attention must be paid.
The challenge for many investor relations officers is get investor and analyst attention. Reality is that most companies simply aren't well known or even a little known by the buy-side analyst/portfolio manager community.
Dr. Baruch Lev, a professor of accounting and finance at New York University, suggests there are about 3,000 companies that are undervalued because investors lack good information. These include numerous mid-cap, small- and micro-cap companies.
Sell-side research hardly covers the universe either. According to Nelson's Information, nearly 4,400 of some 8,300 companies tracked are followed by fewer than three analysts. Indeed, some 1,135 of companies in the Nelson database have no analyst coverage, and 2,460 are covered by just one or two analysts.
While the market has enjoyed an extraordinary eight-year bull run, statistics indicate many companies have been left out. Investors apparently continue to be attracted to growth stocks, and most of these fall into a handful of categories -- technology and certain other industries in favor at the time, large-cap blue chips and those beloved dot-coms.
Performance of the stock indexes supports the notion that investors have a narrow perspective in their stock selection. Some 65 of the Nasdaq composite index of 4,845 stocks constituted 99 percent of its increased return over the past year, according to Birinyi Associates and The Wall Street Journal. Further, just 10 of those companies contributed 75 percent of that gain. Similar numbers come out of close analysis of the Standard & Poor's 500 index and others.
Indeed, people who bet on the indexes worry that some of these leading growth stocks are going to lose some momentum, be seen as overvalued or that investors simply will shift away from these glamour/growth stocks as the market broadens its interest. There's growing talk about value, cyclical and small-cap stocks coming back into favor.
That, of course, would be good news for frustrated CEOs, CFOs and IROs fighting for analyst and fund manager attention. These efforts reaffirm investor relations' most basic principles: The job centers on getting the best information possible to investors most likely to be interested in buying and holding shares.
That's a deceptively simple proposition. And a big job when done to its fullest. Success depends on being able to deliver the information each sell-and buy-side analyst and each portfolio manager needs and demands.
The first question is, "How do I get an analyst or investor's attention?" The answer: Tell a compelling story about your company's ability to grow and achieve returns higher than they are currently. Calculating a company's expected return is virtually what every investor does -- expected growth rate in revenues and earnings and expected valuation, namely, stock price.
Focus on Drivers of Growth
Prospects for future growth must be real, of course. The information that matters centers on the drivers of that growth. They vary by company. The IRO's job is to understand those drivers and to communicate them persuasively and selectively to industry analysts and institutions that will respond positively to the message.
A key part of this communications mix consists of the non-financial factors that drive financial performance. Lev considers intellectual capital to be a main driver of many companies that are undervalued today because they aren't well understood by the market [see the transcript of his Dec. 1 conference call on intangibles on FEI's web site, www.fei.org].
Studies by academics and consultants have done a good job of identifying the qualitative factors important to investors. These studies clearly show non-financial factors are critical in portfolio manger decisions. Key factors include whether the company has a strategic plan and how good it is, quality of management, new product development, intellectual capital, market leadership and strength of customer relations. Managements are measured against a wide set of abilities -- to meet operating and financial objectives, to allocate resources productively, to innovate and to attract and retain talented people.
Lev has done and seen studies that show sell-side analysts have higher accuracy in predicting earnings of companies and industries that are less dependent on "knowledge assets." However, the value of analyst forecasts is greater in industries that are harder to predict, he adds. He cites such industries as technology, telecommunications and pharmaceuticals. In these, he says, "we see a huge contribution of analyst forecasts."
IR is all about managing expectations -- and managing expectations is a process. It starts with a company's ability to understand itself well enough to maintain internal forecasts that are close to reality. This means thoroughly understanding the dynamics of the business, the company's markets, competitive forces and performance. It can be tricky. Some industries and companies are inherently more stable and predictable than others.
Next, executives must understand the value of being open and forthright with the investment community. Today's market provides a wonderful lesson, namely the narrow scope of companies showing stock price gains based on improving performance. Yours may be one of the 3,000 companies Lev estimates to be growing steadily but still ignored.
Then there must be a clear understanding among executives and the investor relations team about what's determining and driving your stock price. This understanding may exist already, but chances are, it doesn't. So sit key members of the executive team for as long as it takes to dissect the true drivers of value in your company. Analyze every aspect of operations. And survey the investment community to gain a market perspective on what drives your company's valuation. After all, it's the market's buying and selling of shares that determines your company's stock price. Update this feedback regularly. It changes.
Want to get really sophisticated? Conduct multi-regression correlation analysis to verify the value drivers that really determine stock price. It's a complicated analysis. A few companies have capabilities internally. A number of consultants specialize in it.
Now the company is ready to focus strategies on value creation and communication on the information that matters. It's important to focus that information and relationship-building effort on analysts and investors with a true potential interest in the company. This is where targeting comes into play, especially on the buy side.
Targeting resources continue to become more sophisticated. Targeting consultants increasingly do a better job of analyzing institutional portfolios to identify the key factors and variables comprising the investment discipline behind the specific portfolio.
Anywhere from a handful to dozens of variables are built into the analysis, depending on the targeting consultant. These analyses help companies identify institutions with highest compatibility based on comparing portfolio characteristics with the company's financial and operating characteristics.
From a deeper understanding of an institution's investment discipline and the variables of greatest interest to a portfolio manager, IR practitioners can determine the critical information to supply. Information can be customized for each institution and fund manager. The story can be told that offers the greatest appeal in creating an attraction.
If you believe your company is undervalued because not enough is known about it -- essentially, it's being ignored -- the challenge is to get analysts and portfolio managers to be motivated to take the time to learn about it.
The equation is in place; sell-side analysts and institutions to target are identified and so is the relevant information. Now the hard work begins. Building analyst coverage and selected portfolio manager awareness and interest takes elbow grease. Ultimately, success depends on contact and the effectiveness of the communications effort.
Use the main communications vehicles at your disposal. Today, they consist of an information-laden IR web page, an equally informative annual report, regular releases to update financial and operating developments, conference calls, daily phone and e-mail contact and meetings, meetings, meetings.
If at first you don't succeed, try, try again. At the end of the day, it's all about persistence and hard work. You've been doing that? Keep at it. Don't get discouraged. Your mission is to break through and move your company off that list of those that are being ignored by the market.
Bill Mahoney is editor of IR Update, published by the National Investor Relations Institute, from which this article is reprinted with permission.