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Dec 02, 2010

Owners’ lack of involvement dishonorable, says Monks

Governance activist discusses the investor relations industry and his new book on corporate valuations

It seems only fair to ask Bob Monks – a previous IR Magazine Awards honoree – to apply his wisdom to IROs. Given that their primary duty is to their company, does Monks think they have a fiduciary responsibility to the investors as well? As a long-term investor and shareholder activist, he replies immediately: ‘I think IR is a profession, and IROs ought to act like professionals: they should not knowingly do harm. They’re not obliged to be perfect, but they are obliged not to mislead people, and at the point when they’re uncomfortable, they really have no alternative but to resign. Generally I’ve had a very good impression of them.

‘The good news about the requirements for massive disclosure of information is that it is entirely possible, and even responsible, to suggest that people can inform themselves. At a certain point, however, that’s not true, when the information is distorted, or relevant information is withheld. But if the IRO makes sure the public information out there is comprehensive and gives a fair view of the company, it’s very difficult for an investor to take exception with what a person says.’

But then Monks recalls something. ‘There are many cases where the information actually was there; it just was so difficult to find it,’ he recounts. ‘Like when the laws in Rome were all carved in stone in the forum, but they were all put in the portals over the top so that people could barely read them.’ He offers as an example Waste Management, the US waste collection and disposal firm, which was losing a great deal of money but still reporting profits. ‘And the reason could have been found at the bottom in a footnote saying, We have a surplus in our pension funds that is being amortized. That money was being claimed as current earnings, and the firm alluded to the fact, without putting in any numbers that allow you to make any connection.’

A matter of honor
For Monks, ‘the lack of involvement in corporations by owners is fundamentally dishonorable.  Look at the great and the good, the great universities, the great foundations – none of these large owners of equity securities can take it upon themselves to become responsible for the quality of the market in which they’re investing. There are some trustees who don’t want to be embarrassed at their club, or maybe the trustee has other business dealings with the executives of the company.’

On either side of the Atlantic, Monks says ‘the government has never tried to enforce the obligation of these trustees to administer their trusts by being active in their management of the portfolio securities. Therefore, because they have been allowed to do nothing, there’s no incentive for the people who would be good at it to do anything, so we’re reduced to a very few people who are activist.’

Many corporate spokespeople, however, say shareholder democracy is protected because, in the end, investors can always sell the stock if they don’t like the management. Monks vigorously disagrees. ‘That was said many years ago, but it turns out to be obsolete, like a lot of things,’ he says. ‘Take for example the index funds, holders of 30 percent of all outstanding stock. By definition, they have to hold the securities. You also have the people who have too much of a holding to sell: the Norwegian pension system owns 2 percent of every stock on the UK stock market, 1 percent of every stock in America. They own too much to sell. They can’t sell.’

He is equally dismissive of the ability of the SEC to represent investor interests. ‘I’m afraid the passage of time has not served the SEC well,’ he observes. ‘Bureaucratic agencies should be mandatorily dismantled after 30-40 years because the enthusiasm of the people who first start them, and the people who are familiar with the reasoning behind the legislation, get older and quit to do something else, and their replacements are more worried about their pension plan and what-have-you. What’s more, the SEC not only got tired, it also got quite corrupt.’

So why would anyone want to invest in the equity markets with all of the cautions and worries Monks talks about? ‘Well, I suppose you compare it with their nearest equivalent, like horse races and gambling casinos,’ he says. ‘It is a method of evaluating a given number of imponderables and taking your chances as to whether you’re going to win more often than you lose.’ He does admit, however, that just as the bookmakers always win from your bets, ‘in this case the brokers always seem to win. So you pick your poison.’

And Monks’ poison prescription is this: ‘The indexes outperform all but a very few of the managers every year, and they have far lower costs, so the benefit to the investor of buying an index fund year in and year out compares very favorably with all but the most gifted fund managers. And the most gifted fund managers invest for themselves; they don’t invest for you, so, as a practical matter, as an outsider, an index fund is about the best you’ll get.’ He does, however, add with some, ‘But that’s no fun.’

Valuable insight
Bob Monks’ new book, Corporate valuation for portfolio investment: analyzing assets, earnings, cash flow, stock price, governance and special situations, is a massive tome, weighing in at more than 550 pages that are really aimed at institutional investors, according to Monks.

‘I had spent a lot of my life musing about investment, starting as a wee child, and I never had a chance to actually sit down and put into a coherent framework a whole bunch of random thoughts,’ he says. ‘Then Alex LaJoux, a splendid professional writer to whom virtually all the credit for what’s good in the book should go, came to me and suggested that we collaborate on doing this book… and I would do what wise old men are supposed to do: drop in little comments about investment.’

The book is eminently readable, exhaustively treating the subject in simple but engaging language, and using practical examples wherever possible. It explains the concepts it uses as it introduces them. It is both ambitious and modest at the same time, covering all aspects of its subject, but disclaiming precision. It admits the hazards of ‘determining the present value of future worth’ and that, ‘despite GAAP and IFRS, financial reports remain only dim mirrors of company value’, stressing other factors ‘such as qualitative measures of corporate governance.’

Getting to the IR heart, the book claims ‘valuation begins from the hour a company’s leaders find equity investors who believe so strongly in the company’s economic prospects that they are willing to provide capital for it with no strings attached. This belief in a company’s future – this hope – is what makes the value of the stock something more than the current value of its assets if valued in a fire sale.’

Of course the book does, at length, consider the different ways to assess the qualitative aspects of a company’s value, but it also expands on that ‘hope’ that, ultimately, is the added value of good investor relations beyond sending out the spreadsheets. It is in that qualitative space where an effective IRO can tease out and illustrate the factors that are not susceptible to number crunching.

Although the book is officially aimed at fund managers, the authors do express the hope that others will find it interesting and of value. And they should. Its combination of penetrating insights that are sharply expressed and carefully built-up reasoning make it not only an amazingly readable work on one of the drier branches of the dismal science of corporate valuation, but also eminently well suited to analysts, IROs and others who want a refreshing and provocative look at their subject.

Corporate valuation for portfolio investment: analyzing assets, earnings, cash flow, stock price, governance and special situations, by Robert Monks & Alexandra Reed LaJoux, $90, Bloomberg/Wiley