Why is it that companies such as Baycorp,
The Warehouse and Waste Management consistently show superior total shareholder
returns over many years when other companies go through ups and downs and only
frustrate and disappoint their shareholders?
The performance of these
three companies over long periods of time is quite staggering. Baycorp has
produced a 70% annual total return to shareholders over the last 10 years. The
Warehouse has produced annual returns in excess of 20% over the last five years.
Waste Management, who is not one of the darlings of the New Zealand stock
market, has returned shareholders an average annual return in excess of 20% over
the last 10 years.
I believe what sets these companies apart from the
rest is their quality of management. The quality (and stability) of management
and the execution of the company strategy has had a great influence on the
performance of these companies - performance that has led to the superior
returns to shareholders over a long period of time.
I also believe that
these companies understand that non-financial measures are very important and it
has been the managing of these key non-financial measures that has led to their
superior financial returns.
This means that when assessing investment
opportunities a prospective investor should find out as much as they can about
the non-financial measures that drive the company. Once these are understood
then a more considered and less risky investment will be made.
This is not saying that the bottom line
does not matter. Of course it does, as does other such vital financial measures
as cash flow and P/E ratios.
However financial measures are generally
lagging indicators. It is the non-financial measures that drive value in the
future.
A proactive management team will have a vision of the future.
That team will execute a good corporate strategy, make tough decisions, quickly
seize opportunities, allocate resources well, attract talented people (and
retain them), drive brand values etc.
Is this belief of mine backed up by
research? The likes of Ernst & Young, L E K Consulting and Bain & Co
have done a lot of research which supports my belief.
Some of that research has shown that
successful companies are more likely to strategically manage key non-financial
measures which leads to higher levels of operating performance - which in turn
leads to higher share prices.
Simulated studies have confirmed that
non-financial data does affect share valuations. What is interesting in these
studies is that superior non-financial performance in one area indirectly
impacts upon other non-financial criteria. Those studies have shown that if
investors like the management quality of a company they tend to judge the
company's overall performance more favourably than they would otherwise. - but
also they will perceive criteria such as the company's brand image or customer
satisfaction levels better even in the absence of hard data on these
factors.
It is these incremental changes in perception that have a long
term influence. It is closely related to the 'brand halo' effect that has been
the subject of extensive academic study over the years. The 'brand halo' effect
impacts on both non-financial and financial performance. What this suggests is
that all non-financial criteria are fed by performance. and in turn, feed the
perception of performance.
Not surprisingly research has also shown that
when non-financial data was taken into account earnings forecast were more
accurate. This really means that non-financial factors can be used as a leading
indicator of future financial performance. More accurate forecasts of future
financial performance result in a lower level of risk because the investment
decision is made on the basis of more knowledge.
Therefore when
considering investment opportunities a lot can be gained from assessing the
quality of management and how successfully that management team has guided the
company in the past.
This assessment in conjunction with a
good understanding of non-financial performance (market share trends, market
perception etc) will lead to a far more accurate picture of future prospects.
Hopefully investors will find such
investment opportunities for themselves that will enable them to achieve returns
like Baycorp, The Warehouse and Waste Management have produced over the
years.
Peter Maiden
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