5 Ways Corporate Governance Affects Investors and Stock Valuations

Published on Apr 14, 2016

Get to the source of shenanigans at companies. Knowing the drivers of good and bad executive behavior makes you a better investor.

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0:00make sure enjoy our webinar today five ways corporate governance facts
0:06investors in stock valuations i'm david dreier the CEO constructs and I'm gonna
0:13get right to the point
0:15governments really comes down to five really important that I called the 5 C's
0:21CEO leadership capital budgeting compensation communication competition
0:28at the CEOs and leave in caring about creating shareholder value and no one's
0:36gonna believe it you don't have top down into its to focus on doing what's right
0:42for investors you're probably not gonna really be that look no farther than
0:49valiant for example of bad leadership capital budgeting if you're not making
0:56decisions about how you allocate capital based on returns on invested capital
1:02based on casual cash return and BB you're not thinking like that then
1:11you're back and investors want to avoid that great example if you are looking at
1:20acquisitions or investments solely based on what kind of revenue that's not good
1:27capital budgeting capital budget not even taking into account the cost that's
1:35a bad thing and really the only way you know someone's joint capital budgeting
1:40right ways they're talking about cash or cashiers it doesn't have to be called
1:44return on invested capital which had to be called something that's true to the
1:49meaning of understanding how much cash for your getting relative atomic capital
1:54you compensation let's face it
1:58executives and leaders will do the most money college human nature is called
2:05self interest if you're paying people
2:10is not linked to creating shareholder value but late to whatever is linked to
2:18is what they're into
2:20not gonna get what you need your executives to be doing if you don't pay
2:25them based on those metrics communication gotta talk about it you
2:34can't articulate the message if you can convince me that you understand return
2:37on capital and that you're you're pushing it through the Organization ICAO
2:44terms of leadership re capital budgeting compensation of the company believes
2:51it's not that hard to articulate will do it for you watch the webinar we're
2:57trying our best to capo see the white paper on return on invested capital and
3:03you'll understand it's not that hard to communicate lastly competition to beat
3:11the competition and focus on return on invested capital that's what drives
3:16valuation
3:19convinced the market that you can out-compete yours yours though some
3:24returned to Mexico so really the purpose of this webinar is in linking all the
3:30webinars we've done together in the kind of the big picture message and you can
3:37see all of our webinars in the Education section of our website
3:46the big kind of clear message here for full circle is governance corporate
3:54governance the end of the day these are the people that said the business up to
3:59succeed or not we talk about american express what we talk about when we talk
4:06about G all always comes to be done case studies and all comes back to return on
4:11invested capital that's what drives valuation and that's what executive
4:17August are so focused on companies with good leadership how to define good
4:27leadership leadership means good corporate governance which means
4:30focusing on return on invested capital was the basis of argument particularly
4:35ideas that 300 cash flows matter and superior profitability is ultimately
4:41rewarded by the market financings into it
4:45been in the business for over twenty years I've been through the temp up
4:49markets get irrational we make many calls he constructs about stocks with
4:55Russia evaluations they do come back to earth
4:59report on the power of high expectations it speaks to even though stocks may be
5:07overpriced wrong time per GB model that the market would cease to exist
5:16the stock market cease to exist if it continually allocate capital to
5:20companies lost or destroyed value did burn adequate return on capital Harare
5:30see the weighted average cost of capital the market would destroy itself because
5:34the money would go away all the other hand the market rewards companies that
5:41create more value market can sustain itself so the sorter basics are part of
5:47nature thing those organisms those entities that create more than a take
5:53they prosper those that just take eventually die unless they can
5:59internet source of free resources basic nature also some basic math right we
6:08lookit return on invested capital this isn't just for sheer comfort for her
6:13financial companies for all but in this situation
6:16expressed fears seventy-two percent correlation between return on invested
6:21capital and valuation
6:25larger groups the S&P 56 percent correlation financials 69 percent
6:31correlation those of you have seen my prior webinars all the time I've even
6:39done on the fly it one of these presentations to show you how quickly
6:44his access our date it's not sexy it's not quite as much of a thrill you know
6:51what the rules lol the end of the day is long term
6:55made money but you did the right thing the real thrill is no you're not just
7:04the right things trying to distract by the noise because it's all around you
7:14this is not entertainment investing is not entertainment about protecting grow
7:19your wealth and we're here to help you do that the right way that's a big part
7:24we're doing we believe the purpose of the capital markets to allocate capital
7:28to its most efficient use I think the biggest reason the United States is the
7:33greatest country in the world compared it to her place years ago when we were
7:37not on the world scene at all what's the difference it's our ability to walk back
7:42to the freedoms of speech engine produces idea has resulted in a more
7:50efficient capital markets are more effective way to get more out of the
7:54resources we have today that we did back then
7:57lakes are cheaper oil wells are fuller we do more with less that's what drives
8:04promises there is a limit that
8:08are investing principles are based on technology to identify the best measures
8:23cash loves to show that the relationship between profitability stock valuation is
8:30not just into it but empirically supported that's what matters so
8:38governance it's about leadership capital budgeting compensation communication
8:45competition that focuses on the end of the day if you can earn more money on
8:54the small amount of money you allocate your peers you win if you can earn more
9:03money on every dollar of capital and your peers you if you can make 20 bucks
9:10for every $100 you invest in 1519 you wish
9:20questions anytime I've already got two or three but I'm happy to answer
9:25questions this is a pretty simple take away and one of the things I like to
9:30kind of two to back up this message
9:35you know that the research the case study on american express showing
9:40exactly how executives to drive value by focusing on maternal capital we've got
9:45models that provide scenarios on exactly how much value the company can create
9:53for its investors if it can focus on capitol natural guy creation of a car
10:00park all these are linked back to change in return we did the same thing for
10:08Oracle case study by the way in each case studies their latest models
10:18are you exactly how we calculate
10:22as you guys know I'm super transparent I want you to know how much work we do for
10:27you
10:29we're here to help you identify and avoid the worst ones that was a perfect
10:36day corporate governance is a disaster they set up compensation plans that
10:41rewarded behavior that was bad for sure they got paid executives got a while
10:51losing money that's why the stock is down a lot lower when we wrote our
10:58dangerous over 40 for that it's in the thirties now we don't think it's gonna
11:10get any better because we don't think the corporate governance just got better
11:16you know we started pointing out the issue because it was sore so widespread
11:20in such a high-profile June 2014 independent research is helpful while
11:31she doesn't help corporate governance find people who actually don't have a
11:36dog fight find people who don't get paid by the companies are supposed to cover
11:42kit ok
11:54return on invested capital is that something has to be done in or or
11:58created tomorrow so when accompanied you like kmi is spending a lot of money
12:13contributors and short-term right we see this in our analysis of free cash flow
12:18and in our training programs you know what my kind of trick questions is it
12:23better for free cash flow positive negative or zero and the answer is you
12:30never know kids there's no right answer to that because it's possible that means
12:38you got so much money left over you don't have a lot of places to put that
12:42you don't have a place where you get a return to present so you just keep it
12:48short hours if you negative when you're you're investing more money than you're
12:54making it maybe that's because you've got a lot of high return opportunities
12:57what it comes down to the end of the day is expectations right so
13:14how much the stock prices date in the amount of money they expect the market
13:22expects Kinder Morgan to make on its return on invested capital does not have
13:28to be immediate just has to be more than the cost that cow that's why this round
13:37fascist guests will also like it much less three or four years that's not the
13:44point the point is quantified the market's expectations
13:49quantify the market's expectations because if you don't have different
13:53expectations for the market should be investing right so the market's
14:01expectations for came by our Super Hybrid returns on invested capital the
14:05maybe all the benefit of that investment is priced at the low maybe it's not a
14:10look at the model you can see that the marketplace
14:19depreciation is only seven years not that long right let's take a look at
14:28what kind of future returns on capital are being back to when you look at more
14:32detail right across 56 percent with basically a return of capital for seven
14:40years but we can model difference in areas right margins
14:47protects the Martins tax rates working capital fixed asset needs
14:57you can forecast along all of those metrics
15:05so if you believe that the margins
15:19company will need less capital in future got pretty heavy we can model that
15:42largest a study needless
15:45returns save that
15:52returns historically it'll be seen historically unusual scenario capital
16:01going up compared to where these models outrage far things get bigger you know
16:08all that stuff don't worry about that probably don't want to have it twenty
16:11percent revenue growth rate in our usual scenario not that went down don't worry
16:18about how far out yet to forecast because let the market is already
16:21looking into our jobs get a sense of what the market is right so we'll just
16:27go with what consensus is years so the results of an interesting area what
16:55we'll see is you know what the stock looks pretty cheap but for those
17:00forecasts company only needs two years of profit growth we think the stocks
17:06were three what kind of expectations that mean that we are playing about the
17:11future performance of the company
17:12nine years ago 25 percent not that big improvement over existing returns ok so
17:22the answer to this question is in the business of making a good investment
17:27that is a good idea
17:30the return of capital is cheap stock and return of capital in the future doesn't
17:35have to get my child what's been the best if we were to redevelop
17:42conversation guidelines
17:43sure where to begin with you and return of capital may get a clock to make the
17:49best of bank their compensation or several
17:51bad company stock depends on what kind of executives lot of things you can do
17:58to stop in the short term at least back to go out how much executives got paid
18:03the Men's Wearhouse acquisition we did a special case study on this recently
18:08special offers the big story here was that meant warehouse executives turned
18:23down an offer to buy that $40 cash for a share cash rightly turn that down
18:32month later put together a deal that's now resulted in stopping at $18 a share
18:38the cost shareholders over one and a half billion and guess what exactly is
18:52going to be bonus
18:57warehouse is increased pay increased by under sixty-seven percent and 9.7
19:01million
19:09eight big bonus make more money investors lost money is an issue the
19:18issue is it like that and yes anytime you see a company trying to sell you
19:23when I get burnings get out of the way why I don't represent 10 profitability
19:29you don't care about probability talk about it
19:36trumpet bets on how can a company like MN st
19:51capital false-positive come still going up faster than economics so kind of a
19:58red flag so even though they got a really great business model is still
20:02going up fashion economic earnings and we think that's a little bit shake it up
20:06and valuations got ahead of itself a little bit too so you know we see a lot
20:11of the market these days companies focusing on a GAAP earnings focusing on
20:17gatherings to just try to do everything they can to focus you something besides
20:23cash and willing to overlook the ballot overlooked aspects overlooked
20:32acquisitions
20:33off-balance sheet they overlook taking on debt to fund negative operations
20:39operations they don't look at what you need to get to the real cash flows
20:46companies take advantage of their stock up to get a good bonus why not focus on
20:53returning to Mexico we make it easy available across over 3,000 companies
20:59part of the reason we're doing these case studies on things like american
21:03express and G one more is to show how our model works for consulting partners
21:13capital directly provides a more transparent link between corporate
21:16valuation was at 11 a.m. always been transparent but because over the years
21:26why because the whole lot easier sell stock of people don't know the rules
21:31properly used car salesmen don't encourage that looks good guys used car
21:43sale I'm just say they're not afraid to show you
21:51superficial stuff their forthcoming with their numbers into it makes sets thanks
22:00very much for joining me today
22:02attendants you have any further questions feel free to email us research
22:06new contracts to support a new contract dot com
22:09great stop got a danger zone idea every week long ideas not quite as off but
22:15they're coming out as well as well and then we've got great were mutual funds
22:22and ETFs were actually looking at the underlying holdings always talking about
22:27individual companies 2004 7,000 mutual funds and ETFs covered up companies that
22:35were able to cover all the holdings or majority portion large majority portions
22:40of the capital holdings of funds and therefore give you our rating on funds
22:47it's just like a rating on the stock
22:49aggregation of data on stocks that holds the ratings that we travel we did it we
22:57just went through all the potential so transparent a much better perspective
23:04not just an individual stocks also thank you