Financial Executive: April 2012

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Feature Article

Investor Relations

Sharpening the Tools in the Investor Relations Evaluation Tool Box

The messaging role in investor relations is critical. Several measurement tools are available to improve clarity, consistency, compliance and credibility.

By Mark Collinson

When it comes to reviewing a company’s investor relations function, its role in annual or long-term planning or the bid for funding, those responsible face a familiar set of challenges. IR must direct the communication of the company’s performance and prospects in ways that are clear, consistent, compliant and credible.

These IR activities must result in the highest sustainable stock price earned by the company’s performance and prospects. While that much is agreed, it is also important to ask whether IR activity has been efficient and effective.

In what ways did the IR function get the company closer to those communications goals than would have occurred without any IR function? What are next year’s IR goals, what are the expected outcomes and what resources are necessary for success?

There are many excellent metrics in most company IR evaluations, but adding the following five measures may prove a useful addition to the evaluation toolkit that can assist chief executives, chief financial officers, investor relations officers and board members in assessing the company’s IR function.

 

An Investment Thesis Map        

An investment thesis is a set of reasons for investing in the company. The first objective is to find the investment highlights in the company’s communications. Whether this proves easy or difficult will be a check on its clarity. Create a table with each column headed by one investment thesis point. If there are more than 10 points, a busy portfolio manager will not recall them. Ideally, there should be four to seven investment points.

Next, make rows of communications channels and events that disclose and discuss these thesis points. Among the examples would be the 10-K, at the annual shareholders’ meeting, at an analyst day, in the investor presentation for conferences or non-deal road shows, on quarterly conference calls and on the company’s website.

By now, there will be a series of boxes in the table. The column titled, “Dominant Market Share in the Asia Widget Market,” for example, will have a row for “Non-deal Road Show Presentation.” In that box, apply a score from 1- 5 for clarity and profile. Is the point made clearly and forcefully in the presentation deck?

Once the table is completed, consistency of delivery will be readily apparent. If consistency of message is shown across channels, then there is reason to expect awareness of the point to show up in the company’s annual or bi-annual study of investor perception. If there are weaknesses, then expenditure of resources to improve consistency is vital for next year’s IR plan.

This is a useful device because it is easy to create and it directly measures (albeit somewhat judgmentally) IR’s function as a clear, consistent communicator of the company’s performance and prospects. The investment relations officer (IRO) has plenty of tools at his or her command to improve performance — such as a revamped road show presentation and better liaison with marketing for future press releases.

Once scores for all fields have been applied, if the investment thesis map is full of “5s,” then the job is being done well operationally. If the company’s most recent perception study still reveals weak, unaided recall of key thesis points, then maybe credibility is the problem. Resources devoted to finding out why investors do not recall or perhaps believe the company holds the “Dominant Market Share in the Asia Widget Market” may be in order.

 

An Analyst Estimate Dispersion Analysis

This very simple analytical device can facilitate IR’s job of communicating the company’s performance, the reasons for it and the prospects. Sell-side analysts will publish their earnings models out one to two years, usually on a quarterly basis. The set of estimates from the company’s analysts for any given period can be analyzed for dispersion by dividing the standard deviation of those estimates by the mean.

For example, for its year ending Dec. 31, 2012, IBM Corp. has an analyst estimate dispersion of its earnings per share (EPS) of just 1.1 percent, suggesting a very tight dispersion. Hewlett-Packard Co.’s dispersion, in contrast, is 8 percent. When benchmarking, comparison across industries is not as valuable as benchmarking against a company’s peers or against its own historical track record; even so, 8 percent is likely to be quite high.

This device will lead the IRO to search for reasons for the dispersion. Is there perhaps one analyst who is way out of line? If there are several analysts in the high camp and several in the low area, this could be an indication of poor clarity of messaging. Could it indicate that key buy-side analysts are similarly confused?

IROs have many corrective tools at their disposal, such as better scripting for quarterly conference calls, better responses during Q&A sessions and improved guidance. Or is an analyst day required where performance and prospects can be re-messaged with all sell- and buy-side analysts in attendance? These are all important available channels to enhance future investor communications.

 

An Incident Report

A simple listing of failings in disclosure can be created to form an incident report. This is a very useful test for compliance. Like an accident report in a manufacturing operation, an incident report can measure any increase in the number of incidents and then call for investigation into the state of operations.

Did the company receive complaints from investors that guidance was changed well after the company knew conditions had improved or deteriorated? Did any press releases have to be reissued due to errors? Did the IR website malfunction or fail to be updated during the quarter?

An honest assessment of the causes of incidents may lead to well-supported requests for increased IR resources or improved protocols (for information flow to and through the disclosure committee, for example).

 

An Institutional Investor Propensity Chart

Having checked for consistent, clear and credible messaging, it is important to deliver that messaging where it will make the most positive impact. This device can prove useful because it is simple to calculate and easy to understand.

There are many targeting services available, some with a “black box” element that can be used instead of, or in addition to, this device. The objective is to see if a given institution is “underweight” the company’s stock. The simple idea is that if an institution owns fewer shares in proportion to its ownership of the company’s entire peer group, then they are worth targeting with some extra effort.

For each of the major institutional shareholders of its peer group, including the company itself, a column of those names should be created. Then create successive columns, each headed by the name of a peer group member, including a column for your own company.

In each cell of that table, make a calculation, as follows: Assume the first cell is the relationship between the company and Fidelity Investments Corp. Take the dollar value of shares Fidelity owns in the company and divide that by the dollar value Fidelity owns in all the companies in the peer group, including the company itself.

Let’s say that produces a number like 0.3. In other words, 30 percent of Fidelity’s holding in the company’s industry is accounted for by its holding in the company.

Then take the company’s market capitalization and divide that by its total market capitalization plus the rest of the peer group. Let’s say the answer is 0.4. In other words, the company makes up 40 percent of the equity value of the industry it is in. Now, divide the first number by the second and multiply by 100. In this case, the answer is 75. This means Fidelity, in comparison to its holdings in the industry, is underweight the company.

Any resulting number less than 100 using the above calculation is an indication of the institution being underweight. There can be many reasons for this. When considering the reasons, it’s important to make sure the underweight stock holding is not caused by Fidelity’s lack of appreciation of the firm’s investment thesis, a lack of the company’s attention to Fidelity or a lack of the company’s understanding of Fidelity’s investment process.

An understanding and explanation of the numbers in this table will provide a very good narrative about the relative attractiveness of a company’s stock in the minds of investors. Any numbers under 100 that are proving difficult to explain may well imply additional IR resources should be targeted to those institutions in the future.

 

An Analyst or Sell-Side Map

A good sell-side analyst can be very valuable in endorsing a company’s investment thesis and putting it in front of investors with a high propensity to listen to its story. A simple way to determine whether the company has the full complement of sell-side coverage is to arrange a table of successive columns headed by the names of the companies in its peer group.

On the “y axis,” or first left-hand column, list the names of all the analysts covering any member of the group. In each cell, place a check mark if there is coverage. When the table is complete, it is easy to tell if there are gaps. If, for example, the analyst at UBS covers all of the company’s peers but not the company itself, then an understanding of the situation is required.

There could be many reasons for the absence of coverage, but it’s a good idea to make certain that it is not due to a lack of marketing by IR or lack of understanding by the analyst of the attractiveness of the company’s story with investors. Any unexplained gaps may well demand more IR resources and attention in the upcoming year.

Remember, it is not always easy for those responsible for the success of something as important as investor relations to communicate their need for additional resources or management attention. These very simple devices are easy to create, easy to understand and can be very helpful to IROs, chief executives, CFOs and boards in discussions about the effectiveness of the IR function from quarter to quarter.

Mark Collinson (mark.collinson@ccgir.com) is a partner with CCG, an investor relations and strategic communications advisory firm with U.S. offices in New York City and Los Angeles.