Shareholder Base

Shareholder Base

We are often looking for broken growth stories, when a once-great company is no longer considered to be great. The market tends to overreact in these cases, as growth and momentum investors move on to the next thing and the shareholder base turns. Since I wasn’t in the stock before, I’m not disappointed if something is no longer a high-flier. All I care about is the future potential relative to what I have to pay for it

Alan Schram, WellCap Partners

Most of the time we’re picking up the pieces after a high-growth company hits the wall at 80 miles per hour, having made at least one too many investments to try to sustain an unsustainable growth rate. Public markets can actually conspire to screw companies up. When you’re growing fast, you get this big p/e and pretty soon you have all the wrong investors with ridiculous expectations and do things contrary to shareholder value.

Jeffrey Ubben, ValueAct Capital

Shareholder base…now there is a subject not too many investors think about. It’s probably more important to the holders of smaller growth orientated firms but its something every investor should be more aware of.

Over the last 35 years or so, the marketplace has become largely institutionalized. The retail investor is in the small minority (a minority I’m proud to be a member of). Institutions (pensions and mutual funds) have an established law or belief system that makes them a power onto them selves. They often say one thing (we are here to serve you) but have hidden agendas (we are here to serve ourselves). Behavior which would be looked down upon in an individual is accepted practice in the world of institutions. These same institutions have brainwashed the investing public into believing the myth that handling their own financial affairs is too complicated and risky. So over time they have come to dominate the investing landscape.

These institutions are in the business of growing assets under management. In order to achieve this they continually try to attract new money by trying to out perform the market on a quarterly basis. This puts an emphasis on short term performance. If the quarterly numbers are not met fund managers could lose their jobs. They have bills to pay and kids to put through university just like everybody else so there is a tendency to do the safe thing. To buy stocks when the market is going up and sell them when the market is going down. “We can all go down together, but I can’t let them go up without me”. Needless to say this does not help their long term performance as it guarantees mediocrity. Another problem is if their funds under management get too big they basically become the market (shadow indexers). Another problem with expanding size is the growth of investment committees where everything needs to be vetted out resulting in further mediocrity. Good long term investing is a solitary game.

The implications of all of this, is that it spills over to the equities they hold in their funds. If a CEO’s company fails to meet his quarterly numbers these institutions dump the stock and move on to the next hot thing. The price of the stock becomes the thing, not the intrinsic value of it.  The result of all of this is a market dominated by short term performance with many CEO’s striving to meet their quarterly numbers at the expense of long term value creation (cutting R&D and advertising budgets). The strong CEO’s who put an emphasis on the long term fundamentals of their companies often see their stock punished and driven down by the lemming like behaviour of these institutions. The media has bought into this game as well as they too put an emphasis on the short term results of the marketplace.

Keep all of this in mind the next time you see a stock you hold beaten down for missing their numbers. 

Now that I have that off my chest lets talk about the minority, the long term value investors. The funds they run have low portfolio turnover as they hold their positions for a long time (years instead of months). They perform due diligence of a company by studying the business Model, the industry structure the company is in and the capital allocation ability of the management. They are concerned with the intrinsic value of a company (the present value of all the cash it will generate in the future). If you are looking for investment ideas these are the people to keep track of and they are the type of shareholders you want holding the same stocks you hold yourself.

Don't let the financial industry or the press take your power away from you. Investing for yourself can be an empowering experience.