors don’t have the right information needed to make an informed decision about the stock.

Tuesday, March 13, 2012

Just When You Thought It Was Safe To Go Back on the Call

Strange as it may seem, National Public Radio and Wall Street sell side research share a common business model – they both give the product away and hope you get paid later. The motivations are different; NPR is a not for profit entity while sell side research sits at the heart of profit driven capitalism, but NPR pledge drives and sell side marketing to get commissions directed their way are similar in many respects. Both occur long after the product has been delivered to the user with no obligation for the user to actually pay for it and both attempt to convince the user that they have been given a superior product.

The reason I bring this up is that occasionally NPR comes up with a story that actually has some bearing on corporate earnings and Wall Street, and they recently did so on February 2, 2012 with a piece entitled “Is That CEO Being Honest? Tone Of Voice May Tell A Lot”. You can find it at

In the story, NPR examines some software developed by an Israeli company based on research referred to as layered voice analysis. The software picks up on “vocal dissonance markers” that may indicate when the truth is being shaded, or when an executive is trying to avoid saying something that should be said in order to make an answer complete.

Of course, analysts on conference calls listen to tone and inflection all the time, so this of itself is not a news flash. The part of this story that makes it interesting is that the research shows that the analysts are much better at hearing the positive tones in a call than they are at hearing the cognitive dissonance in messages that are being shaded from complete truth. According to the radio story, part of this may be that most analysts stand to benefit more from positive recommendations than negative recommendations. Another part may be that most people are less likely to ascribe nefarious intent when a person sounds less than chipper. To this I will add another factor: most conference calls have taken on a very formulaic approach, and much of the time, corporate management sounds as if they are discussing their immanent root canal surgery with their dentist. Sounding unhappy to be on the call is par for the course and, therefore, it is hard to distinguish an unhappy tone from a less than honest tone. Conversely, any time management sounds happy, it really stands out and is easy to pick up on.

Faithful readers with long memories may recall that I wrote about similar research back in August 2010 in a post titled “Using Computers to Predict If a CEO is Lying”. In that case, researchers from Stanford Graduate School of Business took a look at word patterns during the Q & A sessions of earnings calls to help predict when company management was being deceitful. Now we have software that listens to voice tone that does the same thing. So maybe we are getting closer to the day when management will have no choice but to be completely honest with investors on earnings calls.

It could mark the death knell of the earnings conference call…

Thursday, March 1, 2012

Where’s the Beef?

Way back in 1984, Wendy’s, the hamburger chain, ran a commercial that featured a little old lady, played by actress Clara Peller, and the tag line “Where’s the beef?” The commercial became an instant classic because it played to the common sense of the audience to look past marketing hype to try and find the substance of the product. You can find a video of the commercial here:

I bring this up because I often feel the same way when I hear about the benefits of corporate restructuring programs. These programs are often announced to great fanfare by corporations when they take massive one-time write-downs. The benefits are then discussed in diminishing amounts as the ensuing years unfold and we are left to take the company’s word that they in fact achieved the benefits claimed. So I thought I would go back and look at an example of one of these programs to see if I could understand the savings claimed.

Here, for example, is Walgreens President, Greg Wasson, as quoted by on January 8, 2009:

"Our Rewiring effort is finding ways for Walgreens to be more effective and efficient so that our growth strategy can move forward"

In its entirety, Rewiring for Growth targets $1 billion in annual savings by fiscal 2011. The company will achieve savings through:

strategic sourcing on indirect spend (all goods not for resale),

reduction in overhead and labor,

and the POWER project, which is designed to enhance patient-pharmacist interaction while reducing costs.

Walgreens expects to incur costs of $300-$400 million over FY09 and FY10 as it implements Rewiring for Growth. 50% of the project’s benefits are expected to accrue beginning in FY10, with the full $1 billion in targeted annual savings beginning in FY11.”

This sounds like great stuff. If Walgreens could take $1 billion out of its expenses, with 2011 sales of $72.184 billion, they should reduce their expense ratio by 1.38%, which presumably should go straight to the bottom line. So I went and looked at what has happened to expense ratios since 2008, the base year of the announced “Rewiring for Growth” program. When I looked at the S, G & A expense ratio for the company here’s what I found:

2008 (base year) 22.36%

2009 22.68%

2010 23.02%

2011 22.94%

In other words, not only has the expense ratio not gone down, it has gone up in two of the three years since the program was announced and the ratio is 58 basis points higher now than when they started. In fact, if Walgreens had just maintained the same expense ratio that it had in 2008 before the program began, expenses would have been $476.4 million lower than they were in 2011. So I have to ask: “Where’s the beef?” How can you have an expense reduction program that results in rising expense ratios?

In their 2011 Annual Report, Walgreens states way back on page 19: “We have realized total savings related to Rewiring for Growth of approximately $1.1 billion compared to our base year of 2008. Selling, general and administrative expenses realized total savings of $953 million, while cost of sales benefited by approximately $122 million.” If you go and look at some of the company presentations they go to great lengths to try and justify their calculations, but when I read it I find myself in a time warp back to the late 1990s where companies routinely issued press releases about “earnings without the bad stuff”. There must be a method to their calculations – but it’s a little too subtle for me and I always worry about how they decided what to leave in and what to take out. (And let’s not forget that they said they would be getting $1 billion per year savings by now, not over the life of the program.) I mean, they’ve got sophisticated accounting systems and I’m just one guy with a calculator, but I really would like to see it in the income statement numbers, because what they’re saying doesn’t make sense to me. It’s not a successful expense reduction program if you don’t lower expenses.

From an investor relations standpoint, this stuff certainly doesn’t help management’s credibility. Maybe this is just the way things are done, but it’s quit frustrating for your average investor. When I get frustrated, I tend to take it out with food, so I think I’ll go fix myself a hamburger… and find some real beef.