”Once the Internet company completes its $1.1 billion patent sale and licensing agreement with Microsoft, it will top even Apple in terms of percentage of market value accounted for by straight cash.”

(Quote from an article in the Wall Street Journal Europe.  Headline in print edition: “After Microsoft Deal, It Is AOL: You’ve Got Moolah”)

Now that is a weird comparison.

Investors have been asking Apple to return cash to shareholders (which it recently decided to do). AOL – the Internet company that the article quoted above refers to – is also expected to return cash.

But these companies could not be more different in terms of investors’ confidence in their continued ability to generate cash and create future economic profit for shareholders:

“The stock price move is predicated on AOL giving back, in its own words, a significant portion of the sale proceeds to shareholders, a phrase that leaves plenty of room for interpretation. If AOL holds on to too much, investors should fear the windfall disappearing on headline-grabbing acquisitions like the Huffington Post, which boost traffic but also came at a heady price.”

Meanwhile, some expect that Apple will soon be worth more than all the companies in Spain, Portugal and Greece combined, all the while continuing to grow its cash balance rapidly, even with the announced dividends and stock buybacks.

”Indeed, it turns out that the focus on short-term profits is nowhere enshrined in the law. On the contrary: Delaware law, where many big companies are incorporated, gives directors enormous leeway to ignore short-term gain if they believe that doing so would ultimately benefit the corporation.”

From ”What Is Business Waiting For?” by Joe Nocera, August 15, 2011

Bizarre. Do we really need legislation to make sure that managers focus on creating shareholder value? In the article referenced above, it is argued that:

 “…they’ve spent the last 30 years having it beaten into them that the only thing that matters is delivering “shareholder value.” Over time, this phrase has become code for focusing on short-term profits — and chief executives who have ignored this mantra have often found themselves kicked to the street by impatient investors like Carl Icahn.”

And yet, since 1980 there has been a steady decline in the proportion of market cap that can be explained by accounting book value:

(From “A New Paradigm for Managing Shareholder Value”, Accenture, July 2004)

It is commonly argued that intangible assets explain much of this discrepancy between market value and book value. These are assets that allow companies to generate future value:

Accenture describes future value as “future incremental value that the market expects the company to create, beyond the value delivered by current operations”.

Clearly, companies whose managers focus on maximising short-term profits at the expense of future growth potential would not be held in high regard by equity investors. I quote Accenture an awful lot today, but the best example I’ve seen on this was in an Accenture paper I read a few years ago. I can't find it now, but it described a pharmaceutical company that had apparently misunderstood how it was valued by the stock market. The company’s managers consequently cut R&D spending in order to maximise earnings per share in the short term (!). The share price did not respond in line with their expectations. After some analysis, they identified the problem and increased R&D spending, whereupon the share price took off… This story may sound absurd, but perhaps one should not be so shocked:

”Among the major shifts investors need to make in order to adapt to the new market landscape, Mr. Tetrault said, is to adopt a more forward-looking investment approach involving more communication with managers on their objectives and strategies."

(Jonathan Tétrault is a partner with McKinsey & Company and one of the authors of the report “The Best of Times and the Worst of Times for Institutional Investors”)

Disheartening that this should be described as such a “major shift”…

The September 2011 issue of IR Magazine highlighted Swedbank’s IR programme, which was ranked number nine in this year’s Euro Top 100, a ranking of the firms in Europe with the best IR. Last year, Swedbank did not make it into the top 100 (they were ranked 116^th).

How was this feat accomplished?

“Johannes Rudbeck, head of IR at Swedbank, attributes his successful IR program to top management’s attitude toward the importance of investor relations. This includes a willingness to be transparent and allow IR full real-time insight into all financial and business developments.” (emphasis in bold is mine)

There are other best practice examples besides Swedbank, but there are also many horror stories. I think the worst one I’ve heard was told by Annica Strahner, who claims that there are cases where IROs have found out about their own companies’ profit warnings in the newspaper.

I guess that most companies fall somewhere in between these polar opposites.  Hopefully, you're closer to Swedbank’s part of the spectrum, because - as Rodney Alfvén has pointed out - IR is never better than the CEO.

It seems as if fewer and fewer analysts and investors actually read annual reports. A survey by CA Cheuvreux concluded that “most merely glance at them or look at just a few pages”:

People increasingly get the information they need from other sources, most of which are outside of companies’ direct control.

Annual reports are produced with many different objectives in mind, but their importance as a tool for educating a company’s financial stakeholders on various aspects of the business is definitely waning.

So how should you respond? In a recent post, Dave Hogan claimed that online video has the potential to be a real game changer in investor relations and corporate communications. Dave makes the point that “corporate executives and their IR handlers will need to learn more about video production techniques such as narration, B-roll and music.”

Maybe, but I believe that a lot can be accomplished by very simple means.

When I read Dave’s post, I thought about the Khan Academy, a fantastic educational resource that I didn’t know about until very recently:

“With a library of over 2,400 videos covering everything from arithmetic to physics, finance, and history and 125 practice exercises, we're on a mission to help you learn whatever you want, whenever you want, at your own pace.”

Salman Khan, the Khan Academy’s founder and lone faculty member, is a former hedge fund analyst who came up with the idea for the site while tutoring his cousins remotely. Seeing as IR has a significant educational aspect to it, I think this might be a good place to look for inspiration. Perhaps video-based “analyst boot camps” or primers on key concepts to keep in mind when analysing and assessing the company’s performance? Anyway, here’s one example from the Khan Academy (Salman Khan talking about credit default swaps):

I have met investors who have told me that they like companies with low earnings volatility. One told me that he would even go so far as to encourage earnings management in some cases.  I don’t believe that this person represents the majority view, but I was still a little astonished to hear this.

Many companies heed this investor’s advice though. It is well documented that the practice of earnings smoothing is widespread, although perhaps not always with the objective of increasing firm value. If these companies’ goal is indeed to achieve a higher market valuation, their efforts do not seem to be rewarded.

“If investors really preferred smooth earnings, you would expect companies that achieve them to generate higher total returns to shareholders (TRS) and to have higher valuation multiples, everything else being equal. Yet […] there is no meaningful relationship between earnings variability and TRS or valuation multiples.”

From “The myth of smooth earnings”, McKinsey & Company. You can read more about the research results here:

Click here to download:

myof11.pdf (535 KB)

(download)

Click here to download:

myof11.pdf (535 KB)

This article was published in McKinsey on Finance, Number 38 (last article, page 27).

So, investors do not shun earnings volatility per se.  As McKinsey points out, most people realise that the world is not smooth. But if the earnings variability is construed as uncertainty around the strength of the company’s business model and longer-term health, you have a problem.

I believe that companies whose business dynamics, market position and strategy are poorly understood run a greater risk of having to face this situation. Companies in this category may also be more tempted to smooth their earnings.  In any case, I found a study demonstrating that companies that are characterised by a low information environment (using a low level of analyst following as a proxy for this) are more likely to realise a valuation premium as a result of earnings smoothing.

“Overall, across all alternative definitions of high analyst following, we find no significant relationship between earnings smoothing and firm value when a firm is followed by a high number of analysts. The coefficients range from -0.053 to 0.004 and all are statistically insignificant. In contrast, we find significantly negative coefficients for firms followed by a low number of analysts, regardless of the cutoff we use, indicating a valuation premium for earnings smoothing when analyst following is low.”

From Earnings Smoothing, Analyst Following, and Firm Value (Allayannis and Simko, 2009)

My conclusion from all this, though, is that it pays to be transparent…

I just reread this study, and I thought it worth sharing even though it's a few years old. PwC and Schroders conducted an experiment several years ago in order to explore the value of non-financial information to financial market participants.

I believe the conclusions provide an interesting perspective on the benefit of opening up and giving investors and analysts more non-financial information:

"The findings were quite startling. The average revenue and earnings forecast prepared by those with the full set of accounts were actually lower than that prepared by those who only had the financially-based document. This might be a little discouraging for advocates of greater transparency were it not for the fact that despite the lower forecast, members of the group with the complete information set were overwhelmingly in favour of buying the stock. This stands in stark contrast to those with the less complete information set. Although the average estimate that they generated was higher, nearly 80 per cent of this group recommended selling."

You can take a closer look here:

Click here to download:

a_tale_of_two_reports.pdf (67 KB)

(download)

Click here to download:

a_tale_of_two_reports.pdf (67 KB)

A corporate access professional I talked to recently claimed that Swedish shareholders are generally less willing than investors from certain other countries, e.g. the UK, to offer feedback to companies they meet with. 

This intrigued me. Like any form of communication, investor communication must be two-way to be effective. My sense, though, is that investors here in Sweden are more than willing to engage in dialogue with companies and to offer candid feedback.

But perhaps it is necessary to ask for comments a bit more actively here than in, for example, the UK? According to the corporate access specialist I spoke to, investors in Sweden are used to being granted access to management. She claimed that this can be considerably more difficult in other countries and that investors, therefore, may be more willing to proactively offer their feedback in order to ensure continued access to management.

I’m not sure how much truth there is in this interpretation. But it got me wondering about how to best go about capturing feedback from investors.

Some people argue that you increase your chances of getting honest feedback by having a third party approach investors. This is often done by sending out a fairly standardised questionnaire. There is nothing wrong with this approach, which can yield useful intelligence. But I believe that companies must also engage investors directly in discussions about specific issues. One such opportunity might be when thinking about how to improve the company’s reporting framework.

I have not been very active on this blog for a while, and I guess it has to do with the fact that I have just changed jobs. I am transitioning into the role as head of investor relations at Transcom WorldWide S.A., a global outsourced service provider.

I am really looking forward to new challenges as an IRO, but at the same time I will miss my old colleagues at Intellecta Corporate and my clients very much. These last five years have been fantastic with many interesting and challenging client projects in various sectors.

While it is true that this is a very busy period for me, I don't think that's the reason for my inactivity here (life as a consultant is also hectic…). I think part of the explanation is that it's a bit more complicated to blog about IR as an IRO than as a consultant. At least I think it is. While I have often commented on issues I have encountered in my daily work with clients or prospective clients, I have been careful not to disclose the companies’ identities. Well, now everybody knows what company I work for.

There are, relatively speaking, not that many out there who blog about IR. Consultants or vendors run most IR blogs, while very few IROs blog. I want to continue using this site in some way, but it might be a bit quiet for a while. I plan to keep discussing IR issues in other forums as well, perhaps even to a greater extent than before. I enjoy participating in #irchat on Twitter for example.

All the best for 2011!