I was presenting at a Telecoms conference last week and was reminded of an experiment we did a little while back to try to assess the real impact that transparency can have on investment decision making. It is fondly referred to as the "the great experiment" immodestly as the “Coloplast/Schroders experiment” because Schroders kindly provided us with many of their investment team for an afternoon and Coloplast were very supportive of the experiment.
The motivation for the experiment was to try to find an answer to a frequently asked question: what evidence is there that increased transparency will enhance my share price? The answer was and remains a difficult one. Studies like those of McKinsey have shown that good governance (of which transparency is a part) can provide a premium to the average market price of approximately 10% to 12%, but I have always recognised it is difficult to separate out the impact of transparency from those factors that underpin well run companies - a clear strategy, an understanding of what drives value, measurement of the right things etc.
In the "great experiment" we took the annual report of Coloplast, a Danish medical company and an award winning reporter of intellectual capital, and created two versions of the report, one the full version and another edited to remove all quantified contextual data, leaving a document which was financially compliant with current regulations. Armed with these two reports we descended on Schroders, one of the most successful investment management houses here in London. Each member of the research team was presented with one of the two versions of the report and asked to use the information provided to develop a forecast of revenue and earnings for the next two years, to provide a recommendation for the stock, to support the recommendation with their key reasons and to provide an estimation of its beta relative to its peer group - a measure of their perception of the riskiness of Coloplast's return relative to its peers.
Download a_tale_of_two_reports.pdf
The findings summarised below were quite startling:
1. Average revenue and earnings - full report (lower average estimate but tighter spread) - report without quantified contextual data (higher average estimate with wider spread)
2. Stock recommendation - full report (60% buy) - report without quantified contextual data (80% sell)
3. Beta - full report (average risk) - report without quantified contextual data (above average risk)
When discussing the reasons for their recommendations, the value of non-financial and contextual information was clear. In particular the individuals with the full reports had been convinced by the company's clear explanation of its market, key niches and growth opportunities, its well articulated strategy linked to information on how they innovated and developed new products – all of which was supported with relevant quantified metrics. In contrast those limited to the financial information worried about a falling ROIC and EPS growth rates; they had little confidence in the sustainability of financial returns. The overall conclusion from this experiment is clear; well structured narrative reporting, supported by relevant quantified metrics is rewarded by the capital markets.
So as some of my colleagues and friends grapple with the fall out of the credit crunch and question whether the measurement system needs to be improved, I would only encourage caution, and highlight the fact that better disclosure of what sits around and under the reported financial numbers, particularly context and assumptions, can be of significant information value to the market.
If you know of any research of a similar nature to this experiment I would love to know about it.
Comments