Imagine a corporation, A, that owns long-term, stable rental units, but whose shareholders are predominantly day traders. Can the managers of such a corporation have fearless nights?
Probably not. One of the most important yet underappreciated aspects of running a company is its shareholder base. A consistently successful company typically aligns its shareholders with its goals and expectations. While such objectives could be varied, I want to illustrate two critical areas.
1. Business Ownership Mindset
A lot of people are attracted by stock price movements. Worse, they try to make investment decisions from stock price movements. Such investors don't care about business fundamentals such as business economics, competitive position, and intrinsic value.
Furthermore, there are members of the financial community who do look at company fundamentals but don't really have a business owner mindset. Such investors typically care about factors that impact stock prices such as macroeconomic factors, earnings beats, or management guidance. A business-oriented investor understands they own a business where earnings can go up and down based on factors such as industry conditions, cash flows, and competitive factors. He or she would think like a businessperson rather than management's ability to satisfy some analysts' expectations.
Thus, the management of a company with a stock-oriented shareholder base will have a difficult time engaging with its shareholders. How can you detect such companies? Start by looking at their press releases and annual reports. Ask whether this is a marketing document or written by a businessman?
2. Long-term Investment Horizon
A lot of investing communities including both retail and institutional investors talk about having long-term investment horizons but they really get upset seeing their portfolio down 20% for a short-term problem in the portfolio companies. Such shareholders are not good for a company that is making long-term investments.
Having a long-term investment horizon requires not focusing on the next quarter's or next year's earnings or stock market reactions. While the author of this article is not the first person to write the prior sentence, those words are frequently forgotten, leading to a short-term investment horizon. Management of such companies would likely face disgruntled shareholders more frequently. This forces them to keep on showing year-over-year growth in profits. This could further lead to bad behavior including accounting shenanigans.
Photo by Hannah Busing on Unsplash
Building the Right Shareholder Base
How can the management of companies attract and retain the shareholders they want? While there is no formula, there are two key methods that can be useful.
1. Management Communication
Having clear messages about how management thinks about running the business will train prospective and current shareholders accordingly. Such methods include press releases, earning calls, conferences, investor day, and annual reports. For example, if management desires long-term shareholders, they should avoid emphasizing short-term earnings growth. A good management team will also address unfavorable business prospects openly, as such challenges are inevitable. These practices should be continuously followed by the management team.
2. Company Policies
A company's policies play an important role in shaping its shareholder base. A corporation having an investor relation person whose job is to pump the company prospects in every single call they receive is likely to have shareholders who care about the stock price in the next six months. In my experience of talking to management, I tend to prefer situations where a call with them leaves me feeling somewhat uninvited. This likely means that company management is using its precious time to run the operations rather than talking with every investor who reaches out.
Similarly, a policy of projecting quarterly earnings every three months conditions shareholders to concentrate on short-term stock price fluctuations tied to earnings reports, rather than on the company’s long-term business fundamentals.
