Selling the Academic Side of Investor Relations

When you are an academic, if you really want to make it big, you need to come up with a snappy way to sum up your thinking on your area of expertise. For example, Porter has his Five Forces that describe his thinking on strategy – supplier power, buyer power, competitive rivalry, the treat of substitution and the threat of new entry. Similarly, Kotler has the four Ps of marketing: product, price, promotion and place. So I’ve been thinking: Why doesn’t investor relations have a way to neatly encapsulate what it is we do? Seeing this as a real hole in the academic literature, I have decided to step into the void and propose (with apologies to T. E. Laurence and the Seven Pillars of Wisdom), Palizza’s Five Pillars of Investor Relations.

I choose the wording of pillars because what I am about to describe are the skills needed to form a strong support base for an investor relations program (also, I couldn’t come up with a clever acronym or make everything begin with the same letter).  Plus, this allows me to crate a clever visual slide for my class featuring Greek columns to drive the point home. So, without further ado, here is a brief description of what I consider to be the essential skill and knowledge requirements to do investor relations well – the pillars of investor relations.

FINANCE – It is essential that a good investor relations officer have a thorough understanding of the components of his company’s income statement, balance sheet and cash flow statement, as well as the accounting treatments they derive from. On the theoretical side, the IRO needs to be comfortable with the different valuation models used by Wall Street to value his company’s stock and the role of investor relations in the efficient markets.

MARKETING - How to segment the investment universe, target appropriate investors and position the company story to appeal to those investors are basic marketing skills that are critical to good IR. At a deeper level, using marketing techniques to more efficiently use limited resources to focus on the most important investors can help IR have a bigger impact.

COMMUNICATIONS – Crafting a memorable message that resonates with investors is a critical communications skill that is used in IR. This is closely followed by figuring out what disclosures, above and beyond those mandated by regulations, will assist investors in understanding the intrinsic worth of a company. All of this presupposes a solid understanding of your company and industry. Finally, the skilled use of multiple communications channels is becoming ever more important as new means of communication such as social media proliferate.

LAW – Everything in investor relations is circumscribed by laws, regulations and case decisions. They cover everything from what you say (the periodic reporting requirements of 10-Ks and 10-Qs and mandated disclosures of 8-Ks), to when and to whom you say it (Reg. FD) to why you say it (the case decisions concerning materiality and other items). 

CAPITAL MARKETS – Knowledge of how the stock markets work is an essential skill of the IRO. If you don’t think so, try telling your CEO that you don’t really understand what the markets are doing the next time he sticks his head into your office and asks why the stock is trading down. Understanding liquidity, volatility, auction markets and the other things that impact the way your stock is traded and how to access information about them quickly are necessary pieces of information for the IRO.

Well, there you have it: The Five Pillars of Investor Relations. Now all I have to do is sit back and wait for the book offers to come rolling in…

A Hypothetical Model to Help in Thinking About the Value of Investor Relations

(Author's Note: A version of this post originally appeared on the web site Corporate Eye. I liked it so much that I am recycling it here.)

People in the academic world are big on constructing models to prove their financial theories. These hypothetical constructs blithely disregard such things as taxes, transaction costs and the fact that emotional, sometimes illogical humans are part of the market process. They don’t allow messy reality to interfere with their elegant equations, but the models are useful in highlighting a theory or hypothesis. Many an academic prize (and even some Nobel Prizes) has been won by building explanatory models that make huge assumptions and leaps of faith. In fact, my favorite quote about finance makes a nod to this as it relates to the Efficient Market Hypothesis. Fischer Black, a former Professor at the Massachusetts Institute of Technology (MIT), which sits next to the Charles River in Cambridge, Massachusetts, took a job with Goldman Sachs in New York, situated next to the Hudson River. After working there for a while, he was heard to remark, “Markets look a lot less efficient from the banks of the Hudson than from the banks of the Charles”.[1]

As I consider myself only a quasi-academic – that is, I teach but I don’t engage in any of the pedantic research that clogs the academic financial journals (plus, I have not yet sewn patches on the elbows of my tweed jacket, nor have I taken up smoking a pipe), I thought I would serve up for the benefit of my readers a theoretical quasi-model to help think about the value of investor relations. Recognizing that investor relations is a discipline that involves real people and information, I will keep it quasi-simple.

Start by thinking of two theoretical firms, both in the same industry and each performing exactly the same in financial terms. That is to say, according to their past performances, their growth rates are similar, their rates of return do not differ in any material way and they serve the same customer base. Firm A discloses exactly what is required by the regulations, and nothing more. It makes no effort to explain its more complicated accounting treatments and it does not reveal anything about its strategy or future plans. It does not respond to investor inquiries, does not make management available to investors and analysts, and does not present at any industry conferences. In short, beyond the regulatory filings it makes, it remains silent.

Firm B on the other hand, tries to be as open and transparent as possible, going beyond the regulatory disclosure requirements to explain its business and strategy, meeting with investors and regularly presenting at industry conferences. They keep up a steady stream of information that keeps investors informed on a timely basis, not just on a regulatory filing basis.

The question to be asked then, is under that hypothetical situation, should Firm B get a higher valuation than Firm A? I submit that under these conditions, it is highly likely that a premium will be attached to the valuation of Firm B, compared to Firm A. There are several reasons for this, chief of which is that investors will view the greater transparency into operations and management thinking about the future as enabling them to make better estimates about future cash flows. Secondly, the cost to investors of acquiring information has been lowered by Firm B, and this should show up in their valuation. Third, the amount of information asymmetry between the company and the investors has been lowered by Firm B, which should also be reflected in a higher valuation. Finally, although the information Firm B extends beyond that required by the regulations is not material in any one piece, in the aggregate it may help in the assembly of a mosaic of information that may be material to investors.

Unfortunately, I do not have an elegant equation to quantify the value of the of these investor relations activities. I do think it suggests however, that at least for companies where information is widely disseminated, much of the value in investor relations is in the selection and disclosure of information beyond what is required by regulation.

Now, if you want to nominate me for an academic prize, be my guest. Of course, with my luck it will turn out to be a quasi-prize…

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[1] As quoted in Against the Gods by Peter L. Bernstein.

Do You Think You Could Make That More Boring?

Who ever said that an investor presentation has to be boring? (I exclude from this question the lawyers, who as a default position, always feel that boring and incomprehensible is safer than exciting and interesting.)

I was at an investor conference last month and took the opportunity to sit in on several presentations. I think that most of the company presenters must have been listening to their lawyers. After about two presentations I began to tune out because most of what I heard was pretty bland and uninteresting. It was as if the presenters had all gone to the Sgt. Joe Friday school of public speaking. They were determined to give “just the facts” in the most humdrum fashion possible. (For those of you too young to remember, Sgt. Joe Friday was the principal character in the TV drama Dragnet who gave new meaning to the term poker-faced.)

Honestly, how can you expect an investor to get excited about a stock if the company CEO doesn’t show some enthusiasm when talking about the company? Yet that is exactly what I saw at the conference. This was especially true at the beginning of most presentations, when the speaker should be working the hardest to capture the interest of the audience, yet what I often heard was the recitation of bare bones facts about the company without a lot of context to help investors understand the company’s products and position within the industry.

The other major bone I have to pick about what I heard was that most companies thought their job was done when they had explained what their past activities had been. The implication of such a presentation is “Here’s what we’ve done in the past, now you can go ahead and make your own judgment about what we will do in the future without any help from us.” This is like saying that markets are static, conditions are not going to change and we are not working on any new products or markets. This, of course, is nonsense, as American companies and markets are predicated on growth and conditions change all the time. Further, financial theory 101 teaches that investors are buying your stock based upon the value of FUTURE cash flows, so why not give them some guidance about where you are going in the future? Hey, there’s a safe harbor statement about forward-looking statements in every presentation. Why not put it to good use?

All was not terrible, however. There were several successful and engaging speakers I saw at the conference. Generally, these successful speakers seemed to have two things in common. First, they got a little worked up about what their company was doing and what made their products and services unique. Secondly, they allowed some of their personality to come through. This is important because if you’ve ever read any of the surveys of investors and what they care about, quality of management is always high up the list. Yet if management is nothing more than a bland talking head, how can an investor be expected to make a qualitative judgment about them?

After all, who ever said, “I liked your presentation, but you could have been a bit more boring”?

Yowzer! Step Right Up and Hear the Professor!

I’m happy to report that I will be speaking on February 15^th at the Houston NIRI chapter on the topic of “IR Insights from Academia: Does Any of That Fancy Theory Apply in a Real World Context?” This will be the second time I’ve given this talk, having successfully addressed the Dallas NIRI chapter last November (at least they said it was successful). For those interested in attending, details can be found on the NIRI Houston web site, http://www.niri-houston.org/Luncheon--1.html?ModKey=mk$clsc&LayoutID=7&EventID=95

I find the topic fascinating because it gives me a chance to talk about the intersection of theory and practice. Since leaving the corporate practice of IR and developing my investor relations class at Rice University, I’ve had the opportunity to step back from the day-to-day pressures of IR and really think about what it is IR practitioners do and how all of that fits into things that are taught in business school.

When you think about the discipline of investor relations, it incorporates aspects of marketing, communications, finance, law and the capital markets. Further, the audiences it affects go far beyond just investors to encompass employees, customers, suppliers, creditors, bond holders and governmental entities to name a few. When you throw into the mix that there are some schools of academic theory that hold that active investing and investor relations activities add no value, there’s quite a bit that can be discussed.

Just by way of a teaser for some of the topics I cover in the talk, here’s some of the theory versus real world that I cover:

Finance – most valuation models are constructed using discounted cash flow techniques and how they work has a significant impact on your company’s stock price. Beyond the modeling technique however, there lies a significant takeaway to think about.

Marketing – a lot of investor relations literature talks about targeting investors, but that is only one-third of the three crucial steps to marketing.

Communications – there is a lot of really bad IR communications out there, much of it in the form of PowerPoint slides. I look at examples from some of the biggest corporations in the U. S. (This section is the most fun.)

Law – lawyers are taught to think in a particular way, and regulatory lawyers have a unique take on that. As someone who practiced law for ten years, I attempt to bridge the communications gap between lawyers and IR practitioners.

If you are in the Houston area, I hope you can join me. If you are not in the Houston area, but are interested in having me come to a local NIRI chapter, please give me a call. I’m somewhat of an evangelist on bringing more academic rigor to investor relations, so there is no charge for the talk other than travel expenses.

Tell Them Why

Following on to last week’s post about what investor relations presentations can learn from jazz, this week I take my inspiration from a different pod cast, Ted Talks. Anyone who is interested in communications should listen (the pod casts are available on ITunes) or watch Ted Talks (http://www.ted.com/), where you can find some of the best and most passionate speakers on a wide variety of topics. The TED Talks speakers have the ability to grab and hold their audiences, and if you are in the business of communicating ideas, there is no better way to learn about the process than to watch speakers such as these.

The talk that caught my attention and which I think can be instructive for people trying to get their story across to investors was one by Simon Sinek, the author of a book entitled “Start With Why”. The talk, which I gather distills the main idea of his book, offered one overarching thought, which is “People don’t buy what you do, they buy why you do it”. In a world where there are many competing products and services, the thing that distinguishes the winners and makes them appealing is the underlying passion that forms the core of their product or service. The example Sinek talked about is Apple and how they inform everything they do with a passion for combining technology, design and ease of use, but there are plenty of other examples out there. Everything Wal-Mart does is designed to deliver products to their customers at the lowest price possible. Toyota sells Lexus automobiles based upon a relentless pursuit of excellence. Whole Foods wants to deliver better and more wholesome foods.

When you start to think about this in the context of investors, who are purchasing the future stream of cash flows of your company, it starts to make eminent sense to bring to the fore the why of your company. Products, markets and service offerings change over time. Who your company is and why they do things in the manner they do changes far less often. Investors need to know what informs your basic philosophy and culture, because that is part of what they are buying: it goes into everything your company does.

Yet if you look at most investor presentations, what you find is that companies are good at telling what they do, but not why they do it. What they do is something that can be quantified or visualized. Why they do what they do is much less easy to explain. So my thought for the day is: the next time you are putting together an investor presentation about your company, stop and think about the why of your company. Is your motivation to be the very best at providing customer service, are you experts at solving technical engineering issues or perhaps you want to deliver the best combination of value and product offerings to consumers? Every company has a motivating factor and good investor relations dictates that it should be placed on display for investors to make a judgment about.

As for me, I’m passionate (and opinionated) about getting people to understand the principles of good investor relations.

More Essential Life Skills for the Investor Relations Professional

First, a brief commercial: I am happy to announce my seminar, "Fundamentals of Investor Relations" will be given in Houston on February 24, 2010. The workshop was developed from my MBA course at Rice University and is designed to be a comprehensive one day overview of the essentials of investor relations. At a cost of $475.00, it represents a great value. For more information, visit the Seminars tab at my website at www.palizzapartners.com.

In the early days of this blog (September, 2007), I wrote a humorous piece entitled “Essential Life Skills for the Investor Relations Professional”. Much to my surprise, the essay has proven to be one of the more popular posts I’ve written. I suspect that people do a web search looking for relevant advice about how to actually practice investor relations and wind up getting my advice about learning to talk with their mouths full, sound enthusiastic when they’re answering the same question for the thirtieth time and other odd bits of advice, but nevertheless, from the data, it appears that people actually read the post when they get there. Therefore, in an attempt to inject a little more humor into what tends to be a humorless profession, I introduce part 2 to my essential life skills series.

Today’s piece of advice is to learn to think of the analysts that cover your company as your children. This may sound like an odd analogy, but in my experience, their behavior often mirrors that of my children when they were growing up. Consider the following behavior traits:

They all want to be first in line. Think about the fight to ask the first question on your conference calls. Think about how quickly they want to get notes out on First Call.

They all want your attention immediately. When an analyst calls, they are interested in getting the answers to the questions they have NOW, not according to your schedule. This certainly sounds like my children.

They all want you to love them best. The job of an analyst is to assemble pieces of information into an investment thesis, and they all want better information flow (their version of love) than anyone else.

Because they’ve been to school, they think they have all the answers. In the case of my children, it was grammar school, while in the case of analysts, it’s business school, but other than that, it’s pretty much the same. Actual practical experience doesn’t seem to count for much.

When it comes to finding out information, they prefer to be told rather than dig the facts out of a book. My children would always opt to try and have me give them the answers instead of looking it up in a textbook. All you have to do here is substitute Report on Form 10-K for textbook and you can see my point.

I could go on, but by now I think you understand the analogy. The question then becomes what parenting skills come into play as essential life skills for investor relations professionals?

First, just as you must love all your children equally, you must also love all the analysts that cover your company equally. There is no room for playing favorites. Many people will find this piece of advice difficult to follow, because, just as with your children, every analyst has a different personality, some of which are nicer than others. Nevertheless, you must act like an adult here and be fair and consistent, even if the analyst has a sell rating on your company.

A corollary to this is that, just as you teach your children to respect others, you must also respect all analysts. Company investor relations officers often lose sight of the fact that analysts are pulled in many different directions by portfolio managers, hedge funds, research directors and the need to continually generate investment ideas. Compounding this you have a divergence of viewpoints – to most IR officers there is little difference between the company and its stock, whereas to an analyst this is a crucial difference. Because of this, a lack of respect for the work being done by the analyst can arise. An essential skill of an IR professional is to respect the work an analyst does regardless of their conclusions.

Finally, actions speak louder than words. It doesn’t matter how much philosophy you may preach to your children, if you don’t walk the talk, they will see right through you. The same is true of analysts. You have to be honest and straightforward in how you respond to their questions. If in discussing a topic, you fail to cover some essential points simply because the question asked wasn’t specific enough, your credibility will eventually suffer.

Although I could continue in this vein for an extended period, I have to stop now. My children are home for the holidays and I have to go break up a fight about who gets to use the car tonight…

Keep Your Eyes on the Ball

The underlying premise of investor relations is simple: to the extent you can give investors a clear picture of what your company’s future earnings prospects are, the better they will be able to accurately assess the value of your firm and its stock price. This derives from the financial principle that the value of a firm is equal to the sum of its future cash flows, discounted back to a present value. Your past earnings history, even yesterday’s quarterly release, is germane only to the extent that it illuminates and gives confidence to estimates of future cash flows.

I bring this up because lately it seems to me that there are more distractions than ever to the discipline of investor relations. To start, it is the silly season in Washington and regulatory initiatives are in full swing. Every day seems to bring more news about SEC initiatives, whether it’s on flash trading or creating a new division of Risk, Strategy and Financial Innovation. They seem determined to prove that they can cure past ills by more regulations. Further, the industry association, NIRI, seems to be singularly focused on regulatory issues, which I guess makes sense as they are based in Washington and are creatures of their environment. Added to that we have whole new channels of communication opening up in the amorphous world of social media with twitter, facebook, linkedin and blogs. Then we have technical issues such as XBRL reporting and IFRS accounting to worry about. All of these are things that investor relations officers need to be aware of, have an opinion on and react to if it is their ox that is getting gored, but are not central to what they do.

With all of this going on, it’s very easy to forget the main function of investor relations: creating a clear and concise picture of what your firm’s prospects are and how you intend to get there. I will grant you that investor relations derives from regulation. Without specific regulatory guidelines most companies would be loath to tell investors anything, regardless of what the financial theory says. But the jumbled mess that we refer to as securities law regulation is a means to an end, not an end unto itself. Let the lawyers worry about the latest SEC staff interpretations; let the accountants worry about IFRS. What investor relations people should worry about is whether the market understands how what your company is doing leads to profits in the future. This means disclosing not only what happened in the past quarter; it also means helping investors gain insight into your markets, your industry and the trends, both long-term and short- term, that drive your business.

Likewise the social media that we are seeing today is nothing more than additional forms of communication. I’ve been around this business so long that I remember when conference calls were a novelty. Today conference calls are just another tool to get the company’s story to investors efficiently. Done well, they are helpful; done poorly they can be a disaster. Social media will eventually play out in a similar fashion.

So my advice is to let the hype and chatter pass you by. Keep your eyes on the goal of getting investors to understand your business and its prospects. Appropriate valuation in the form of stock price will follow.