They market their companies.
The management has to be confident of their companies’ ability to survive and thrive even when the situation looks difficult. They have to.
Their CEO and team can be charismatic with good showmanship, touting rosy macro trends in their favour with an inspiring plan and a bright future (also known as storytelling). It can get investors excited and FOMO (fear of missing out) wanting to buy the stocks, causing the share price to surge with just the press releases and presentations, without any substantiative results.
Example: Launch of new products that promise to be cheaper and/or better than existing ones with an expanded total addressable market; game-changing with lots of potential. We see these in EV and EV-related startups, renewable energy, artificial intelligence, SPACs that are in pre-revenue or very early revenue stages, biotechs, and cryptos.
When they are being affected by the challenging operating environment, they present a brave front and show what they have done right. Some would select metrics to show their resiliency. Some may attribute that they have shown decent earnings with the tough situation. Their message to investors: have faith and be assured; keep holding (or better, buy more); the situation will improve and they will thrive.
During earnings releases, companies may select whichever good operating and financial metrics to show “their good progress” and hide those that are not so good. Beware of these companies who are not consistent in their use of operating metrics, it is a red flag! Some created their own metrics of “profitability” (Uber with “core platform contribution profit”, Wework with “community adjusted EBITA”, and Groupon with “adjusted consolidated segment operating income”). Worse, behind the “successful” establishments were frauds hidden well over the years such as Enron, WorldCom, Luckin Coffee and Satyam Computer Services,
There are three kinds of lies: lies, damned lies, and statistics.
Mark Twain
New and inexperienced investors (new to investing and fundamental analysis, have not been following the company diligently and do not understand the industry and competitive landscape) base their understanding and investment decisions on these companies’ reports, presentations and press releases (i.e. believing and buying into their stories). They tend to be gullible, feel excited, convinced, confident or at least assured that their investments are in good hands. They believe that the management has the investors’ interests at heart.
The CEO and team are skilled in selling the company.
Examples:
A few have turned out very awry in 2022: Nikola Motor, Lucid, WeWork, Snap, Peloton Interactive, Twilio, Grab, Meta Platform
Some turned out well: Apple, Amazon, Google, Microsoft, Tesla, Nvidia
Fact: No executives will tell us, the investors, that the company will continue to do badly or the share price is highly valued; do not buy or sell the shares.
Companies have to market themselves and their products to customers and other stakeholders (employees, suppliers, partners and shareholders). They need to inspire and be confident no matter what. It is their job.
They cannot show weaknesses. Anything negative can cause a confidence run and can affect the running of the company adversely — shareholders dumping their stocks, suppliers insisting on cash payments, banks pulling their credit, employees demoralised, and quitting. The future will be promising.
Companies may not highlight the real issues and challenges resulting in declining revenue, margins, debt level or weak cash flow. While its financial performance has been mediocre for long periods, the company keeps presenting a bright future that its fortune will change for the better with its new plans and products; keep having faith and hope.
We have to ask ourselves:
- How have the track records of the company been and the management so far? Have they been meeting their promises and expectations?
- Is the focus of their story more on the macro tailwinds and the future than the present and about the company? If yes, is this to distract the investors from the current issues?
- Do they have the capability and competitive advantage?
Trust is built based on their past track records for their ability to deliver. At times, changes in the CEO or a senior executive can create a difference in the company. We have to validate.
Sidenote: The same applies to others (analysts, gurus, friends) presenting their bullish case about investing ideas (Cathie Woods/ARK). We can get excited because of their experience, expertise (i.e. “guru” status) or simply the way it was presented.
Warren Buffett said bluntly that most annual reports are a sham. Too many managers report with excess optimism rather than honest explanation, serving perhaps their own interests in the short term but no one’s interests in the long run.
We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising business value. Our guideline is to tell you the business facts that we would want to know if our positions were reversed. We owe you no less. Moreover, as a company with a major communications business, it would be inexcusable for us to apply lesser standards of accuracy, balance and incisiveness when reporting on ourselves than we would expect our news people to apply when reporting on others. We also believe candour benefits us as managers: The CEO who misleads others in public may eventually mislead himself in private.
Berkshire Hathaway, An Owner’s Manual, Owner-related business principles Number 12
We, as investors, just need to be less gullible and improve our due diligence process to differentiate the good ones from the bad. Being investors, we have to know the business and its operating environment well and be able to exercise our independent thinking to evaluate whether their story is true and what is unsaid. We have to take responsibility.
Bluntly, don’t trust the company’s bullshit!
More often than not, the dream scenario may be hyped up by the management morph into a nightmare.
We have to protect our own interests. Don’t trust the CEO or the Board that they have our interests at heart, even if they have a big stake. They would have trimmed some or made it back through their generous compensation and dividends.
Don’t be gullible.
There are very few high-quality companies; many do not do well.
This is similar to many other aspects of life. Our resumes present our achievements and strengths and not weaknesses. Salespeople pitch a well-crafted sales pitch on how good their products are. Worse, scammers present a too-good-to-be-true investment. 🤦♂️🤦♀️
Nothing here; some hide their secret sauce
On the other hand, some companies wrote and said minimally about what they have been doing, their achievements, their plan and their outlook. They are secretive about what they have been and will be doing. They let the results speak for themselves and disclose what is required. They are secretive so that competitors will not know too much about their plans and specific progress to realise the market potential and copy them. They do not intend to impress anyone. Do first, talk later.
A good example is Amazon.
- It hid its cloud computing business (Amazon Web Services) under the nondescript “Other” column for about 10 years. When disclosed in Q1 2015, the AWS 2014 revenue was already $5 billion and expected to grow to $6.26 billion in 2015; giving them a huge first-mover advantage over its competitors.
- It disclosed its advertising revenue for the first time in FY 2021 and it was already $31b. Again, its management decided to break out advertising on its own after considering how large a proportion it was encompassing in its other segment.
- It has not consistently disclosed its Gross Merchandise Value (GMV) for its e-commerce segment in its earnings. This makes comparisons with other retailers and e-commerce players difficult.
Warren Buffett holds in high regard managers who report their company’s financial performance fully and genuinely, who admit mistakes, share successes, and are in all ways candid with shareholders. He admires managers who dare to discuss failure openly.
Some undersell and many oversell. Who can we trust? We have to do our due diligence. There are a few ways to evaluate the companies’ claims and these should be part of our investment evaluation process and checklist to construct our conclusion.
Reconcile their plans with actions over the longer term
Investors should study as many annual reports and quarterly earnings as possible instead of just relying on one report to conclude about the company.
- What had management said about their strategies in the past? How consistent have their strategies and financial performance been over the years? Have they been changing their strategies?
- How have they progressed with their past strategies and plans?
- How well have they overcome previous challenges?
- How has their thinking changed with time?
- Are they able to deliver as they planned?
The value of the management and their qualitative factors will show up in financial performance over time. The financial statements are important. They are the outcome and validation of the company’s vision, strategies and plans (and stories and hypes). It is good to track their long-term financial performance such as revenue growth, margin, profit growth, returns on equity and free cash flow over a few years or any other criteria.
Reconcile the financial performance with their plans to evaluate (a) the quality of the execution of their strategy and (b) the consistency of their financial performance and ability to handle various operating situations — i.e. the consistency and integrity of the management.
One of my principles used to be that I never met managements or visited the businesses. It was inefficient. One of the negatives about meeting management is that you talk to people who are exceptional at sales. Ben Graham said it would lead to a negative distortion. But one of the changes I made was my decision I couldn’t do India without meeting managements. India is a lot more like private equity with some of the smaller businesses. I started making trips where I meet various management teams in India, and those have been exhilarating. I’ve met some companies that are outright frauds. It’s fun to sit in a room with the frauds and to see what they look like. There were no horns growing. Then there are others who are exceptional entrepreneurs with great runways and great governance. This is early in that process, and I visited or met with maybe a couple dozen companies.
Mohnish Pabrai
“.. what you’re better off doing [than interviewing management] is sitting in a room and reading the last 10 years of what they said what happened, and then form your own conclusion of where you think the business is going to go in the future, rather than having them tell you about it.”
Mohnish Pabrai
Validate what the management will say with past performances and beware of our possible biases and biased actions (buy!). Some investors practice “cooling periods” to prevent them from being excited and impulsive.
Compare with competitors
While some companies will self-praise how well and how resilient they have been, we need to compare them with their competitors to verify for greater objectivity. At times, what a company says may not make sense compared to the results of its competitors. Example: General Motors compared to Tesla.
The same investing checklist can be used. How are the competitors faring in terms of revenue growth, margin, profit margin, returns on equity and free cash flow? Who is really good?
Do the due diligence. Trust yourself.
An approach I take: Let the numbers do the talking first
In researching for companies to invest in, I would have a brief understanding of what they do before diving into their financial performance across the years and comparing them to other similar companies/competitors. For any abnormalities (spikes in revenues, profits and margins), I would search for answers in the company’s reports, analysts’ reports and/or social media. Looking at the financial performance first provides a more objective assessment of the company than being swayed by its storytelling.
A related post: Multi-baggers with growth companies
Conclusion
- Do not be easily swayed by the stories from the CEO and management, especially when we are unfamiliar with the business and industry.
- There are two ways to validate:
- Study their past — Have their plans and past stories in the past tallied well with their financial performance?
- Compare their performances with competitors — How do their plans and financial performances compare with those of their competitors?
- It is not possible for us to predict the future and whether the company will deliver as promised. Their past records are the best validators. The future can be different from the past; the characters and quality tend to be more enduring.
- If we ever find the company and CEO turn out to be not trustworthy, sell/avoid and move on! There are many other better investment opportunities available.
Fool me once, shame on you; fool me twice, shame on me.
