Picking the Best Stocks: Candor Counts

stock-market

How do you pick which stocks to invest in? It probably has something to do with a combination of looking at profit margins, revenue growth and a mind-boggling array of ratios coupled with consulting a map of the constellations and calling your preferred psychic hotline. Oops. I think I’m getting stock tips confused with my sources for dating advice.

In any case, you definitely wouldn’t base stock picks on something like a company’s letter to shareholders, right? They’re vague, hot-air-filled pieces of fluff meant to assuage any investor concerns, which essentially renders them completely useless.

Ha. Just kidding! They’re totally useful!

Letters to shareholders reveal something that numbers can’t; the company’s candor.

As The Motley Fool contributor Selena Maranjian has pointed out, these letters are useful in gauging how honest a company is with the very people who have chosen to be a part of it. If it’s not honest with them, are you going to trust it?

The annual Rittenhouse Rankings Corporate Culture and Candor Survey revealed some interesting correlations involving how candid a company is with its investors and how well it performs.

Candor, Credibility & ROI

Rittenhouse founder Laura Rittenhouse knows a thing or three about corporate candor, writing in her book Do Business With People You Can Tru$t; “When leaders clearly communicate the company’s principles and profit expectations to customers and investors, they build confidence in the company. When they walk their talk, they are more likely to extract better performance from their employees. These CEOs can draw on ‘credibility currency’ when times get tough.”

Sounds legit. But is it?

The Rittenhouse Rankings Corporate Culture and Candor Survey evaluates how frank the leaders of 100 leading companies are and how well those companies’ stocks have performed. The companies in the top 1/4 of the group (meaning the most candid ones) in the most recent Rittenhouse survey saw their stock rise an average of 9.9 percent over the year of the survey, while those in the bottom 1/4 (the least candid ones) experienced a drop of 5.7 percent.

And this is the sixth year in a row that the most candid companies have outperformed the least candid companies.

A corporate policy of frank, honest communication seems to have a big influence on company growth. The five companies with the biggest gains in rank in the survey over the previous year had stock gains that averaged 12.4%, compared to a 5.7% loss for the bottom companies and a gain in the S&P 500 of only 3.1%.

The five biggest improvers were:

  • Home Depot (HD);
  • Intel (INTC);
  • FootLocker (FL);
  • Franklin Resources (BEN);
  • Citigroup (C).

Best & Worst

Among the 100 large and midsize companies that Rittenhouse studied, here are:

The Top 5

1. Church & Dwight (CHD)

2. Alcoa (AA)

3. Southwest Airlines (LUV)

4. Google (GOOG)

5. Ford Motor (F)

The Bottom 5

96. Hewlett-Packard (HPQ)

97. CSX (CSX)

98. Cisco Systems (CSCO)

99. Bank of America (BAC)

100. AIG (AIG)

AA vs. HP

No, this isn’t an addiction support group squaring off against a steak sauce, this is a comparison of Alcoa and Hewlett-Packard.

As it has over the past decade, Alcoa’s stock lost ground over the past year. (But it should be noted that the company recently reported Q4 earnings that exceeded the expectations of analysts). In his 2011 letter to shareholders, CEO Klaus Kleinfeld led with bad news right up front (we’re talkin’ first paragraph up front here, folks):

“Whenever someone tells me, ‘I have good news and bad news,’ I always ask for the bad news first. … We are acutely aware of the dramatic impact that Alcoa’s share price drop had on so many people.”

And in his closing to the lengthy letter, Klaus ended with a summary of potential threats in the near future.

“As we enter 2012, we remain cautious in the short-term and highly optimistic in the long-term. Volatility persists in Europe; political uncertainty could stall the U.S. recovery; and there is a possibility that the meteoric pace of economic growth in China may slow.”

On the other end of the list is Hewlett-Packard, whose stock fell around 45% in 2012, the first full year that current CEO Meg Whitman has been at the helm. That plummet, by the way, gives the company the dubious distinction of being the worst performer in the Dow for 2012. Not that Meg is completely to blame. Clearly Hewlett-Packard was a pretty sick puppy before she adopted it.

In Meg’s 2011 letter to shareholders, the CEO started on a positive note.

“First, let me say how confident I am in the future of Hewlett-Packard.”

And early in the letter she acknowledges some of the company’s problems albeit in some pretty vague terms.

“My initial focus as CEO has been to get HP out of the headlines and back to being the reliable, trusted company that you can count on.”

To conclude her letter, Meg eschews specifics while looking into the future.

“While I’d like to say that we’re through the tough times, many of the fiscal 2011 headwinds are still with us as we enter fiscal 2012, and our near-term focus is on stabilizing the business.”

And while Meg mentions the company’s substantial free cash flow, she opts not to mention that it has dropped in recent years.

So, to recap, Klaus laid it all on the line to shareholders, the good, the bad and the ugly and even told them about the maybe not-so-rosy future ahead while Meg opted to play it safe with vague words and phrases.

The Bottom Line

The Culture and Candor Survey shows us that while all those numbers are useful and carry a lot of weight with them, a company’s words and how it uses them should be equally important when making investing decisions. Choose wisely.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s