Why Great CEOs Check Their Stock Price Every Now And Then by David Merkel, CFA of Aleph Blog
I was doing my daily reading, when I bumped across the article, Why great CEOs ignore their stock price. Yeah, I know it is the USA Today, so it has to be simplistic. Most of the article is correct. I am not in favor of short-termism, and much less managements managing only to maximize their compensation.
Back in July, I wrote a piece called The Stock Price Matters, Regardless. Though the whole piece is good, let me give you one quotation from it:
If management/board thinks the price of the stock is undervalued, they will be among those buying shares in the secondary market, improving the value of the shares for the remaining shareholders.
If management/board thinks the price of the stock is overvalued, they may look at other companies to buy that are reasonably priced or cheap that will make their firm more useful. At that point, their stock is a useful currency for acquisitions.
There is a lot of value that can be derived from the current stock price, to a management team that is focused on creating value. Buying back stock when it is cheap, and issuing stock to strategically acquire companies cheaply are important ways of creating value for shareholders.
Part of the job of an investment analyst is to analyze the management team and see if they are managing for themselves or for shareholders. If they don’t use free cash flow well, it is not a good company to own.
One more problem of the USA Today article is that most large investments by corporations tend to do badly, whereas small investments tend to do well. Management teams need to be careful about investing, and ask whether the investments are worth the risk.
Though there are innovative companies that have promising opportunities, such that they do not pay dividends or buy back stock, that’s not true of most corporations — reinvestment opportunities are limited.
It’s wrong to look at a bunch of special companies, and assume that all companies can do the same thing. What I insist from the companies that I own is that they follow portfolio rule six.
Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.
Not all corporate investment is good. Think of the long-term oriented managements in Japan back in the late ’80s. At that time I thought, “How can accepting low returns on equity be a bright idea?” There is always the possibility of wasting money via overinvestment.
I look for intelligence in the management teams in stocks that I own, and am quick to sell those that destroy value through bad investments, or bad buybacks. I try to think like a businessman in all that I do as an investor. It leads to good results. As Buffett said,
“I am a better investor because I am a businessman, and a better businessman because I am an investor.”
Don’t look for simple metrics to analyze investments. Embrace complexity, and realize that you have to consider how management teams use their free cash, whether to reward investors, or invest for the future, hopefully in productive ways.