How do management teams establish credibility and become well-regarded by investors and sell side analysts?
Summary
Well-regarded management teams are generally characterized by their ability to establish credibility with investors and analysts. Credibility is earned through effective and balanced communication, rigorous financial planning, and the ability to respond to, and incorporate change into strategic planning. Company representatives who interact with the investment community are often held personally accountable for the tone and content of the corporate message. The establishment, or lack, of credibility often results in higher, or lower, multiples of the public equity. The achievement of higher equity multiples will generally lead to stock price outperformance, higher employee retention, and a lower cost of capital for the company.
What attributes define a credible management team?
Historically, an important factor in establishing credibility with the investment community was a management team’s ability to deliver consistent financial results, quarter in and quarter out, preferably with consistent upside surprises. Premiums were accorded to management teams that could communicate a reasonable forecast and deliver ahead of said forecast; the “beat and raise” approach to financial guidance communication. Investors favored such situations because they did not have to “worry” about financial results being volatile and consistency was rewarded handsomely.
Following the dot.com bubble, the financial crisis of 2008-2010 and, today amidst the COVID-19 turmoil, investors have recalibrated how a management team’s credibility is evaluated. Over time, investors have become skeptical of “smoothed” operating performance that relies on management’s assumptions and accounting interpretations. If a business is dramatically outperforming peers in a volatile environment, business (and accounting) practices are scrutinized for compliance, legality, and sustainability. If the slightest oddity or inconsistency is found to drive financial performance, heavy skepticism is immediate.
During more normal times, the number of financial metrics used to assess the quality of financial performance are incalculable. Every investor or analyst has an opinion about which financial metrics are relevant indicators of future financial performance: revenue growth, backlog, R&D spending, operating income, EBITDA, free cash flow, balance sheet quality, accounting assumptions, etc. However, in 2020, during a period of sustained uncertainty, the assessment of a management team’s credibility has expanded. Today, it is of increasing importance to investors and analysts how a management team communicates the company’s approach to financial planning, the outlook on industry dynamics, the focus of internal investment priorities and the resetting of “normal” financial objectives.
During periods of uncertainty, investors and analysts spend a significant amount of time analyzing and corroborating specific individual executive’s statements. There is an intense focus on communication style and personality which drive trustworthiness and influence credibility. These traits have become significant points of focus for investors. How management team members discuss uncertainty, the depth of knowledge regarding the markets in which they operate, and the acknowledgment of key drivers of success for customers and suppliers all help shape the perception of credibility for a management team. Today, it is just as important to communicate awareness and understanding of the key issues impacting the business as it is to communicate what the company is doing operationally. If investors have confidence that management is proactively addressing the “known unknowns,” the management team’s credibility increases.
How do investors differentiate levels of credibility among management teams?
When faced with circumstances like those of 2020, it is imperative for management to articulate the financial planning process and identify the key variables which drive decision making. There are few expectations of management to establish financial guidance in 2020. Yet, it is very important to the investment community that management outline the framework for business planning and highlight metrics which they believe accurately represent the health of the business, both for the immediate and medium term.
A crucial element of establishing credibility is acknowledging the forward-looking uncertainty while articulating a proactive approach to planning. It is essential to maintain an outlook and framework grounded in realism. The communication of past performance and the framework for the underlying operating assumptions should be clear and concise. When management can frame and quantify the risks and opportunities in a balanced manner, the investment community will likely embrace an evolving plan.
Proactively addressing challenges and acknowledging an evolving strategy or goals increases a management team’s trustworthiness in the eyes of investors. Unfortunately, if recent success of the business is not expected to continue, a management team will lose credibility by focusing on the past success while minimizing future uncertainty. Keep the message focused on what lies ahead to build credibility with investors and analysts.
How do management teams lose credibility with investors and analysts?
When a CEO or CFO focuses on unsustainable business strengths or defends outdated planning assumptions, the investment community will discount every piece of information communicated from the company. Failure to recognize change in the key planning variables and adjust accordingly will put a management team in the proverbial penalty box with investors. It is almost impossible for an individual to recover their communication reputation once they have overstated optimism about the prospects of the business.
During this period of uncertainty in 2020, there is asymmetric risk/reward to focusing on better than planned performance, minimizing the risk of uncertainty and/or issuing formal guidance given the volume of issues with significant uncertainty. Acknowledge the risks and articulate the plan to address them.
Implications for management and the stock when credibility is lost
Consistently optimistic or pessimistic guidance damages the credibility of the management team. Damaged credibility leads the investment community to speculate on management’s “intentions” which drive “whisper” expectations for financial performance. This speculation will overly influence investor sentiment on management and the business itself which will likely drive trading volatility of the stock.
Increased opinion-based investor speculation is the last thing a management team wants to be saddled with. Without confidence in the message or the people delivering the message, the potential for stock price volatility increases significantly. As a result, entire groups of investors will avoid certain stocks and/or will be limited “renters” of the stock; neither of which bodes well for long term value creation for shareholders or wealth creation for employees.
When investors believe management lacks credibility, the markets respond in the following ways:
1) financial multiples often remain in the bottom two quartiles of peers,
2) investor turnover increases and remains fluid over time,
3) investor speculation on strategy increases,
4) investor interaction becomes less amicable and can turn confrontational, and
5) investor interest wanes with the investment community becoming indifferent to good news.
Establishing credibility with investors will benefit individuals and the company in the long run
Management teams can use this period of uncertainty to establish foundational relationships with investors by being transparent about how they plan and operate the business. Clearly articulating key internal and external metrics management relies on to assess performance goes a long way towards building credibility with the investment community. It is best to acknowledge recent success with an eye towards the outlook and incorporate the obvious uncertainties into commentary or script. Investors will appreciate a candid assessment of facts and reasonable assumptions which will build credibility for when the time comes to issue guidance with a higher level of confidence than exists today.
For more information on how your management team can establish credibility with investors and sell side analysts, contact us today.
David Deuchler, Managing Director
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