Monitoring Investments

With a dozen or so investments, I’m not running around playing whack-a-mole reviewing ongoing performance.  I’m also not obsessing about stock prices. Once I heard someone say you should look at your stock prices about as often as you mow a lawn—about once a week. That’s a pretty good rule-of-thumb.  I check prices about  twice a month.

I am far more focused on the company operations than the stock prices. I really don’t care what the talking heads on TV (or online) have to say.  Most of them are idiots anyway, advancing a specific agenda, and with knowledge that is five miles wide and a millimeter deep. Besides, no one goes back to them six months later and asks them to account for their past predictions. We live in the distraction economy and reward morons who spew one bold projection after the next, with no retrospective accountability.

As for macro-economic forecasts, there is the old joke that economists have predicted eight of the last five recessions.  As Peter Lynch said about forecasts:

If you spend more than 13 minutes analyzing economic and market forecasts, you've wasted 10 minutes.

For my investments, I have an earnings spreadsheet with the approximate dates when the companies announce quarterly earnings (90 days since the last earnings announcement).  I don’t trade on news, so I have no interest in jumping online the nanosecond the earnings are published.  

In time—generally within a week of the earnings release—I will review the announcement, 10Q filing document, and the transcript of the quarterly earnings call with analysts.  I start with the 10Q if it is out, so I don’t get biased by management propaganda laced throughout earnings press releases and quarterly presentations. My goal is to check-in on the company in an unbiased manner, and then update my valuation spreadsheet.

Quarterly Earnings Calls with Analysts

The Quarterly Earnings Call is when the senior executives have a scheduled call with Wall Street to discuss their company’s quarterly financial results. The quarterly call is weird beast and regrettably does not offer investors much insight. I don’t listen to quarterly calls, but I review the written transcripts, which are published online a day or two later.  

I have closed out positions based on the transcript, when I decide the management team is disingenuous, or just plain clueless. Often this comes when they continually change key result areas, or when they are trying to justify a huge expensive initiative based on a silly and implausible use-case. (News flash, dear reader. It turns out Blockchain is not going grow to ten times GDP in the next three weeks. Nor is AI. Remember Big Data? How about IoT or VR?) The issue is the erosion (or vaporizing) of management credibility.

Let’s discuss the structure of the quarterly call. Here’s how it works.

Usually about a month after the end of quarter, the company releases its quarterly earnings just after the end of the trading day. Thirty minutes later, the company has prearranged conference call with industry analysts where a couple of members of the management team review a slide deck. Anyone can listen to the call—this is a legal requirement—but only invited Wall Street analysts can ask questions.

The is an example of the company using selective access to keep people in line. Note my earlier comments about access, proximity, and exclusivity. This is the same manipulation at an institutional level.

In terms of mechanics, the company distributes a slide deck concurrent with the analyst call. The head of investor relations hosts the calls and gives the standard caveats about forward-looking statements.

The CEO gets on for a few minutes and gives the ‘strategic overview’ of the business and the quarter. Another executive, typically the CFO, or sometimes the COO, gives more detailed review of key financial and operating metrics. 

The slide deck typically lacks a “wash, rinse, and repeat,” consistency from quarter to quarter. Having this might invite inconvenient comparisons and corner the management team with embarrassing questions from a shrewd analyst. Another legitimate issue is that the business evolves from quarter to quarter, so last-year’s warmed-over dinner may no longer be appropriate.  

Then there is a 30-minute Q&A session where each analyst is allowed to ask up to two polite questions.  At the end of the 30 minutes, the execs thank the analysts for their participation, and everyone goes away.

It is all very controlled, polite, scripted and sterile.

I’m not expecting an episode of The Jerry Springer Show, but as an investor I’d like something more authentic.

What’s really going on here? 

Here is my harsh assessment: the quarterly analyst call is nothing more than an exercise in Kabuki Theater. 

If the quarter went well, the undercurrent is “Your management team did a brilliant job and executed flawlessly. By the way we need a raise.” 

If the quarter did not go well, the tone is, “We faced significant impediments that hobbled us for doing our job. By the way we need a raise to stay invested in the company. Seriously, it’s not our fault.”

Oh, and did I mention we need a raise?

Here’s the ugly truth: candor is not the management team’s motivation. For legal reasons management is prevented from wholesale fabrication.  However, the management team’s real motivation is to set the narrative with Wall Street lest things go awry. The whole thing is not a con job, but is often a spin job.

Hosting a quarterly call is tantamount to having a press conference the day before you have to testify before Congress: you get your story out first.

Note that the pacing and the structure of events.

1. The call happens a few minutes after the public earnings release. The freshness of the information keeps the analysts off balance and gives them little time to dig into the results and formulate probing questions.  An alternative approach would be to have a press release at the end of trading on day 1 and then have the analyst call just before trading day 2, fifteen hours. This approach would give analysts a change to digest and analyze the report. No such luck.

2. Analyst call participation is by invitation; the company is using access to keep the analysts in line. Do you have the audacity to ask the CEO an embarrassing question? You get booted from the club.

The analysts ask only softball questions and do so in a diffident manner. A typical question steeped in analyst-speak is something like:

I appreciate you faced FX headwinds this past quarter. Can you give us some color on guidance for the rest of the year given your product mix in Europe?

Here’s the translation:

It sounds like you guys screwed up because you had not anticipated the strength of the US dollar.  Why should we believe your European forecasts for the rest of the year?

In my fantasy, I’d like to ask the question this way:

Guys, last quarter you said this would be a walk in the park. Obviously, you screwed up. I know this, because your competitors attained 20% growth even though they faced the same strong dollar. So why should anyone believe your pipe dreams? By the way, how soon are you going to get fired so someone else, who actually knows what they are doing, can right the ship?

Something just dawned on me: I now know why I am not a Wall Street analyst.

Alas, we have to be polite.

And so it is with analysts. 

There are few reasons for this. First, many of them are young buck MBAs trying to build a career. Making enemies of senior industry executives can be career limiting.

There is a power imbalance. The company executives are VERY senior in rank to the analysts, who are often star-struck that they are actually speaking to the Big Cheese. This creates diffident behavior. It’s Wall Street’s version of a 22 year-old intern working in the West Wing.

Moreover, the analysts eventually do get the last word. They have editorial control over what they report to their clients.

Analysts are not in the same power position as journalists conducting a presidential debate. As a result they cannot unleash on the spin-meisters.  It is one of the limitations of the format.

Some analysts do (rarely) ask the question that prompt me to think, “Wow, that’s’ a great question. I wish I had thought of that.”

Accept analyst calls for what they are and don’t rely on them too much.

By the way, I don’t give sell-side analysts much credence. In my opinion, most of them are whores.

Board of Directors

I’m not a fan of Boards of Directors as a governance body. Most of them are AWOL.  In theory the Board represents the shareholders, the owners of the company. The management team, especially, the CEO works for the Board, and indirectly for the company owners. 

In theory, theory is the same as in practice, but in practice it isn’t.

I am not a big fan of individual Board members either. Generally they are charter members of the “What’s in it for me?” club.  On balance, they have cursory duties, for which they are paid handsomely.   

Some Boards are “whore boards”, meaning membership is more about signaling than about substance. These Boards are populated with former US Cabinet members and Senators and other prominent celebrities, who have little business experience or anything to offer beyond branding.

The average Board member is a lapdog, not a rottweiler, not that I am a big fan of rottweilers. They can be unnecessarily aggressive and disruptive. On the other hand, someone has to hold the management team accountable. 

Most companies also carry “D&O” insurance. Director and Officer insurance is coverage that protects Board members from getting sued by disgruntled shareholders. In my opinion, this makes them feckless. If they were personally liable for their misdeeds, they would take their fiduciary duties more seriously. .

Guess who pays for the insurance? You got it. The company, using money that would otherwise be available to shareholders. Golly, what a surprise.

Notably Berkshire Hathaway does not have D&O insurance, so their board members have skin in the game.

In general, I have found Boards only act under duress when the personal reputation of the individual Board members is at stake. Otherwise, they are too deferential to the management team.

One positive trend in Board governance is the emergence of independent directors, and bypass reporting, where executives are sanctioned to engage with Board members directly and outside of the CEO’s control. This alternative channel is a positive move. An example of this is the CFO and finance team reporting directly to the Audit Committee. I find this a healthy trend.

The Annual Meeting

This is another corporate charade.

Legally, a public company must have an annual shareholder meeting once per year. Most Board members and CEOs view the annual shareholder meeting as a necessary evil, something akin to unclogging the toilet on Christmas morning because no plumbers are available.  

Here’s how the meeting works.

A few weeks prior to the annual meeting, the company mails a proxy to the shareholders of record allowing them to vote on a small selection of issues such as election/re-election of Board members and confirmation of the auditors. The proxies are mailed at the last possible moment to maximize non-response, although online voting has helped alleviate this issue.

Directors are elected by a plurality, not a majority, of votes.  Most Boards take a page out Kim Jung-un’s book where he always manages to capture 104% of the popular vote in every “free-and-fair” election. 

Noted.

Board elections are about as undemocratic as possible.  It is a system designed by and rigged for the insiders. In reality most disgruntled shareholders vote with their feet.

The official part of the annual meeting, the procedure of recording the votes, is a tense process like a courtroom waiting for arrival of a violent defendant constrained in manacles.  There is a lot of formality around motions, seconds, official vote tallies. All of this has been rehearsed by the management team and their lackeys. The official meeting is commenced and closed as quickly as possible like a guillotine dropping. This is the thwart any gadflies from disrupting the official proceedings. 

Once the official part of the meeting has closed, the insiders exhale knowing they have a “Get out of jail for free” card for the next twelve months. Talk about Kabuki theater.

The next part of the meeting is usually the CEO giving a presentation on “how well your company is doing,” glossing over any ugliness, and spinning an episode of historically-based fiction. This performance is like watching a Peter-Pan shadow dancing on the wall. It is sort-of true, but weirdly disconnected from reality.

The next section is for shareholder questions. Generally, shareholders are respectful, but they are not always on good behavior, unlike the financial analysts in the quarterly earnings calls. I have never seen the proceedings descend into a barroom brawl, but there can be tense exchanges. Regrettably, despite this, most Board and Management are tone-deaf to the notion that they actually work for the shareholders.

In general, the CEO will deflect any ugly questions and offer glib responses to any probing inquires.

In larger companies, there will be a cadre of protestor-shareholders whose primary goal is to use the annual meeting as a public forum to air their pet political grievances, which typically have little to do with the company’s core business. 

Almost all annual meetings have gone virtual, so it is possible to attend from your desktop. Here is an added bonus: you can now be frustrated from the comfort of your own home. How exciting!!!

This completes the series of posts on how I invest. The next post is a list of key resources.

My key messages are:

• You can do this. The average Wall Street puke is not that smart or that capable. He’s just a schlub trying to make a quick buck from gullible investors.

• Own your future.

• Investing is one way to obtain financial independence—or at least financial resilience and flexibility. Doing so will reduce your blood pressure.

• Investing successfully takes commitment and time. Read the books in Key Resources (and others) and take Professor Damodaran’s online valuation course.

• Investment research is solitary and has to be brutally analytical. It is not a social activity. Trust your gut. If you are feeling pressured to ‘be a player,’ you are being played. Walk away or at least step back and contemplate your decision.

• You have to be a detective. Investments don’t show up on your doorstep with a big red bow tied around them. If they do, beware.

• Be skeptical and scrutinize things. Great investors say ‘no’ over 99.9% of the time.

• Good investors use a lot of triage (i.e. ‘not now’ a lot). With rare exception do you need to make an investment the minute it shows up on your radar.

• Your ideal scenario is an exceptional asset reasonably priced. This combination is extraordinarily rare.

• You don’t need many investments. A dozen should suffice.

• Look for companies with sustainable competitive advantages, as evidenced by long term superior economics. Often these companies also have a dominant market position.

• Look for shareholder friendly companies. Such companies typically have meaningful insider ownership. These companies often buy back their stock opportunistically—only when it is below intrinsic value.