Management Changes: Bigger Boost For Stocks With Low P/B

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It’s obvious that a management changes can have a big effect on a company’s performance, but figuring whether the change will be good or bad for investors isn’t always as clear. The question has become even more important as the rate of CEO or CFO changes at European companies has gone from 15% in 2010 to 21% last year, and it turns out that it’s pretty close to what you might have guessed: out-sized performance (good or bad) usually reverts to the mean, but it’s easier to turn a small company around than a large one.

Good and bad performance both muted by management changes

“Shares in companies who announce management changes do not generally outperform the market subsequently, however the extent of under-performance slows materially over time and nearly stops in the subsequent 2 years,” writes Morgan Stanley analyst Krupa Patel.

Relative under-performance actually increases slightly on a one month time-frame, reflecting market uncertainty about the transition and possibly some increased scrutiny. But under-performance hits parity three months after the change is announced and is significantly muted after that.

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But just as under-performance is usually tempered by a change, significant out-performers tend to be cut down to size.

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The stocks discount or premium, measured by price to book value, was much less symmetric, showing that stocks trading at a deep discount can see a huge jump in price, while stock trading at a high premium only dip slightly. This asymmetry is probably related to investor awareness: stocks that trade at such a deep discount aren’t typically showing up in headlines so investors might not know to research them until a change in management draws their attention.

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Market cap plays a key role in new management’s effectiveness

These results don’t take market cap into account, and the difference between small and large caps is enormous. Companies with a market cap above $20 billion actually did worse than their peers following a management change. Companies between $5 billion and $10 billion seemed to be the sweet spot where management has enough tools at their disposal to really effect change, but weren’t faced with an unwieldy, unmanageable business. This does give some credence to activist investors who insist on scaling down and simplifying businesses as a first step towards rebuilding shareholder value.

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A change in management could be the catalyst that an unloved, mid-sized company has been waiting for, but it’s not enough reason to invest in and of itself.

“Investors should consider a qualitative overlay to our database as well as a purely quantitative one,” says Patel.

Patel (along with other Morgan Stanley equity analysts) have compiled a list of 14 European companies that have announced management changes in the last 18 months that she thinks is worth investigating further as the potential benefits haven’t yet been priced in.

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