Archive for the ‘Disclosure & valuation’ Category

Majority still offer guidance

May 19, 2009

Despite the wild economic ride we’re on, most companies haven’t stopped providing forward-looking guidance on earnings, according to a survey by the National Investor Relations Institute.

In an Executive Alert published May 18, NIRI says the practice of guidance continues to decline – but not very fast:

One might assume that the recent dramatic economic decline would necessarily result in a meaningful decline of public company guidance. Counterintuitively, NIRI member respondents have not abandoned guidance in large numbers.

A few highlights from the 2009 survey of 515 NIRI members:

  • 60% say they do provide earnings guidance, down from 64% a year ago. The ranges companies provide are wider amid economic uncertainties.
  • 50% of the companies offer guidance on revenues, also down a bit.
  • Guidance on annual expectations is most popular, with quarterly updates.
  • The most common reason for offering guidance is as a way to keep sell-side expectations in line with what seems reasonable to companies.
  • My own feeling is that the decision “To guide or not to guide?” is individual to each company. The answer depends on needs of your investors, comfort level of your management and board, predictability of your business and so on. In some cases, offering qualitative or quantitative views on earnings drivers such as trends in key markets in which you compete may be as useful as an EPS range.

    Point is, most investors assess the value of your stock based on some forward-looking estimate of earnings or cash flows – so IR needs to provide as much guidance as the company is comfortable providing.

    A company’s policy on guidance, NIRI suggests, should include decisions on metrics that management wants to give forward-looking information on, time frames for that guidance (annual, quarterly, monthly), and frequency of communicating guidance. NIRI also offers links to supplemental information for members (see the Executive Alert).

    So there it is – some guidance on guidance.

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    Talk about real economic value …

    March 12, 2009

    Most investor relations people have run into fund managers who aren’t satisfied with the tables in the 10-Q. Donning green eyeshades, these investors want to slice and dice operating cash flows, cost of capital, and returns on capital in pursuit of … well, their own metric.

    They’re after some version of a shareholder-oriented performance measure known as “economic value added” (EVA) or economic profit. To build value, the approach says, a company must earn a rate of return greater than its cost of capital.

    Bennett Stewart, one of the originators of EVA, continues to promote its benefits for companies that are truly committed to building shareholder value. Speaking today to a Financial Executives International gathering in Kansas City, Stewart argued other metrics like free cash flow and even return on capital can create perverse incentives for managers – while improving EVA invariably creates real shareholder value, the kind a shareholder sees in the share price.

    Essentially, EVA is a non-GAAP calculation of net operating profit after taxes (a cash flow measure) minus a capital charge (the firm’s cost of capital times capital deployed). You can look at EVA as a spread between return and cost of capital, compile a detailed EVA P&L, look at EVA margins at each level, and consider changes in the trend. You can get lost in an endless stream of alphabet-soup abbreviations.

    Stewart says “EVA momentum,” a ratio of change in EVA to trailing-year sales, is highly predictive of market value for public companies.

    To confess my bias, I’ve have always liked the EVA approach. Stewart’s book The Quest for Value (HarperBusiness, 1991) is one of my favorites in the finance genre. Its shareholder-oriented insights are relevant in developing messages on, say, a proposed merger or new initiative – even for companies that don’t formally use EVA.

    Stewart, who left EVA consulting firm Stern Stewart & Co. to start EVA Dimensions in 2006, now is working to “commoditize” the management approach with a software package, a stock rating tool and a hedge fund using EVA methodology. The EVA Dimensions website offers a variety of articles – and, yes, promotion – on using the approach to manage for results.

    Stewart offers innumerable proof cases for EVA, but two of our best-known corporate giants offer a good contrast:

    • Wal-Mart. Managers minding only the P&L might focus on raising margins, but Wal-Mart chose a low-margin pricing strategy to pull consumers in, driving faster turns of inventory and higher returns on capital. And it invested in profitable growth. Stewart wrote WMT up as an EVA champion in 1991; since then it has continued to build value.
    • General Motors. When Fortune wrote the carmaker’s early obituary this fall (“GM: Death of an American Dream”), a bar graph showed eight straight years of negative EVA – and a TTM figure of minus $11.5 billion. Oddly enough, GM also was getting horrible marks for negative EVA two decades earlier when Quest for Value was written.

    As if to emphasize the relevance of EVA in the Internet era, Stewart also cites Google’s high EVA momentum and stock-price appreciation. So investment in profitable growth and careful management of capital work in the new economy, too.

    For companies burdened by the recession, Stewart says, “The first message of EVA in these tough times is don’t go cutting and slashing and burning … We should cut where we should cut, and we should invest where we should invest [in projects and businesses where the numbers show positive economic returns].”

    The decision on whether to use EVA as a management tool is typically an issue for CEOs and CFOs. Accountants also have something to say about it. (One FEI member today asked a controller sitting at our table, “So are you ready to start keeping two sets of books?” referring to GAAP accounting plus EVA.) Investor Relations communicates whatever management adopts.

    If a company uses EVA, the IRO needs to work diligently on how to communicate the shareholder benefits clearly. Focus on intuitive concepts like earning returns greater than the cost of capital, generating cash and increasing the productivity of assets. Benchmark EVA communications. And don’t bury investors in jargon.

    The EVA body of knowledge suggests important principles for investor communication. Most companies, for example, don’t do a good job of talking about the relationship between the income statement and balance sheet. We need to discuss cash and what happens to it. We need to explain (and quantify) management’s effectiveness in using assets to create value.

    An IR approach driven only by disclosure requirements is likely to obsess over GAAP accounting – to “worship at the altar of EPS,” Stewart would say. Instead, we should explain performance in terms of real economic value for shareholders. Assuming we really are in the shareholder-wealth business.

    Risk & return: Is half the formula missing?

    August 29, 2008

    One thing investor relations people need to improve is disclosure of risks.

    I’m not talking about legal disclosures – pages and pages of “risk factors” in the 10-K or Q, from the possibility of bumpy economic times to, God forbid, the unexpected demise of the CEO. These are risk notifications. Yes, they inform investors – especially if one compares the current period to prior years to see what new risk factors have bubbled up – but the language is so, well, lawyerly.

    We need to work on explaining and quantifying the business risks that an investor should incorporate in his valuation of our companies’ shares. The market gurus say it’s all about risk and return. But our focus in IR – and the obsession of many analysts – is on the income statement, the return side.

    In the classic financial models, risk has everything to do with valuing a company. The stream of future cash flows that people work hard to forecast is discounted by the cost of capital, a subjective number that most analysts simply plug in as a guess. The real cost of capital, or discount rate, is made up of the risk-free return (easy to estimate) plus the risk premium (much harder). You formula buffs, get out the old textbooks or see here or here – and consider what goes into the “d” or “re” term.

    As a profession, investor relations people need to work on how to profile risk in a company. Uncertainty is uncertain, but we have some qualitative and even quantitative assessments of risk- from the macroeconomic uncertainties right down to the sensitivities in a product’s sales.

    Three recent episodes have started me thinking about risk:

    … The massive failure of financial institutions to manage the risks of lending and investing activities, as evidenced by mega-writedowns by banks and I-banks continuing through 2008.

    … Another meltdown in a biopharma company’s share price after the FDA called into question the safety of a key product for diabetes.

    … The reaction of global markets to Russia’s war-like actions in Georgia, which made investors ratchet up the geopolitical part of their risk premium.

    The issue of “miscommunicating risk” was raised this month in the IN VIVO blog, an adjunct to a magazine of the same name that covers deals and business trends in the pharmaceutical and biotech industries. IN VIVO commented:

    There seems to be a big disconnect between the seriousness of a safety issue from the regulatory perspective (where a safety “update” by FDA treated two deaths from pancreatitis as important information for prescribers, but not a call to action) compared to the reaction of investors (“The sky is falling!”).

    IN VIVO wondered aloud whether the two biopharma companies involved might have headed off the market’s Chicken Little reaction by better disclosing their perspective on the risks in advance, before the FDA turned on its loudspeakers.

    In any industry, companies need to work hard at properly communicating risk. IROs should make it a major focus – preferably before the roof starts to cave in.