Wednesday, January 4, 2012

Still can't ignore the basics in investor relations

Posted by Joe Crivelli
A few weeks ago, I had the opportunity to speak with a member of the board of directors of a troubled company. This company had once been a high-flyer, but has since fallen on hard times as a result of the financial and real estate meltdown. The company is losing money and under intense competitive and regulatory pressure. As you can imagine, the stock has been pummeled and is trading at multi-year lows.

During our conversation, the director shared some of the company's investor relations challenges with me, and expressed frustration that Wall Street did not recognize the intrinsic value of the company. But as we chatted, I realized that the company had lost sight of some fundamental principles of investor relations:

Guidance matters

In this age of transparency and accountability, it's essential that public companies provide guidance. When public companies don't give guidance, it signals one of three things to Wall Street, and none are of them good: first, that management has no visibility into the business; second, that the business is in free fall; or third, that management just has no desire to be shareholder-friendly or accountable.

In this case, both #1 and #2 apply, and the company has long ago given up the notion of providing guidance to the street. Wall Street analyst estimates are all over the map, indicating that the street has no idea where the business is heading either.

World-class management teams are able to predict where revenue and net income will be. They can do this within a 10 percent margin of error, over the next 12 months, and have the internal fortitude to make a call and hold themselves accountable. Those that don't, don't get a premium valuation. Ironically, most C-suite executives would bristle if an employee didn't want to set goals for the coming year -- in fact, the employee probably wouldn't make it to his or her next annual review.

The game is played one quarter at a time, one year at a time

As long as I can remember, IR types and C-level executives alike have bemoaned the quarterly earnings cycle. There have been rumblings of a move to real-time disclosure, and efforts to get investors to look at the longer term.

It was clear from our conversation that this gentleman was casting about for some other way to measure the company's progress. "Can't we just give the street insight into how we think we will fare over a broader economic cycle?" he pleaded.

But here's the thing: Investors like to be able to keep score. They like a periodic checkpoint and a gauge to see how their investments are performing. And the way they keep score is four quarters per year, one year at a time. It mirrors the seasons. It mirrors our currency system. And of course, it mirrors a football game. It's simple and easy, and you can rail against it, but the quarterly reporting convention is not going away. And we'll get punished when we miss expectations for a quarter, and rewarded when we exceed them.

GAAP is king

He also shared his company's struggles to find a financial metric that was a reliable and consistent measure of the company's progress. The company was providing a non-GAAP financial metric to give investors some sense of financial momentum, but it was a veritable alphabet soup of exclusions and addbacks and financial alchemy.

These non-GAAP metrics make sense in some cases, when companies have to incur extraordinary CAPEX and have heavy depreciation expenses right after project completion. But in this case, the company was relying on these non-GAAP metrics simply because the core operation was losing money and had been year after year.

At the end of the day, this is a capitalistic society, folks. It's about profits. And profits are measured by net income. A shareholder's share of net income is measured by EPS. And that's the metric that matters. Get that going in the right direction, and everything else will take care of itself.
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