Posts Tagged ‘Annual reports’

Metrics are the message

March 26, 2012

Flipping through the annual report of an oil company I own a few shares in, I skimmed over the usual headline cliches (“proven business model,” “rigorous execution,” “strong results”). As a shareholder – and a practitioner of investor relations – I’m glad they don’t have a discredited business model, lackadaisical execution or weak results. But maybe there’s something more to take the measure of this company.

As a casual weekend reader, I passed over the gray-looking shareholder letter. I did have to circle back and see if there was an explanation of that puzzling schematic diagram on the cover – it was an engineer’s view of the company’s proprietary oil sands technology, of all things, decorating the cover of the annual report.

Finally I landed on a page headed Financial Highlights. And there I dug in.

You often hear investors say, “It’s about the numbers.” Or if you talk a bit more, the numbers and management – because having the confidence to bet money on a company includes believing in the management team.

But the numbers – more particularly, key metrics – are the main thing investors are looking for in a company’s disclosures, reports and presentations.

The metrics and what management is doing about them are the strategic message.

When I landed on the financials in this report, my eye was drawn to the 5-year history of sales and a similar line for net income – both up nicely in 2011, looking like the last time oil prices were high, in 2007-08. I scanned down to ROE and ROCE, both of which which this company provides – nicely. Other metrics of interest … well, they weren’t there, until I went to work on the financials with my calculator.

My thought is that investor relations people ought to make key metrics – those viewed by management and your investors as driving the share price in the long term – easy to find in news releases, reports and presentations. Because key metrics are what investors, whether institutional or individual, are looking for.

A few metrics are likely to be top-of-mind for nearly any company:
  • Earnings per share. Sure, I know the theories about cash flow or some other measure being more important, and some managements are passionate about EBITDA as the key metric. For most shareholders EPS is still the bottom line.
  • Growth rates of sales and earnings. Whether the picture is pretty (sales up 23% in the current period) or ugly (earnings down 14%), companies ought to make growth rates easy to find. And do the math for investors; don’t make ’em get out their calculators.
  • Return on equity – or capital employed or assets. To know whether a business is attractive as an investment, the most basic question is whether it earns more than its likely cost of capital. If  ROE is 27.5%, as an investor I’m comfortable on that issue. If it’s 7.5%, I’m going to look a little closer.
  • Profit margin & its trend. Gross margin seems to be the most popular, or operating margin. Investors want to know the power of a business to take raw material or merchandise, sell it and turn a profit. Margins provide an objective view of the impact of rising costs, dropping prices or lack of scale.

Every industry and many companies have their own key metrics. Same-store sales growth. Net income margin. Proven reserves. Milestones in drug development. Whatever investors see as driving the value of the company for the future.

Of course, companies also offer up all kinds of non-GAAP metrics like “adjusted EBITDA” or “ongoing operating earnings” – which investors may or may not trust. If it works for you, OK, but you may want to validate that with your investors.

In any case, settle on your key metrics (not 20, just a few) and then use them …

Investor reporting ought to emphasize, say, three or four key metrics – make them highly visible in words, tables and graphs – and explain what you are doing about them. When they improve, take credit on management’s behalf – this is what we did to add 50 basis points to margin. When they go the wrong way, acknowledge it and tell shareholders what management is doing now to turn the situation around.

I see metrics as the core message of investor relations. What do you think?

© 2012 Johnson Strategic Communications Inc.


Annual report in two pieces

April 13, 2011

As an investor relations person, I love this time of year. I enjoy working on clients’ year-end reporting, of course – but it’s also a time when I get to experience IR from the other side, as a member of the audience.

Believe me when I say I am a small shareholder of a few companies (not of any clients, by the way – a separate issue). But when the mail brings an annual report, proxy statement and voting materials, I love it! I dive into those reports, to review companies’ performance and see what they’ve done in the way of presentation. And I vote my proxies, as a believer in letting management know where I stand.

Let me share an example: the annual report in two pieces.

One of my reports came from Shore Bancshares, Inc., a smallish bank holding company based in Maryland and listed on Nasdaq. What made it different was the two pieces: a front section with shareholder letter, financial highlights and marketing stuff like bank locations, and a black & white 10-K. (Results were uninspiring – not the point here.)

Not dramatic or unique … but offering two pieces strikes me as a good solution.

The Shore “marketing” annual report, 8 bound pages all on cover stock, has one page of financial highlights and graphs, a 2-page shareholder letter, a page of locations with maps of the market, board and officer lists and an large photo of the board arranged around antique furniture, and contact info for the banks and insurance offices. The cover says Presence. Stability. Strength. Knowledge. Well, OK.

The 10-K, of course, provides data on competitive position in each of the markets, six and a half pages on risks, revenue and expense breakouts, detail on the assets and issues in the loan portfolio, and so on. It’s red meat for the shareholders.

The marketing version is perfect for a coffee table in a bank branch, another accessory to make customers feel comfortable banking there. The 10-K is not so reassuring for the lay person but useful for investors deciding to buy, hold or sell.

Banks are classic examples of companies whose annual reports have at least two audiences: shareholders or potential investors on the one hand, and customers on the other. Bank customers may see the annual report as an assurance of security for their money, though we might hope the FDIC provides even more solid backing.

The other day I walked into my own bank, in Kansas City, and there was a stack of glossy new 2010 annual reports. I picked one up, of course. But this one, a front section and 10-K bound together, ran 160 pages – really overkill for my needs as a depositor. As a bank customer, if I see assets are substantial and the bank has earnings – and maybe a photo assures me the officers or board members are not motorcycle gang members – I’m OK with leaving my money in that bank.

An investor needs the details. So here’s an idea: If your annual report is serving two different audiences, one approach is to print it in two pieces – send both to shareholders, and give the summary version to customers, vendors and employees.

© 2011 Johnson Strategic Communications Inc.

Explaining your secret sauce

February 27, 2011

Warren Buffett’s latest letter to shareholders of Berkshire Hathaway, posted Saturday, rewards the reader with pithy quotes on nearly everything in business, as have so many of his annual reports in the past (a 34-year archive is here).

Most of us wouldn’t suggest that our CEOs write a 25-page shareholder letter, but neither do we work for a cultural icon nicknamed “the oracle of Omaha.” Most of the time I think Buffett speaks more from self-interest than from revelation, but what he says – and how – bear examination by everyone engaged in investor relations.

Explaining the business is at the core of Buffett’s 2010 Chairman’s Letter, just as explaining the business should be the heart of every IR presentation or report.

But not just the business – this letter works to explain the “secret sauce” that makes Berkshire Hathaway Berkshire Hathaway. The secret sauce isn’t secret, of course. It’s what makes a company different from – better than – anyone else around. This is not likely to be obvious from a glance at the income statement and balance sheet. But in Berkshire Hathaway’s case it is really a financial story, which Buffett lays out in between those quotable quips on everything else.

Let me see if I can capture the essence of it (summarizing the sage):

  • Berkshire Hathaway is basically an investment company. It held $158 billion worth of stocks, bonds and cash instruments at year-end. The secret sauce, apart from the legendary instincts of Buffett and Charlie Munger, is the interest-free financing for more than one-third of those investments. Buffett explains: “Insurance float – money we temporarily hold in our insurance operations that does not belong to us – funds $66 billion of our investments. This float is ‘free’ as long as insurance underwriting breaks even, meaning that the premiums we receive equal the losses and expenses we incur.” Figure the income on $66 billion, and investing the cash for those insurance companies becomes very profitable.
  • Second, Berkshire Hathaway owns 68 non-insurance companies – businesses Buffett and Munger have fallen in love with and decided to marry – and these operating companies generate earnings. Over 40 years, the pretax earnings of those companies has grown at a compounded 21% rate; the value of those earnings is quantifiable. Buffett explains, somewhat persuasively, that the operating companies benefit from good managers who love running those businesses and from a pervasive owner-oriented culture. The secret sauce? The operating businesses aren’t limited in reinvesting the cash they generate – they’re part of Berkshire Hathaway. A typical furniture store chain, let’s say, would feel compelled to plow earnings back into the furniture biz. But Berkshire Hathaway can allocate cash thrown off by Nebraska Furniture Mart into a railroad … or the stock market, or T-bills … whatever looks promising.
  • Finally, Buffett cites a more subjective source of value: the company’s ability to deploy today’s retained earnings into investments that earn good returns in the future. While nearly every company accumulates retained earnings, he says, “some companies will turn these retained dollars into fifty-cent pieces, others into two-dollar bills.” And the secret sauce? Well, it comes back to Buffett and Munger, plus some younger investment guys they’ve brought in to carry on after Warren and Charlie are no longer around. I assume shareholders will increasingly ask for tastes of these newer versions of the investment sauce.

We should each think about our companies’ secret sauce. Is our financial structure geared to create higher ROE? Are assets minimized to boost ROA? Do we get 2 cents per transaction, times a billion transactions, with volume growing daily? Do we have a brand or intellectual property that can’t be matched for years to come?

We need to have our CEOs analyze – and explain over and over – our secret sauce.

Meanwhile, the Omaha oracle and his long-time partner are carrying on. The letter defines growing book value as a metric for success, a proxy for Benjamin Graham-type intrinsic value. It walks shareholders through what’s happening in each of the key businesses. Explains the rationale for the big M&A deal of 2010: BSNF Railway. And comments on the business environment and stock market. All worth reading.

Buffett lays out the near-term expectation: “Charlie and I hope that the per-share earnings of our non-insurance businesses continue to increase at a decent rate. But the job gets tougher as the numbers get larger. We will need both good performance from our current businesses and more major acquisitions. We’re prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.”

The 2010 annual report of Berkshire Hathaway, of course, has financial tables and footnotes and an MD&A – even a cover. But every year, the way Buffett explains the business makes his shareholder letter the star of this show.

© 2011 Johnson Strategic Communications Inc.

Let’s think about year-end

July 1, 2010

Arrival of the second half, naturally I think, sets investors and investor relations people to thinking about year-end. We’re halfway through 2010, so we begin to ask, “What will the outcome of this year be, in earnings and other accomplishments? … or in disappointments?”

As an IR person in the US, I’ve always seen Fourth of July weekend as a kind of pivot for the year. Whether it’s the start of third quarter or the holiday picnics and fireworks that punctuate this time for you, here are some questions to contemplate:

  • What kind of year will 2010 be in your memory, and that of your shareholders, 2 or 3 years from now? Do your communications now reflect that tone?
  • More immediately, when you report second-quarter earnings in the next few weeks, how will you answer questions about full-year 2010 prospects?
  • What do the first-half trends tell you about likely sales, costs and earnings in the next 6 months?
  • Does your outlook include a second-half turnaround, and what evidence can you offer of its probability?
  • What accomplishments has management promised for 2010 that need to get accomplished in the second half? Or do you need to soften those projections?
  • Do the CEO and CFO plan any mid-course corrections? If so, when is the appropriate time to begin to disclose those to investors?
  • What tone and messages will your audience get in the 2010 annual report? Time to get started is coming – whether your “annual” is a robust piece full of image, strategy and performance, a plain 10-K, or something in between.

Sure, we have a few weeks to relax – except for reporting Q2 results and all the interaction around earnings time – before the real rush to year-end begins. But the onset of second half is a good trigger for starting the thought process.

© 2010 Johnson Strategic Communications Inc.

Warren Buffett reads annual reports

December 12, 2009

This weekend’s Wall Street Journal has a readable piece on what Warren Buffett didn’t invest in during the financial and economic crisis (“In Year of Living Dangerously, Buffett Looked ‘Into the Abyss'”) … Bear Stearns, Lehman Brothers, AIG, Wachovia, Freddie Mac and others.

Besides making the point that deciding not to invest can be as important to a portfolio manager as pulling the trigger to buy, the story contains this nugget of side interest to those of us who labor in investor relations:

That night, in his offices in Omaha, Neb., Mr. Buffett pored over Lehman’s annual financial report. On the cover, he jotted down the numbers of pages where he found troubling information. When he was done, the cover was dotted with numbers. He didn’t bite. Six months later, Lehman filed for bankruptcy protection.

So Buffett reads annual reports. Oh, I know, he’s a seventy-something sage, and many of us get most of our information online or on our phones. But Buffett is an investor with influence over market-moving sums of money. And apparently he digs into financial reports, marks them up and then makes his decisions.

Not that a nice annual report would have saved Lehman or AIG. But in the normal course of investing, quality of disclosure and clarity of explanation do matter.

Let’s make IR more visual

May 20, 2009

Whether you’re raising first-round venture capital or cultivating shareholders in a public company, investors need to understand the business model – and drawing a picture of it may help – suggests Cliff Illig, co-founder and vice chairman of Cerner Corporation, a mid cap healthcare IT company listed on NASDAQ.

Illig told a meeting of entrepreneurs last night at the Polsinelli Shughart law firm in Kansas City that a business model is essentially a value proposition. It’s not about how well-designed your widgets are, or the wonderful efforts you exert internally to develop or produce those widgets.

The business model looks outward and answers the question, “How do we create value for customers?” Someone else has described this less delicately as “How do we move money from the customers’ pockets to our pockets?”

Cerner includes a picture of its business model in each annual report and in every presentation to Wall Street, Illig said. Of course, I had to see this picture – so I looked it up (apologies for the shrunken copy shown here).

CERN business modelWell, Cerner’s business model picture isn’t exactly pretty – most companies bog down in complexity when explaining their business – but it does explain their financials. The graphic is a flow chart showing where the money comes from (sales pipeline on top), how it flows through contracts and backlogs into each of the business segments, what the margins are – and, ultimately, how money gets to shareholders in the form of operating profit and EBITDA (at the bottom).

I’m not pointing to Cerner as the Michelangelo of IR art – but do consider this picture.

A schematic of a business model says a lot. The more you can simplify it, the better. My feeling is that investor relations people ought to be doodlers – always taking what we hear and looking for ways to sketch a picture of it – simpler, more visual and more intuitive. Bottom line, we want investors to understand how we create value.

Annual reports: not extinct yet

October 29, 2008

Annual reports are evolving – but not extinct – as a primary tool for telling a company’s story, according to a survey released this week by the National Investor Relations Institute (NIRI). Of the 182 companies responding, 91% produce annual reports, although the clear trend compared to past years is toward spending less on printed copies and more for online versions.

My comments on a few top-line results from those who do annuals:

… The 10-K wrap is most popular (53%), followed by traditional (35%) and summary (12%) reports. When you ask professional investors about the annual, they always claim to head straight for the MD&A and other meaty sections of the 10-K. The wrap adds the personal touch of a CEO letter or narrative, and perhaps visual elements, to drive home the key messages.

… Print budgets for annual reports are coming down. The number of copies is dropping as companies use the Notice and Access process to reduce the number of mailed books (35% now print less than 10,000). The shift toward 10-K wraps and summary reports also is cutting print costs.

… Online annual report budgets are rising, though some designers include digital versions in the print bid. Just posting a plain PDF to the website isn’t keeping up with the way people like to read online. If you haven’t already done so, you should look into offering user-friendly features like an interactive  HTML-based report, hyperlinks, an online index or financial tables downloadable into spreadsheets.

… On average, companies start the annual report process 3-1/2 months before year end. So if you’re on a calendar year, you should be more than a month into planning, creating messages and developing designs.

NIRI’s survey is a good resource for benchmarking your annual report practices, including a reality check on budgets. If you’re a NIRI member, access the “Executive Alert” from the NIRI home page or the full survey report here. If you’re not a NIRI member, sign up now – or you can buy the “Executive Alert” here.

Swimming naked gets so embarrassing

September 23, 2008

While we await the outcome of Washington’s proposed mega-bailout, an observation from Warren Buffett sheds more light on the current financial crisis than most recent commentaries. The quote goes back to six months before Buffett’s announcement Tuesday afternoon that his firm would invest $5 billion in Goldman Sachs. In his annual letter to Berkshire Hathaway shareholders earlier this year, Buffett said:

You may recall a 2003 Silicon Valley bumper sticker that implored, “Please, God, Just One More Bubble.” Unfortunately, this wish was promptly granted, as just about all Americans came to believe that house prices would forever rise. That conviction made a borrower’s income and cash equity seem unimportant to lenders, who shoveled out money, confident that HPA — house price appreciation — would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief. As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out — and what we are witnessing at some of our largest financial institutions is an ugly sight.

Of course, a true value investor isn’t above putting money into something “ugly” if the price is right. With the prospect of Uncle Sam writing bigger-than-ever checks to ease the pain of Wall Street’s rummage sale, Buffett decided to buy into the least ugly of the big names, Goldman Sachs.

Apart from trying to learn from the financial industry’s woes, investor relations folks might look to Berkshire Hathaway annual reports as an interesting model. Thirty-one years of shareholder letters are available online. Though most IR professionals don’t have “the sage of Omaha” as a CEO, the candid tone, factual recitation of results, and admission of mistakes offer plenty of examples for emulation.

I probably wouldn’t recommend humor in an annual report – unless your CEO is some sort of sage – because clarity is the main goal in investor communications. And not everyone is Warren Buffett.

Pet peeve – graphs that deceive

September 16, 2008

Just as sure as a hurricane brings TV news footage of a reporter standing on a boardwalk with waves crashing in the background, stormy times in the market also bring out journalistic cliches. Breathless and overhyped commentary and pictures abound – in print, on the air and online.

One of my pet peeves is a subspecies of exaggerated reportage: graphs that deceive the eye. I’m not saying it’s intentional, but some graphs depicting the latest carnage create an erroneous perception that overstates the “meltdown.” (The graph shown here is from Page One of today’s Wall Street Journal, though I’m not singling them out.)

The problem is – I know this will sound nerdy – the lack of a proper scale on the Y axis. When a graphic designer sets the base of the scale not at zero but at some higher point, it creates a visual exaggeration. In this case, a Dow Jones Industrial Average index of 10,900 is the base. The truncated scale makes a more dramatic picture, but the reader gets a quantitative impression that is out of context. Instead of a 4.4% drop, our eyes see the stock market plunging more than 95% – very close to “zero” on the graph.

Of course, an editor might say readers are smarter than that; anyone sophisticated enough to read the WSJ can tell the difference between zero and 10,900. Yes, but images do influence our thinking – and more on an emotional level than a rational one.

A leading expert on graphic communication of statistics, Yale’s Edward Tufte, states the positive principle in his book The Visual Display of Quantitative Information:

The representation of numbers, as physically measured on the surface of the graphic itself, should be directly proportional to the numerical quantities represented.

Tufte even offers a formula for a “Lie Factor” to gauge how far out of proportion a graph is. (This calculation is off the scale for most stock-price charts in the media, which are vertically truncated.)

Moving beyond whining about a pet peeve, I might suggest a lesson for investor relations professionals: We should always look at our graphs – those bar charts that fill PowerPoint presentations and some say are eye candy in annual reports – and test them for visual integrity.

The classic bar chart might show EPS rising from $3.00 to $3.25 to $3.50 over three years. If the Y-axis scale starts at zero, the eye sees a 17% total rise – looks steady, not too bad. But if you draw the scale starting at, say, $2.00, the increase in EPS looks like a more dramatic 50% – much more “growthy.” Try it both ways in Excel or PowerPoint; you’ll see. My Excel sets “zero” by default at $2.70 – which really makes for skyrocketing growth.

Financial communicators of all sorts, corporate or journalistic, should be careful to present information not only accurately, but in context and with perspective … which I think means graphs drawn to scale.

Got that annual report planned yet?

September 2, 2008

When Labor Day rolls around, I always start thinking about annual reports. It’s a little hyperactive for some companies – but, hey, thinking ahead is part of my calling. When I was in IR on the corporate side, I first began feeling those urges around the Fourth of July.

So September has arrived – time to think about annual reports. For most IROs and communicators, year end is coming up soon.

We’ve mapped out the annual report process over the years, and common elements apply across companies. A few first steps will get things rolling:

… Assemble the team. Identify a hands-on group from accounting, legal, IR, communications – as well as any outside designers or writers.

… Brainstorm. As third quarter winds up, the big picture for the year is coming into focus. Good year, bad year? Problems, achievements? Gather the team to talk about themes, concepts and tone.

… Make a timetable. Sketch out the schedule, perhaps working backwards from the drop-dead mailing date through the various stages of creating, writing and producing the annual.

… Enlist management. Have a first conversation with your CEO or CFO on what shape the annual report might take. Get direction (or buy-in) on the tone and broad messages of the report.

The annual report, print or electronic, is still the marquee publication that investors (and perhaps other audiences) use to judge your company. Its readers are the right audience – we must be sure we reach them with the right message. Whether the annual report is a 10-K wrap or a full glossy book, its clarity, focus and tone are critical to effective communication.

And now the fun begins.