While useful, the metrics explored in the previous section on capital allocation deal primarily with historical figures. Investors, however, must always look forward -- however cautiously -- and make projections about how they believe a company will perform and compete in the future. Understanding management's strategy and the way it hopes to make -- or keep -- its company a winner can add color to the numbers and ratios a firm reports and generates over time.
I won't discuss specific corporate decisions -- target markets, product or service suites, marketing messages, and so on -- here, beyond the idea that investors should look for managers who can cultivate "sustainable competitive advantages," the byproduct of good business development that is the acme of corporate accomplishment.
A clear mission
Are management and corporate goals clear and easy to understand? Does your company have a "mission statement"? While that phrase may seem like a buzzword, a well-defined corporate mission can -- and should -- frame everything a company does. It provides a way to guide growth and effort, and can represent a rallying point for a company's employees and stockholders, as well as a reference point for customers and partners.
In its absence, a company may act without focus, targeting market opportunities or product segments of questionable merit, or which fall outside its core competency. Such a company may grasp at straws, stress publicity over productivity, or waste valuable time and capital on efforts that don't contribute to long-term value. "If you don't stand for something," the saying goes, "you'll fall for anything."
Conversely, a company that does stand for something -- even if that "something" changes over time as a company grows -- stands a better chance of serving its stockholders, customers, and employees well. (Jeff Fischer examined this concept in greater depth.) Good mission statements often incorporate a company's purpose, business goals, and values into one credo.
The above term is really just a fancy way of describing events during which a company either gives or gets money in some form: mergers, acquisitions, or debt and equity offerings. To an investor, all are just that -- events, to be evaluated on their own merits but not considered a company's reason for being.
Anyone who paid any attention to the markets over the last few years knows the excitement of an IPO: The word came to be the grown-up version of "Happy Birthday." But while a one-day pop is great for a day, what happens tomorrow? IPOs -- as well as secondary or debt offerings -- are just funding events, after all.
Investors need to understand what that money is for. Is there a business plan waiting on the other side of that IPO, or was the business plan the IPO? Did the company demand enough cash? Was the IPO a "sink or swim" deal? And what about the terms of such deals, which can mean increased dilution and outside ownership -- both of which can affect stockholder returns and corporate decision-making.
Then there's the mergers and acquisitions process. For acquiring companies, it can represent a way to take out competitors, move into new markets, acquire products and expertise, and spur growth in mature markets. For those on the block, it can mean unlocked value and an opportunity to be a part of a more powerful, dominant company.
But buyers can overpay, pick deals that fail to boost earnings -- Rick Aristotle Munarriz explained that concept in a useful article -- choose companies with hidden financial problems or incompatible cultures, or set themselves up for regulatory disasters. And sellers can panic and accept too little, or be overly concerned with preserving their own jobs rather than getting the best possible deal for their stockholders. In the end, all of these decisions and determinations fall squarely on management.
As corporate and consumer spending has slowed, companies that didn't give a moment's thought to their cost structure in the late 1990s have made layoffs cool again -- that is, unless you were among the laid off. And, truth be told, it's hard to boo a so-called restructuring if a company's expenses were out of line with its revenues or market opportunities.
But such decisions must nevertheless be evaluated critically: While obviously they can save money, layoffs can also hurt morale, attract bad publicity, lower the bar for potential productivity, result in further attrition, and reduce intellectual capital.
As a result, investors should consider whether job cuts are good cost management, or simple retreats from past over-hiring. And since they carry costs that are generally taken as charges to earnings -- gotta pay severance -- investors should make sure that their company doesn't keep taking "one-time charges" every few quarters.
Who doesn't like a buyback? By announcing plans to repurchase their company's shares, managements hope to send a message to investors: "We think the stock is cheap, and you should buy it, too."
Unfortunately, companies rarely disclose specific information about how much they think their company's shares are worth, or how much they would be willing to pay for them. But without that data, a buyback announcement is of debatable value. (And remember the difference between shares authorized for repurchase and shares actually repurchased.)
Buybacks are just another form of capital allocation, and must be weighed against all others -- including, naturally, reinvestment in the business. It's management's job to make decisions that create the most long-term value for the company.
But if a stock buyback is simply an attempt to stop a falling share price -- or reduce shares outstanding in order to make next quarter's earnings per share targets -- is any value really created? And without information on how much a company thinks its own shares are worth, how are we supposed to compare management's assessment of intrinsic value with our own? (It can be done, but it's tough.)
Stock splits get bottom-rung mention here because, frankly, they deserve it. Though we've said it countless times, it bears repeating: Stock splits have no bearing on the value of a company.
So why do companies do them, and do them so frequently? Some say it's to "signal optimism about a company's future performance" as they hope to keep shares "affordable" for all investors -- never mind that investors should be concerned with their percentage, not point, gains and losses. Others, more cynically, say they're trying to draw attention to (or "pump") the stock.
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