Stock answers, how to impress analysts

Public company finance directors know that presenting to the investment
community is an essential part of their job – easily 20% of the working week, in
fact. What they also know – and something which makes them break into a cold
sweat – is that investors are not to be trifled with.

The words ‘no shocks, no surprises’, should be at the forefront of every FD’s
mind when thoughts turn to investor relations, as good communication is vital.
“What we’re looking for is to be kept informed, and we want it done in a manner
that builds and sustains our trust in the FD over time,” explains Philip Green,
an analyst at Merrill Lynch.

Although Green believes it is perfectly acceptable for FDs to demand that
analysts, in turn, do some of the work themselves in order to broaden their
knowledge of the company, he also believes FDs and their companies have to be
prepared to put enough in the public domain for the analysts to be able to form
a reasonable picture of what is really going on. The entire investment
community, he points out, wants to be ahead of the news flow. And, although not
everyone can, the analysts’ job is to get an earlier glimpse of the emerging
picture. Once the whole market can see which way the wind is blowing, the
opportunity to make a smart investment, or to divest oneself in a timely manner
of an investment that is turning sour, vanishes. The share price moves and the
opportunity moves off.

“There is always the possibility that an FD will paint a picture to the
analysts that bears no relation to the truth, and the only thing an investor can
do when that happens is use the law to recoup losses and ensure that everyone
concerned gets the chop,” says Green.

But, of course, the truth comes in many flavours when one is dealing with a
complex situation, and my glass half-full might be your glass half-empty. This
kind of difference does not constitute a difficulty, unless matters reach the
point where the FD’s optimism starts to strike analysts as foolish.

Green explains that nothing is solely black and white, and every piece of
information can be defined and reinterpreted by its context and its place in the
unfolding performance history of the company. “We all know that FDs sometimes
focus on putting forward the best case for their business rather than presenting
the raw facts. It is up to us as analysts to build up a picture over time of the
company and its style, and of the management and their style. Ultimately, it
comes down to how much you feel you can trust them,” he says.

For analysts, the role of the FD is to demonstrate they are worthy of trust.
You can’t blame FDs for events over which they have no control, says Green, but
you can blame them for underestimating material risk – which is another way of
saying don’t expect much sympathy if things go south.

The assumption will tend to be that a better, more astute FD would have had a
‘plan B’ for such an event. Even acts of God might need a scapegoat or two if
the market feels sufficiently pained by the experience. This lesson for FDs can
be summed up as: ‘Don’t expect life to be completely fair to losers.’

As far as normal trading is concerned, there is one cardinal rule: don’t
mislead the City – not even by accident. “If something happens soon after the
company has issued a trading guidance note to the market, which then makes
nonsense of that note, it creates a great deal of annoyance,” Green warns.

There is no room for second chances. “If FDs get it wrong, they should be
prepared to fall on their sword. Shareholders are quite vocal. Directors are
there as stewards of the shareholders and if they are not on top of their game,
then shareholders may call for their appointment to be reviewed,” he warns.

This might sound harsh, but it is simply the price of the FD’s newfound star
status, according to Richard Ratner, head of equities at Seymour Pierce. He
points out that the City will look to the FD to explain how the board’s strategy
is playing in the real world. “You expect the FD to have a sound grasp of the
numbers, but more than this you expect them to have a good vision of the
underlying business. They have to understand the company and its strategy at
least as well as the CEO. The City will expect to talk to the FD just as it
would to the CEO, and he has to be up to speed with the company’s strategy, its
merchandising, markets, performance and even its competitors,” he explains.

As the person responsible for presenting to investors and analysts, the FD
must ensure he has excellent presentation skills. A poor presentation will only
aggravate the City’s disquiet if the numbers go sour, he warns. On the other
hand, presentation skills should not be used to mask poor performance. “No one
wants an FD to turn into a smooth bullshitter. There’s no room for that,”
Ratner says.

Green also values presentation and believes there is no excuse for FDs not
having decent presentation skills, especially as presenting is a central part of
their job. “When you come across impressive FDs, they impress because of the
quality and coherence of their presentation, particularly when justifying a
company’s acquisitions strategy. The quality of their explanation is always
being judged.

“A notable FD will come across as very assured, as someone who can articulate
the company’s strategy and how it intends to go forward. They will carry you
with them when they explain which investments make sense and which do not,” he
says.

He also points out that FDs need to be aware that analysts are skilled at
spotting tiny differences in a presenter’s style. “Often, what you see is a
subtle change in body language and in the chemistry between the executives who
are presenting to you on behalf of the company – and this tends to capture the
analysts’ attention,” he says.

An audience of analysts is a highly interactive beast. FDs will find that the
audience constantly retests the quality of their argument and the quality of
their thought processes. If something changes and the audience gets the feeling
that things are not stacking up, trust in the company can dissipate sharply.

Paul Sloane, an analyst at fund manager Martin Currie, makes the point that
FDs of public companies should take the time and trouble to acquaint themselves
with what the competition is doing by way of disclosure. “The fact is, if the
company does not have ‘best in class’ disclosure, then the FD will be under
constant pressure to open up more and to disclose the information the analysts
think is fair game,” he points out. Classically, FDs who favour disclosing as
little as possible will claim commercial sensitivity as their reason for not
releasing more detail in the accounts. However, Sloane says that that argument
is dead in the water if most of the company’s competitors are disclosing
whatever it is the FD is trying to keep out of the public domain.

FDs also need to be aware that even if they are quite legitimately saying no
to a disclosure request, the analysts will still push for some directional or
qualitative indication. For example, if the company does not want to break a
product figure into two distinct product lines, the market will still want to
know where each of these two segments are going. Is one falling away and being
compensated for by the other?

“The old story with companies and FDs is that everything in the business is
core and integral to their plans up to the day they sell it,” he says. The
market is far too sophisticated to buy into that kind of ploy and analysts can
react against FDs who try this on. Similarly, he points out, companies that
consistently set targets that are all too achievable in order to beat those
targets by a small margin will find they are testing the market’s patience. ”
Any disappointment in the results of a company that is playing this game will be
treated harshly. To set yourself easy targets and still fail is not really
forgiveable. Similarly, we tend not to think well of a management team that has
a habit of setting targets that are clearly too conservative,” he notes.

Sloan says one of the things he is particularly interested in is the FD’s
grasp of balance sheet events, particularly the way in which the company reacts
to changes in accounting standards or the regulatory environment. “A balance
sheet shock can be materially worse, in reality, than an earnings shock,” he
says.

If the FD sees that the regulatory environment or the accounting standards
environment is going to be setting tests that are much tougher than those laid
out in the current procedures, they need to get their act together and
communicate the impact of those changes clearly to the market. “We expect them
to brief us about these things rather than expecting us to wade through 200
pages of broker notes so that we can discover the issue and quiz them on it,”
he comments.

FDs have to demonstrate that they know the difference between a change in
accounting practice that is merely presentational in its effect and one that is
truly price sensitive. “Accounting changes often alert us to things that we
perhaps did not understand in the past. It might be the way that revenue is
accounted for in major projects, for example. We have seen companies trip up
before on changes to IFRS. This is the FDs’ remit and they need to show they are
on top of it,” he says.

On the relationship between the FD and the CEO, Sloane says that a clear sign
for him that something is amiss is when he feels disappointed about getting one
rather than the other. “They should be interchangeable, as far as their ability
to present an accurate picture of the company and its strategy is concerned,”
he says. There is a real problem if you get the FD and come away feeling that
you now have a great grasp of the numbers, yet you still have unanswered
questions about the strategic vision of the company.

This risk is much more acute, he feels, in mid-cap plcs than in FTSE-100
companies. “In the mid-cap range you might be more likely to come across the
classic beancounter FD, but at the higher end FDs now have to be good
communicators,” he says. v During a presentation, no matter how much pressure
the FD is under, Sloan expects them to be able to demonstrate an ability to
provide cogent answers to virtually all the questions thrown at them. “There is
a tremendous wealth of detail that comes out in analysts’ questioning and the FD
has to show they are up to speed. You can’t have an FD saying continually, ‘I’ll
get back to you on that one’. And you don’t want them disappearing into a woolly
fudge. They have to be there with clear, persuasive answers,” he says.

However, he is quite prepared to respect FDs and CEOs who turn to analysts
and say, ‘Hey, what’s going on with our stock? Why isn’t it priced the way we
think it should be? What do we have to do to change things?’ Those sorts of
questions deserve answers. “I think it is a good sign for an FD and a CEO to be
asking some questions themselves when they feel the share price is out of line,
” he says.

Having made his points about the value he places on clear communication,
Sloane jokes that he and his colleagues actually rather like buying companies
where the marketing is terrible, at least as far as the company’s presentation
of itself is concerned. “The problem with effective communication is that the
price tends to reflect the real value rather speedily. A badly marketed company
can have real value that the bulk of the market hasn’t yet caught on to,” he
says. After all, in a totally transparent world, what is there left for the
analyst to bring to the party?

TAKING THE LONGER VIEW
While buy-side analysts have the job of trying to estimate, moment by moment,
how well a company’s share price actually reflects its value and whether it is
on course to meet the strategic objectives outlined by its CEO and FD, other arm
s of the City have other interests. Some are more concerned with ensuring the
rules of the game are operating properly.

ABI manager of investment affairs Michael McKersie points out that the ABI’s
interest, in particular FDs and CEOs, is largely in instances of how companies
are interpreting disclosure requirements so it can get a grip on reporting
trends that might affect the long-term savings game.

“Our real interest is in how boards work, how well board committees are
functioning, and whether the non-executive director role is achieving its aims,
” he says.

Particular FDs have a critical role to play, but from the long view they are
simply points on a graph, indicating that things either are working smoothly or
that anomalies are creeping in to the process.

“FDs should adopt this view from time to time as a corrective remedy to bring
them back down to earth after a glittering performance in front of analysts.”