Why Great CEOs Check Their Stock Price Every Now And Then


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.

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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.

Why Great CEOs Check Their Stock Price Every Now And Then

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.

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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.
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