Tagged: Board reports

Open Water

If you want to be creeped out – and who doesn’t? – see the movie “Open Water.” It explains the problem with Board reports in investor-relations too.

American director Chris Kentis based his 2003 film on real events. A couple go scuba-diving and are left behind at sea.  He spent $500,000 making it and earned $55 million at the box office. That’s not the part resembling Board reports, unfortunately.

I don’t want to spoil the movie if you’ve never seen it, but I won’t because it’s a psychological drama depending not on action but implication that takes place in one spot on the sea.  Imagine you went scuba diving miles from shore and surfaced and everyone was gone and the current kept you out?

Now suppose as an investigator later it was your job to measure what happened to the couple. You had at your disposal film of the very spot on the ocean that the couple had occupied. You play back four three-month time-lapse slices of film at high speed.

Nothing. Open water.  It’s all you see. Sky whizzes by, days and nights are nearly indistinguishable, the sea appears as an unmarked surface moving across time.

It’s the wrong measure.  To understand what happened to the scuba divers you’d have to zoom in and watch spare increments.  Then you’d see – wait, there.  Are those specks in the water?  Sure enough, two people.  What are they doing?  Now let’s watch….

And that’s what’s wrong with Board reports.  They don’t measure the stock market the way it works. Executives have long strategic horizons and companies are generally benchmarking progress every quarter and looking at years of stock performance.

But your stock is like scuba divers bobbing on the water and your business is as timeless as the sea by comparison to what sets price. Blink.  Okay, blink again. That’s 350 milliseconds, give or take.  Many stocks trade 500 times in one blink.

No, don’t report to the Board every blink in your trading. But if we’re going to impart understanding – the point of providing information – of how shares change in value over time, the measures must reflect the way the ecosystem for your stock functions.

Your buy-and-hold investors have the same horizons you do.  But that’s not the money setting prices most days. Because it buys, and holds.

About 40% of the volume in your stock aims at horizons of a day or less, and generally just fractions of seconds to catch a penny spread a thousand times. Another 33% moves with the ocean, indexes deploying and removing money metronomically with a model. Another 13% or so pegs opportunity to instruments derived from your shares such as options, futures, forwards and swaps with horizons of days or weeks at most.

So just 14% of your market cap traces directly to your long-term strategy.

You say, “That cannot be true.”

In 2006, half the value of the housing market traced to real estate and the rest reflected rights to homes via mortgage-backed securities, and in some markets it was more than 80%. We know because that’s how much home-values declined.

On May 6, 2010, the Flash Crash, the Dow Jones Industrial Average lost a thousand points, or about 10% of its value, in mere minutes, because the money with tiny horizons disappeared from the market.

On August 24, 2015, some exchange-traded funds diverged by 30% or more from the underlying value of assets because money with horizons far shorter than the business strategy of any of the stocks giving them derivative value left. Briefly.

Those are outliers but lesser manifestations are a thrumming reef of vibrancy every day in your stock. At ModernIR, we measure price-setting in one-day and five-day increments because it’s the only way to see the scuba divers bobbing in the water – or the Activists, the fleeting shift in risk-management behavior reflecting deal-arbitrage, the evaporation of momentum, the abrupt drop in index-investment, the paired behaviors indicative of hedge funds coming or going.

Were we to paint stocks with bold brush strokes, the nuances responsible for price-changes would be as flat and impenetrable as open water. And meaningless to the Board and the management team.

The next time you ready information for the Board, think about the ecosystem, which is frenetic – in stark contrast to business strategy.  If nothing else, make sure they recognize that at any given moment, price depends on the 85% oblivious to strategy.

That might seem frightening, like sharks. Like the sharks it’s but a fact of the stock ecosystem, something to be understood rather than feared (and if you want to learn about the ecosystem, ask us!).

Babbling Happily

Picture a mountain river still crisp with snowmelt babbling happily.

Now imagine a town on its banks. Suppose thousands of people jammed the waters congenially in every kind of flotation device, laughing and floating downstream. That’s Steamboat Springs CO on July 4.

But babbling should not describe your interaction with the Board when you offer an investor-relations perspective. It’s the season, with earnings upon us soon again. There’s been extensive discussion at the NIRI Forum about what to convey to management.

Your IR section should articulate why shares underperformed or outperformed in the focus period (presumably the quarter), strengths and weaknesses in your equity (distinct from your story), and expectations about future performance. Sure, explain what you’ve been doing, who you’ve been seeing, what analysts and others have been saying. I offered them too as an IRO.  But management values strategic contribution. You’re the product manager of the equity market – which all else from the balance sheet to incentive plans depends on.

One IRO included four slides on the stock’s structure some weeks after a pivotal earnings report.  The first highlighted strengths and weaknesses, summarizing:

Strengths. Active value investors are buyers, setting price. Asset-allocators are back, signaling a return of passive sector money, a core driver. Short volume is down 14%, risk-management is down. These signal renewed investor-commitment and lower risk, the purpose of communication.

Weaknesses. Investors were surprised by weak execution and sold reactively, and despite improvements in risk-management behavior over intervening weeks, it remains high relative to long-run averages for the stock. Investors are challenging us to deliver.

Let me explain risk-management. Do you have life insurance? It’s protection that comes at a cost. Money spent on mitigation is less to spend elsewhere.  Investors put money into your shares, which are a risk asset, and they insure them with forms of risk-management or hedging – options, futures, swaps, pairs trades, shorting. If they spend more managing risk, it implies uncertainty.

When it becomes more profitable buying and selling insurance on your shares than it is investing in your story, that’s the definition of “short-termism,” and it’s measurable and observable. If risk-management declines along with investment demand, investors are planning to direct less money to your shares in the future. They hedge what they hold and they stop spending money on hedges that aren’t needed.

Back to our example, the IRO also included a graphical representation of market behaviors before and after results, a table of key comparative market-structure metrics either side of results, and a slide that set forward expectations, which concluded unwaveringly: “(the ticker) is now a VALUE proposition and must deliver VALUE results first before it can again attract growth money that brings price appreciation.”

Don’t miss this point. The company considers itself a growth story. But with value money as buyers following a reversal, retaining base value in shares requires a focus on value drivers and value results – cost-containment, wise capital deployment, returns on equity and so on.  You know them.

Management teams often confuse the business with the equity.  If all the investors in the market were buying fundamentals, the two would be the same. But over 30% of market volume is asset-allocation. Blackrock and Vanguard don’t listen to earnings calls but they’re the biggest investors. To them you’re an equity product, not a business story. Intermediaries drive half your volume. They’re middle men. To them, you’re a product with appeal to different consumers.

Discount these factors at your own risk. Don’t just list accomplishments, news, coverage, investors, in Board reports. Present your equity market strategically. Wrap that information in powerful directives reflecting the reality of the product.

This is IR in the 21st century.  You’re not tubing down a river of roadshows and conferences, a buoyant stenographer. You’re a product manager. We have the data, metrics and experience to help you manage and message best.