February 22, 2017

Outliers

“Since I started Baron Funds in 1982,” said Ron Baron on Squawk Box last week, “we’ve owned 2,500 stocks. Take 15 of them out and we’re average.”

Baron is quintessentially rational. Visit Baron Funds and click on About and the words across the top are Long-term Investors. Research-Driven. No better proof can be found than that the director of research at Baron, Amy Chasen, was the IR head at Avon for years.

There are 36 fund managers and analysts at Baron overseeing about $21 billion of assets and the firm since 1982 has distinguished itself via patience and homework. Pick good companies and hold them for a long time. 

What percentage of the picks would you expect to be outliers – top performers? Maybe 75%?  The firm is looking for outliers after all. They’re not aiming to be average like Blackrock and Vanguard.

Okay, that’s probably a high expectation. Every time we demonstrate Market Structure Analytics to somebody new we expect there’s a 35% chance, based on the numbers we track, that that person will become a client, because we’re also patient and persistent.

So let’s lower our target for Baron.  Seventy-five percent is too high but you’d think stock pickers would be hoping they’re right at least half the time.  No?

You already know the answer: 0.6% of the firm’s stock selections beat the averages. That’s what 15 of 2,500 is.  The other 2,485 choices add up to average.  Now the good news for Baron is they don’t have to be right often to be good.

The bad news for IR is that using Baron Capital as our index of investor-relations outcomes, the likelihood that you’ll stand out from the crowd is less than 1%. 

“Oh come on Quast, what is this? The beatings will continue until moral improves?”

Oh ye pessimists, it’s the opposite.  IR is not just a storyteller.  IR is the product manager of the equity market.  If your management team thinks you have a 90% chance of standing out from the crowd and you lead them to persist in that belief, you’re creating a lot of needless IR stress. 

It doesn’t mean you stop trying of course. According to our illustrious trade association, NIRI, which at long last as a CEO again, 92% of public companies hold earnings calls (you wonder who the 8% are that don’t, and I’d love to know if they trade differently than the 92% — and my bet is there’s only about a 1% chance they do).  We tell the story because we must. 

But it’s high time IR adapts to the market we’ve got and it’s a lot like retail.  By that I mean the money isn’t one demographic, any more than the customers in Nordstrom are all one demographic group (they may share some characteristics sure, but they’re not all the same age or gender or height or weight).

And by that I also mean you all have high-speed pricing. Do you know that Amazon changes the prices of many items every 15 minutes?  They reprice with algorithms in response to online demand.  Well, now all the other retailers have had to adapt.  Walmart, Target, Best Buy and others may change prices 5-6 times a day now. 

I’ve got the Market Structure Report for a large food company here in front of me. It traded over 53,000 times daily the past week. Theoretically it could be a different price every time. The spread each day between highest and lowest prices averaged 2.3%. Add that up over 20 trading days and it’s 46% of the stock’s market cap.

Retailers are continuously engaging in markdowns to rid the shelves of “the dogs,” the stuff that’s not selling. And some hot new thing will come along and demand patterns change and retailers start lifting prices. It’s happened to me with hotels and airlines.  You too?

Juxtapose that with long-term research-driven investment and you see the problem. The dominant investment behavior of the day is Blackrock and Vanguard. They want to peg the averages of these continuously shifting notions of what’s a dog, what’s hot, what’s up, what’s down, or what’s getting continuously repriced in fractions of seconds.

And it appears they’ll be right 2,485 out of 2,500 times, or about 99% of the time. Over the past decade, 98% of active fund managers (and I think Baron was in the 2%) failed to beat the S&P 500, says Morningstar (Dec 2005-Dec 2015 but you get the point).  

The 20th century was all about active investment for IR, and telling the story, and as a result 92% of us hold earnings calls. But we’ve got to catch up to the market. 

Sometime over the next decade, 92% of us should be viewing ALL the money as the audience, messaging to some of it and consistently measuring the rest, like retailers do. We’ve got to be data analysts in IR.

Because we won’t all be outliers.

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