Tag: Analysts

What happens if you miss consensus?

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CFOs are obsessed with meeting consensus – so obsessed, in fact, that they are often willing to make decisions that could damage their company’s long-term performance in order to make sure they don’t miss it.

Yet research shows that the stock price of companies which employ earnings management to meet consensus perform worse in the following year than honest companies that miss consensus.

CFOs are obsessed with meeting consensus

Research by a team from Columbia Business School has found that most CFOs would choose to make decisions that could destroy corporate value rather than miss analysts’ consensus.

As a result, they would carry out earnings management to meet consensus – at the expense of their company’s long-term performance.

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For example, 80% of CFOs said that they would decrease discretionary spending to meet an earnings target – even though they accepted that such actions can destroy corporate value.

And 55% said they would delay starting a new project to meet an earnings target, even if such a delay can destroy corporate value.

Several interviewed CFOs candidly acknowledged that they have made real corporate sacrifices to hit an earnings target.

Is this obsession justified?

What proportion of companies miss consensus?

An analysis of 180,000 quarterly results over a 17-year period found that:

  • 13% of company results reported an EPS that met analyst consensus precisely
  • More than 25% of companies beat consensus by $.01 – $.03
  • Combined, this means that almost 40% of companies met or marginally exceeded consensus
  • Whereas just 15% of the sample missed consensus by $.01 – $.03

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So, if you miss consensus marginally, you are in the company of a small selection of poorly-performing companies.

And – to make matters worse – everyone will assume that you did everything possible to meet consensus but failed – creating doubt about your underlying corporate performance and management competence.

So what is the impact if you do?

What is the short-term impact of missing consensus?

In another analysis, a team from the University of Chicago School of Business found that:

  • Stocks of companies that hit consensus rose by 1.6% on average over the 3 months ending with the earnings announcement – reflecting investors’ response to management guidance and analysts’ forecast revisions made prior to the final results.
  • Those that missed consensus dropped by 5% on average.
  • Those that beat consensus increased by 5.5% on average.

Yet within those averages, there is a wide disparity

In fact, research also suggests that some companies get hit hard yet others are not affected at all.

What creates the greatest stock price declines after missing consensus?

Investors respond differently to earnings misses for different companies at different times. Some are punished severely while others escape unscathed. And, interestingly, the size of the consensus miss had only marginal impact on stock price movement.

The Chicago School of Business analysis found that two factors had the greatest impact on the stock price declines of companies that missed consensus:

  1. Weakness in Company Fundamentals

If the consensus miss is disclosed with a disappointment in sales, cashflow, margin – or with a downbeat management outlook – it invariably leads to significant loss of share price.

  1. High Growth Expectations

The team at Chicago ranked the companies that missed consensus according to their market-to-book ratio (the ratio of the forward-looking stock price to the historical-based book or equity value per share), and they found that:

  • Companies that missed consensus, but had low prior growth expectations, experienced a stock price decline of -3.6%.
  • Companies that missed consensus, and had high prior growth expectations, experienced double that decline: -7.3%.

In short, high-growth companies are hit twice as hard as low-growth companies when they miss consensus.

And overvalued stock is hit the hardest.

As a result, it is not in the interest of any company to employ earnings management that camouflages weakness in corporate performance.

In fact, research suggests that companies that are honest to the markets about their performance achieve superior stock performance that those which choose to camouflage corporate weakness with earnings management.

What is the long-term impact of missing consensus?

Sanjeev Bhojraj and a team from Cornell examined what happens to companies that miss the consensus estimate by a penny – without employing earnings management.

They identified such companies by tracking unusual changes in the major expense items that commonly reflect earnings management – accounting accruals, R&D, advertising expenses etc.

They found that manipulating companies that beat consensus received a temporary 3-4% increase in their stock price – but had lost it all by year-end.

But companies that missed consensus by one penny without manipulating earnings did not receive any decline in stock price in the short-term – and a year after the consensus miss, their stock price had increased significantly.

Honesty Pays

It is most likely that you will risk missing consensus sometime, if you haven’t already.

According to an analysis by Morningstar, for example, just 3% of companies have reported an increase in EPS consistently over a 10-year period.

And only 3% have reported an increase in free cash flow consistently over a 5-year period.

So you will probably miss consensus one day.

But earnings management can both damage your stock price and erode your corporate value.

As a result, rather than camouflaging weak performance under earnings management, companies are advised to communicate the issue to the markets with a clear plan to address the weakness.

If you deliver on that plan, your stock will emerge stronger.

Reputation is a Research and Strategy Consulting Firm that advises CEOs and Boards of Public Companies how to achieve Fair Valuation for their Company’s Stock. 

If you would like to discuss how we can help you achieve Fair Valuation for your Company’s Stock, please connect with us via our website or by email to Connect@TheReputationPartnership.com.

How CEOs should engage with Analysts.

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Our latest research provides clear guidelines to help CEOs create more valuable Analyst relationships.

Research has consistently confirmed that perceptions of Corporate Leadership is the No.1 most important influence on Investment Decisions and Share Valuation.

But our most recent research confirms that CEOs do not control the management of Analyst relations with the same discipline as they manage many other – less critical – parts of their executive responsibilities.

We carried out a series of confidential interviews with a representative sample of Buy-Side and Sell-Side Analysts who cover Asia-based Corporates.

Our aim was to identify the most persuasive influences that shaped their positive and negative impressions of CEOs.

And we found that Analysts were consistent and crystal-clear about their requirements from CEO engagement:

10 Principles For Effective Analyst Engagement

Throughout all our interviews there were 10 core principles that consistently created a perception of ‘CEO Added Value’ – regardless of sector.

Different Analysts gave different priorities to each characteristic, but the core guidelines were always the same.

These principles are detailed here, with the relative importance of each principle ranked by qualitative evaluation:

  1. Strategic Clarity

Most important of all, Analysts gave a much higher value to CEOs who were able to communicate a clear, compelling rationale for their Strategic Decisions.

This Strategic Clarity demands a clear, consistent description of their primary Corporate Objective, a persuasive articulation of their Strategic Options, an Option Analysis including their respective upsides and downsides – resulting in a clear, powerful support for their chosen Strategic Direction.

Analysts attributed a significant Premium to those CEOs who delivered impressive Strategic Clarity – and a significant Discount to those who were less effective.

  1. Industry Vision

A CEO’s Vision for the future of their Industry in the mid- and long-term is absolutely fundamental.

Vision determines the potential value of the CEOs entire Business Strategy. It must shape every decision, and every value judgement.

Analysts are obviously specialists in their sector, and they encounter many different Visions of the future, and have access to all relevant data on which to make their evaluations.

Every CEO must therefore be able to clarify a persuasive view of future trends, threats, opportunities & implications, based on facts, presented with power and passion.

  1. Honest Dialogue

Analysts place enormous value on having access to open, one-on-one dialogue with CEOs.

This personal dialogue and relationship shapes trust, confidence and empathy – and enables a clearer understanding of the CEOs Vision, Strategy and Issues.

This dialogue must always be informal, unscripted, one-on-one contact – preferably face-to-face, definitely on con calls.

The CEOs who provide the most personal, unscripted access are invariably the ones who are most confident in their own abilities and decisions, and – consequently – the ones who command the highest ‘Leadership Premium’.

  1. Consistent Delivery

On many occasions, Analysts have found themselves impressed by a CEOs ability to articulate a persuasive Business Strategy based on a convincing Industry Vision – only to hear of inconsistent actions or directions with little advance notice or explanation.

This creates confusion and doubt.

Analysts fully appreciate the need to move fast in order to seize opportunities or mitigate threats.

But they frequently hear of Management Changes, for example, with no warning or explanation.

Not only does this make them doubt the decision, but it also undermines their CEO confidence.

Analysts have most confidence in CEOs who deliver management actions that directly relate to their Vision and Strategy.

And if there are necessary variations, they value advance notice and a persuasive explanation.

  1. Future Focus

The more obsessed a CEO sounds with their Short-Term results, the less confident Analysts feel about their long-term potential.

Institutional investors assign premium value to Corporations with CEOs who have identified a persuasive Industry Vision, a powerful Business Strategy – and the Management Capability to deliver.

The more focus placed on Short-Term results suggests Short-Term problems and Short-Term focus – neither of which, obviously, lead to premium Valuation.

  1. Conscious Transparency

In conversations with Analysts, CEOs often try to avoid, minimise or dismiss developments which could threaten their Vision, Strategy or Plan.

That never works.

It often makes things worse.

Analysts give much more respect to a CEO who is both alert to potential new threats and challenges, honest regarding their implications, and prepared for response.

  1. Competitive Respect

According to Analysts, many CEOs are hardwired to either dismiss the strengths of competitors, or to diminish their threat.

Obviously, Analysts are specialists in their sectors and have a full understanding of the competitive landscape. They are not fooled by a CEOs feigned confidence.

Analysts therefore place a high value on CEOs who are honest, open and respectful.

And, not surprisingly, they have greater trust for CEOs who exhibit a thorough awareness of their competitors’ strengths and threats, because they will be better prepared to defend against them.

  1. Critical Visibility

One of the most common and criticised characteristics of CEOs, it seems, is to ‘disappear’ when there are significant problems, issues or challenges for their business.

When the going gets tough, many CEOs go into hiding.

Yet these are precisely the times when CEO contact and dialogue is most critical and most valuable.

Challenges and Crises are the ultimate test of Vision, Strategy, Transparency, Authenticity and Capability.

These are opportunities to add enormous value to the CEO brand.

The more a CEO hides and avoids contact, the worse the impression of their courage and competence.

And the more they avoid direct dialogue, the more they are missing a valuable opportunity to engage, impress and add long-term personal authority.

  1. Financial Credibility

Many CEOs are more comfortable talking about Vision, Strategy, Management Actions and broad Financial Issues – but are less comfortable leading discussions that drill down into Financial Details.

As a result, they often ‘hide behind the CFO’, leaving responsibility for communication of all financial details to their CFOs.

Analysts, however, have far greater respect for CEOs who are confident debating the numbers, convincing in financial discussions.

This doesn’t mean that they have to lead all finance discussions – of course not.

But they must be happy to lead discussions about the most important financial issues, exhibiting a confident grasp of the most critical details.

  1. Corporate Consistency

It’s critical for Analysts to see the CEO’s Vision and Strategy communicated throughout the Corporation.

The Leadership team must all be aligned, consistently communicating the same principles as their CEO, and presenting Corporate Actions in the context of the Company’s Vision and Strategy.

This obviously applies to direct Analyst Communication, throughout Earnings Calls, AGMs, Conferences and Investor Websites – but also throughout all internal and external messaging.

Analysts have witnessed several occasions where the CEOs Vision and Strategy is not reflected in further Management Dialogue or Corporate Communications.

The result is simple and profound:

CEO Authority and Credibility is immediately undermined, and Market Valuation is eroded.

Analyst Engagement Demands CEO Dedication, Not Delegation.

All these principles are obvious and logical.

But it is truly amazing how often Corporate CEOs fail to follow them.

CEOs should manage their Analyst engagement with the same discipline and dedication as they manage their business.

They should not be led by their CFOs. They should not be led by their IROs. They must lead all engagement themselves.

Yet, precisely because it is one of the few parts of their role that they cannot delegate or direct, it is often one of the hardest for them to apply.

Reputation is a Research and Strategy Consulting Firm that advises CEOs and Boards of Public Companies how to achieve Fair Valuation for their Company’s Stock. 

If you would like to discuss how we can help you achieve Fair Valuation for your Company’s Stock, please connect with us via our website or by email to Connect@TheReputationPartnership.com.

The 2 most critical Investment Drivers among the Buy-Side – and what they mean for CEOs today.

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What really drives the Investment decisions of Buy-Side Analysts? And how should CEOs manage them?

An extraordinary research study among Chief Financial Officers found that ‘78% would “give up economic value” and 55% would cancel a project with a positive net present value—that is, willingly harm their companies—to meet Wall Street’s targets and fulfill its desire for “smooth” earnings’ according to Harvard Business Review.

This is absurd.

It is even more absurd when you read all the recent research into the Investment Drivers of Buy-Side and Sell-Side Analysts.

One of the most recent was released by the world’s leading research company specialising in the Investment Industry.

Rivel Research’s 2015 Global Study of the Buy-Side’s Investment Process was based on extensive interviews with Buy-Side Analysts around the world.

The research is wide-ranging, but deep inside lie some fundamental findings.

And the most fundamental of all was this:

Short-Term Numbers are not the most important drivers of Buy-Side Investment Decisions.

There are two critical influences that are much, much more influential than the Numbers.

I’ll explain what those two influences are in a moment, but first let me share some other important findings:

Big Business Issues Aren’t Necessarily Big Investment Drivers

Interestingly, the research found that many of the most important principles for Business today aren’t particularly important for Buy-Side Analysts:

  1. CSR/Sustainability isn’t important: CSR/Sustainability is clearly the least important of all the 13 Drivers, way down at the bottom of the list, scoring only 22%
  2. Attractive Dividends don’t matter much: They are equally unimportant, right at the bottom, just above CSR, with 30%.
  3. Innovation isn’t fundamental, with ‘Innovative Products/Services’ scoring only 35%.
  4. Corporate Governance isn’t critical: Corporate Governance may be increasingly important within Business today, Buy-Side Analysts don’t see it that way, with Corporate Governance scoring below 50%.

Numbers Count, But They Aren’t The Most Critical

presentation2The most important Financial Measures are  clear:

  1. Cashflow is King; a Strong Balance Sheet is Queen.
  2. Potential Revenue Growth, Sustainable Margins and Prudent Capital Deployment are all important.
  3. Attractive EPS Growth is a little way behind – and Attractive Dividends don’t matter much.

But the two most important Investment Drivers are not Financial.

They are much more important than short-term numbers.

The two most Important Investment Drivers are those that create Investor Confidence and Long-Term Value

The two most important Investment Drivers for Buy-Side Analysts were:

72% Management Credibility

69% Effective Business Strategy

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These findings are consistent with earlier Rivel research among Sell-Side Analysts, which also found that the two most important drivers of Sell-Side motivations were ‘Management Credibility’ and ‘Effective Business Strategy’:

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Rivel’s most recent study includes the findings from their latest Survey of the European Buy-Side.

And in Europe in 2016, ‘Reliable Cashflow’ was this time rated as the No.1 Investment Driver.

But both ‘Management Credibility’ and ‘Effective Business Strategy’ were ranked as equal No.2 – well ahead of ‘Strong Balance Sheet’, ‘Sustainable Margins’, ‘Attractive EPS Growth’ and other Financial Criteria:

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Without question, a Company’s ‘Management Credibility’ and ‘Effective Business Strategy’ are two of the most fundamental influences on all Investment Decisions, for both Buy-Side and Sell-Side.

Which leads to one obvious conclusion:

Listed Corporations must be much as obsessed with creating confidence in their Management Credibility and their Business Strategy as they are with delivering their Short-Term Numbers.

This raises some interesting questions for most CEOs:

  • How much of your time do you spend building your own Management Credibility and shaping your own Personal Brand?
  • How much of your time do you spend building and communicating your Business Strategy, as opposed to implementing it?
  • How much of your attention in Analyst Meetings and Earnings Calls is devoted to the Numbers, as opposed to the most important Investment Drivers of all: Management Credibility and Effective Business Strategy?

Reputation is a Research and Strategy Consulting Firm that advises CEOs and Boards of Public Companies how to achieve Fair Valuation for their Company’s Stock. 

If you would like to discuss how we can help you achieve Fair Valuation for your Company’s Stock, please connect with us via our website or by email to Connect@TheReputationPartnership.com.

Can you afford to lose 20% of your company’s Market Value?

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A Corporate Crisis consumes most CEOs. Are you prepared for yours?

According to Oxford Metrica, a strategic advisory firm, every company today faces an 82% chance of experiencing a Corporate Disaster within any 5-year period.

They define a Corporate Disaster as an event that results in a company losing 20% of its Market Value.

So if you believe them – and they are a rigorous analytics company that is respected around the world, so I think you can – your company will experience a sudden and dramatic loss of your company’s Market Value in the near future.

According to another study by the Wharton School of the University of Pennsylvania, a sudden Stock Price drop is not just a short-term problem – it’s a long-term problem.

On average, it takes 80 weeks for a company’s Stock Price to recover after a sudden price drop – that’s 1½ years before the company’s Stock Price recovers to its original value.

If the Stock price fall is the result of Earnings Risk, recovery takes longer: 93 weeks.

If it’s the result of Acquisition Risk, it’s 121 weeks.

If it’s Industry Risk, it’s 137 weeks.

And if it’s Competition Risk, the recovery time is more than 3 years – or 162 weeks.

They also analysed the recovery time by risk, across industries, and the situation is much more extreme for the IT, Utilities and Healthcare sectors.

So the brutal conclusion is this:

  1. Your company will probably experience a Corporate Disaster that could result in a sudden 20% loss of Market Value, sometime in the next 5 years.
  2. After this event, it could take 1½ years on average for your Stock price to recover – maybe more.

Equilar calculates that the average S&P 500 CEO serves just 7.4 years in charge of their company – and just 6.0 years at the median.

So it’s likely that your imminent Corporate Disaster will dominate your tenure.

But recent research has shown how companies with strong Corporate Reputations are less affected by Corporate Crises, and recover from their Crises faster.

Reputation is a Research and Strategy Consulting Firm that advises CEOs and Boards of Public Companies how to achieve Fair Valuation for their Company’s Stock. 

If you would like to discuss how we can help you achieve Fair Valuation for your Company’s Stock, please connect with us via our website or by email to Connect@TheReputationPartnership.com.