Mr. Market, is an imaginary investment partner introduced by Benjamin Graham in his seminal book The Intelligent Investor. The name speaks to the collective psychology of investors that influence stock price fluctuations – especially in the short term.
While the book is of an age and tenor where the term “bullshit detector” may not have adhered to common decorum and publisher standards, Graham’s disciplined approach to fundamental analysis addresses the term nonetheless. The fundamentals eventually do surface, and Mr. Market’s bullshit detector is the ultimate arbiter. It just happens much more quickly and violently today.
There have been many changes since the book’s first publication in 1949. Among the most notable are the structural market changes brought about by technology – the rise of algorithmic trading, indexing and ETFs – and the enactment of regulations surrounding information disclosure, dissemination and conflicts of interest. New MiFID II rules on decoupling of research from trading commissions that just went into effect in Europe will have a profound impact on how institutional investors pay for ideas.
These changes have reduced investment time horizons. They’ve also accelerated a trend toward shrinking resource pools devoted to fundamental research and analysis.
A Correlation Worth Heeding
In an era where research analysts are an endangered species – and the pool of them continues to shrink – some CEOs and CFOs miss the whole point of educating, demonstrating and validating their value proposition to the investment community. They litter their presentations with enough buzzwords to make them sound plausible to unwitting analysts and investors. Then they concoct metrics – of the non-GAAP variety – that support the “story”.
Eventually, Mr. Market catches on. S&P Global Market Intelligence research revealed that there is a link between companies whose executives speak incomprehensibly and their stock price performance. Natural language processing (NLP) was applied to quarterly earnings conference calls for the four quarters ending with the second quarter of this year.
Researchers scored the complexity of the language used. NLP also picked up on tone, pitch, cadence and pauses. It found that “only 20% of communication is verbal”. This is amazing considering it is a conference call or a webcast where the participants cannot see the facial expressions or body language of the speakers.
Bottom line: the more bullshit in the language used, the greater the stock’s underperformance.
An Illustration
But one does not need NLP for this. Sell-side analysts in particular have finely tuned ears. In fact, one of my most notable “calls” on a stock came when I was a tech analyst a number of years ago. A CEO who always spoke confidently – even cockily – at times, had a slight quiver and cleared his throat as he began delivering his script. He apologized to the listeners that he was dealing with a cold.
I told my associate to keep listening, and ran to the head of trading. I told him that the company was about to deliver bad news, and that all holders of the stock should be notified immediately. He didn’t hesitate; by the time the conference call and garbled Q&A ended one hour later, the stock was down 15%!
This is why much of my time working with CEOs, CFOs and IROs goes beyond the strategic message. Delivery of the content is just as important as the message itself. In fact, it can affect the stock price even more.
The Case for Straight Talk
As David Pope, who led the study said, “Academic research shows when management is trying to hide bad news, they use language that is not easily understood. In so doing, they eat up time, so there is less time for the Q&A with the analysts on the call.” There is a doozy of a quote in the article that I defy any analyst or investor to interpret. It made me grateful that I wasn’t an analyst on that call.
It can be reflexive to go into spin mode when there’s bad news to deliver. But the audience would rather hear it straight. If they don’t, they’ll punish companies twice: once for the bad news, and a second time for trying to put a positive spin on the news, for which they are much less forgiving. A missed quarter is easy to recover from. A credibility issue? Not so much.
The 7 Rules for Investor Messaging serves as a guide when communicating with the Street. One of its purposes is to steer executives away from testing Mr. Market’s Bullshit Detector. It is a highly-tuned instrument that rarely misses more than once.
This article first appeared on LinkedIn.
