Some of my most relaxing days at the office are the days when earnings are released. It’s a blast – I come in and I talk to the press,’ avers Sallie Krawcheck, an analyst at Sanford C Bernstein.
She goes on: ‘I have no more information on that day than anyone else because the earnings releases are essentially a page long and relatively meaningless. It’s amazing what a veil of secrecy exists at all of my companies.’ What makes this especially notable is that Krawcheck covers brokers and asset managers, surely among the most experienced number-crunching and market-savvy of groups. And if they’re not, they certainly should be.
Every public company must, of course, devise its own disclosure policy, deciding precisely how much information beyond the requirements of the regulator to provide to the investment community, and strategies for managing that flow range across the spectrum.
But it is information that is driving capital with increasing speed through the markets, and, as the investment landscape undergoes profound transformation, one trend is clear: the demand is for more and more information, ever faster and better, especially where a company’s numbers are concerned.
‘There are a lot of tricky issues now,’ maintains one fund manager. With the markets becoming ever more powerful, trading frenetic, and investors increasingly plugged in to the constant buzz of information, many firms are simply having trouble keeping on top of the process. ‘A lot of investor relations officers are not up to speed,’ he explains. ‘Companies should recognize their own role in affecting and potentially manipulating the effects of capital markets on their firm and stakeholders. It should be apparent that they play a big role, but sometimes they don’t even realize what they’re doing.’
He cites as an example one prominent bank which responded to October’s widespread global pressure on financial institutions by totally withdrawing. ‘The only thing they communicated was that they didn’t care about communicating, and so they did a really lousy job. I can tell you there was a big impact on their investors.’ Even the appearance of stonewalling is universally deplored, and, as Machiavelli advised the Prince, while sincerity itself might not be a necessary quality to stay on top, the appearance of sincerity is of paramount importance.
Opacity option
Corporate cultures vary, of course, and some firms prefer to take a very conservative line as a matter of course. ‘You’d be surprised how many companies fall back on bland platitudes with no real information and then just provide the balance sheet,’ notes Merrill Lynch banking analyst Judah Kraushaar.
Opting for opacity, however, is not without cost. In Krawcheck’s view, a tight-lipped policy is a big disincentive for investors. ‘The best and the brightest of my stocks, even stars like Morgan Stanley Dean Witter, are trading at less than a 60 percent relative multiple,’ she explains. ‘And it’s because there’s not enough information.’ Confirmation for this view came in a 1996 study conducted by Russell Lundholm and Mark Lang, which found that, for comparable companies, a more open disclosure policy results in significantly lower stock price volatility, a tighter consensus in earnings estimates, and a larger analyst following.
While some firms do provide a lot of information, it’s just not in user-friendly form, so that a given earnings release seems to get more complex the more you study it. ‘They’re a Full-Employment Act for Wall Street analysts,’ notes a detractor. ‘No fund manager can put in the time to decipher these cryptic documents.’ And seemingly little things count: ‘I’d like to not go blind by the time I’m 50,’ said one critic of the notorious penchant of one financial powerhouse for releasing elaborately Byzantine documents in minuscule typeface. But, user-friendly or not, most agree they’d rather have data dumped on them than be treated parsimoniously or selectively.
Each company is expected to put its best foot forward when reporting earnings, and, for the most part, everyone in the investment community is willing to play the numbers game. In fact, analysts and investors alike are eager to hear management’s view on results, especially if they are disappointing. ‘It’s very helpful when companies explain things and not just offer excuses,’ says Morgan Stanley Dean Witter broadcasting analyst Frank Bodenchak. ‘They should be upfront about what is recurring as opposed to one-time or non-recurring items.’
But, of course, no-one likes to be taken for a fool. In the words of London-based Kieran Mahon, who covers European food producers for Schroder Securities, ‘Honesty is the best way to handle earnings surprises. To think that we aren’t bright enough to see through massaging and tweaking is just silly. There’s really no point in it.’
Looking for the color
And time, of course, is of the essence; one of the very worst things a firm can do, according to one sell-side analyst, is to issue a misleading or not easily understood comment in a press release, and then wait until the following day to have a conference call. In fact, earnings releases are now viewed as merely one component of the information process, of which the other important pieces are pre-release faxed background data and the post-release conference call. ‘The earnings release can’t do it all,’ explains Bodenchak. ‘Discussion with management gives you the color behind the numbers.’
So, what do investors want? Bina Thompson, who has been handling IR for Colgate-Palmolive for over ten years, says the answer is simple: ‘In the best of all possible worlds, by definition, what investors want is everything.’ She notes that the practice of investor relations has become more sophisticated in responding to investor demands. ‘We’ve always issued a press release that was extensive, but we’re now far more ready to anticipate questions from the investment community.’
But rather than being forced to ask, analysts would like to see things spelled out. ‘I like to look under the hood,’ maintains Bodenchak, ‘so I like to see what a company’s organic, as opposed to acquisitive, growth looks like. Plus, I like to see the numbers on a fully diluted basis, which most companies are now providing.’ For Kraushaar, having a company isolate its key trends gives extra value, and he, too, appreciates accounting transparency. ‘I like line of business clarity. The more you can decompose earnings and return on equity by key businesses and then follow that with good management discussion of the results and where the company is going, the better.’
Aggressive evolution
One company with a reputation for getting the process right is Chase Manhattan Bank which, over the past two years, has been aggressively evolving its financial reporting. ‘Chase stands out for being proactive, informative and transparent,’ raves a fund manager.
Written in a simple and straightforward way, the bank’s extensive press release is replete with significant detail that reveals rather than obfuscates the key points. User-friendly tables illustrate primary concepts, and the numbers are easy to read and understand, since detailed line of business information is provided for three major divisions broken into eleven subsets. At the analysts’ meeting, in addition to the finance people, the company often presents senior business managers who can give hands-on perspective to developments in their respective areas. Says a bank insider, ‘They can explain their particular business with passion.’
In summing up Chase’s investor relations policy, Kathleen Baum, VP for financial communications, notes, ‘Our senior management team really believes in simple, straightforward reporting that accurately reflects the diversity of the portfolio and its performance.’
In addition to breaking down the numbers for past performance more finely, some companies are also discussing future prospects more openly. The US Safe Harbor for forward-looking information contained in the Private Securities Litigation Reform Act of 1995 provides corporations with the opportunity to offer projections without an overriding fear of litigation, so long as they issue the proper cautionary statements.
Twin pitfalls
While only 26 percent of companies say they routinely forecast, up from 12 percent a few years ago, according to last spring’s Niri survey on corporate disclosure, only 33 percent say they never do it, up from 66 percent in 1995. Earnings forecasting allows companies to manage investor expectations with far greater finesse, while avoiding the twin pitfalls of selective disclosure and entanglement.
Playing from a position of strength as the world’s largest supplier of chips and one of the most profitable companies in history, Intel, has been in the forefront of this practice. The firm issues its own earnings expectations and then periodically indicates whether or not its performance is on track, offering updates and explanations as necessary, irrespective of what the Street is thinking.
‘Forward-looking statements are the core of what IR does,’ Cary Klafter, director of corporate affairs in Intel’s legal department, told a recent Investor Relations magazine-sponsored executive conference call on guiding earnings in a volatile market.’ One of the primary goals is to keep analysts’ ranges moderately tight and realistic, since it is a sad fact of Street life that when numbers are missed, there is hell to pay. In early March, for example, when an analyst cut his Intel rating amid concern that profit would be hit by waning demand for computers, the stock declined 6.2 percent in a single day. In that week, it dropped 18 percent.
As earnings reporting practice in the US evolves in the direction of fuller disclosure, it is having an impact all over the globe. The number of Canadian public companies issuing extended quarterly news releases has increased by 30 percent, according to Melanie Kurzuk, corporate communications manager of Canada NewsWire. These now routinely feature messages from the CEO, disclosure information on the various business segments, full financial statements with major notes, plus an occasional editorial article.
With increasing clout in Asia, US banking powerhouses have put pressure on companies in the region for greater disclosure too, and many local brokers have adopted the American-style model of research coverage. To compete for capital on a global level, Asian companies have had to become far more transparent (see fund management profile).
Euro gold rush
In Europe, the euro has created a whole new ball game. Estimates of inflows into European equity markets over the next decade are in the $13-17 trillion range. Companies have been scrambling to adapt to the accelerating speed and power of market moves, while also gearing up for ever-fiercer competition.
‘EVA analysis has highlighted the need to isolate profitability and increase accountability,’ maintains Schroder Securities’ Mahon. ‘The managements themselves now have a much better sense of where the profit drivers are, so there is increasing transparency in their own internal structure.’ Companies in possession of better numbers can now pass them along to investors.
Eva Quiroga-Thiele, who covers the European food sector for Morgan Stanley Dean Witter, notes that there are other forces at work as well. ‘In the past, analysts and investors were frustrated because there was no transparency whatsoever, just a few margins.’
While most agree there has already been significant improvement in IR, especially among the large-cap European companies, much remains to be done. ‘Continental European companies are still in the Dark Ages when it comes to the way they release information,’ argues Warburg Dillon Read’s European food analyst Mark Lynch. Part of the problem is that many of these companies still see themselves as a domestic investment, but this is ‘an increasingly anachronistic point of view’.
Since opacity tends to turn off investors, there needs to be a recognition of the bottom-line value of disclosure, an understanding of the fact that it drives down the cost of capital. At the end of the day it comes down to raw, crude numbers, notes Mahon: ‘If he’s got the best returns, the CEO can tell you to sod off, and you’ll still buy his company.’
