Do Investors Buying Common Stock Control Their Investment?

Well, I was honored to be tweeted to by Mark Cuban.  Here it is:

@howardlindzon @AlephBlog the real question is why would an individual buy a share of stock? It no longer reps ownership in company

Now let me try to answer the question.  Yes, average people buying stocks with the small amount of money that they have, have no control over their investments.  What is worse is that those who invest through mutual funds have less control, because the mutual funds don’t care much about governance except when something critical comes to them: an acquisition, a spinoff, a merger, etc.

Small investors need to realize that they are riding on the bus of the company (ies) that they own.  They have little ability to affect the board of the company, much less management.

So why buy, if you don’t get control?

Well, let’s talk about institutional investing in alternatives.  Many institutions ride on the buses of general partners with expertise, while they are limited partners.  They have little to no control, and they invest because they think their LP interests will be worth more by the time the partnership matures.  The partnership must raise liquidity by the end of the term, and players get paid, even if they are rolling into the next deal.

The key here is a liquidity event, or the threat of one.  Something that forces the investment to interact with the cash world.  It can be a spinoff, selling a subsidiary, an outright sale of the company, etc.

But liquidity events are rare with publicly traded equities.   Maybe not *so* rare, when you consider dividends and buybacks.  But full acquisitions happen rarely, and individuals play a small role in M&A.

So here is the answer, which only makes sense if you are a value investor: we buy stocks that we think will compound value.  We may not have control, but we look for situations where management honors the investments of outside passive minority shareholders.

We may be aided by larger investors that seek control, or not.  When you own an undervalued company, catalysts appear. It may take time, but the effort to make value emerge will work more than half of the time.

My view is to focus on companies that are growing value and own them.  That will result in increases in the underlying value of the companies held, which will result in high market values.

Yes, we may not have control.  But if we focus on undervalued equities, we may own companies that those large enough to buy whole companies will buy out, rewarding our patience in holding neglected companies.

And so, Mr. Cuban, though I am nowhere as successful as you, I regularly do better than the S&P 500 by picking stocks with my value discipline, buying stuff that few want to own, and profiting when the stocks exceed expectations.

That is why I own individual stocks, for myself and my clients.  I note that you on rare occasion buy common stocks, including this purchase of Apollo Group.  Guess what?  I own that as well.

I buy the stocks of companies that are out of favor, but have a margin of safety — if I am wrong, I won’t get killed.

That’s why I buy shares of common stock even though I know my ability to control is limited.  (That said, at least in the insurance industry, if I call they will listen to me, at least among the midcap and smallcap firms.)

But I agree with you.  Small investors ride on the backs of larger control investors.  Thus small investors should ask, “What will the large control investors like?  And that is why clever small investors should buy shares of stock, despite the lack of control.

Full Disclosure: Long APOL

By David Merkel, CFA of Aleph Blog



About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.