The balance sheet & all the rest

Legendary value investor Marty Whitman gives a good interview on investing in the October 30 Barron’s. It’s a fun read, if you like to gather wisdom from folks who have been around Wall Street for more than a few bull – and bear – markets.

The 86-year-old founder (and still chairman) of Third Avenue Management talks about value investing, the need for transparency in markets, short sellers, lessons from the latest financial crisis, and academic theories (he doesn’t much like them).

Investor relations people may benefit from Whitman’s No.1 lesson from the 2008 financial meltdown: the importance of the balance sheet, which IR messaging often skimps on or ignores. And his No. 2 lesson: the importance of management in protecting investors from getting clobbered by something like the ’08 crisis.

Both should be themes for investor communications, especially now.

Whitman’s advice to other investors also has applications to IR:

You have to be gestaltist. Every accounting number is important, and is derived from other accounting numbers. So you have to understand the whole accounting cycle. If I want to estimate earnings, and I only have one tool, I would pick the current balance sheet.

As a value investor, what you are interested in is whether the company is creating wealth. There are four ways to create wealth; it is not just cash flow. They are [bullets added]:

  • One, having cash flow from operations available to security holders. A company can use that cash to expand its asset base, reduce liabilities or distribute the money to shareholders, either by paying dividends or buying back stock.
  • Two, and probably much more important, is having earnings, which we define as creating wealth while consuming cash. Remember, though, that earnings for most companies do not have a long-term value unless the company also has access to capital markets because if it doesn’t, sooner or later, it will to run out of cash.
  • The third—and very, very important—value-creation method is resource conversion. … Mergers and acquisitions, changes in control, massive recapitalizations, spinoffs, etc.
  • The fourth wealth-creation method … is having extremely attractive access to capital markets.

Food for thought as we develop messages for annual reports, presentations and financial releases. Many companies give a nod to “creating shareholder value” but fail to spell out the strategy for doing so.

Investors in most companies would benefit from management doing a better job of showing shareholders how business results – and changes in business strategy – work through the income statement, balance sheet and cash flows. Basic IR.

© 2010 Johnson Strategic Communications Inc.

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One Response to “The balance sheet & all the rest”

  1. Jon Falk Says:

    Great post.

    All too often I hear “we are about creating long-term shareholder value” without the appropriate follow up outlining a strategy of how the company is going to go about creating value. The strategy is in place for most companies, but it is often not delivered in an approachable format because time (and effort) has not been used to craft the delivery. I think it is critical to prepare a succinct delivery of a company’s strategy and story in the context of a particular year’s results and with a view to the future. The work that goes into communications with stakeholders – investors, customers and employees – goes a long way in establishing understanding and building confidence.

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