Investor

Boiled down to its essence, investor relations is consultative selling.

Investor relations professionals want the right type of customers (investors) to buy a piece of their company (stock) and to have a good ownership experience (own the stock for a long period of time).

The potential market for a company’s stock is vast, covering institutional investors and individual investors, who can be either domestic or foreign. Because the market is far larger than can be reached by a typical investor relations department, it requires careful application of available resources. This is where the marketing tools become useful.

Often, when you speak to people in the profession of investor relations, they speak about “targeting” investors. However, marketing theory teaches that targeting is only one-third of a process of segmentation, targeting and positioning.

Segmentation

Segmentation refers to the process of breaking down the investor base into distinct groupings so that an investor relations department can deal with a clearly identifiable classification. There are a number of ways to whittle down the investment universe, starting with separating active from passive shareholders. It obviously does no good to pursue index funds as they will simply hold you in proportion to your weighting in the index. Next, you can classify investors as either short term or long term. Considering the time and effort it takes to get an investor to buy your stock, many companies will consider it far preferable to have investors who will be around for a while, but as discussed below, this may not always be the case. Next you might wish to consider the groupings of institutional versus individual shareholders and how to divide your time and efforts.

At this point, the process should be clear that regardless of how you wish to divide up investors, you will need to clearly break them down in to manageable groupings.

Targeting

Once segments are identified, marketing principles state that the attractiveness of each segment needs to be evaluated. For many companies, the obvious choice here is the segment of investors that are active, long term investors. These may be institutional, because that is where much of the investible funds reside, however, some companies may also wish to consider individual shareholders for the desirable qualities of low turnover and loyalty to company products. Some companies, particularly those with low trading volumes and visibility might wish to target more active short term investors in order to raise their liquidity profiles. The point here is that companies need to consider their individual situation before making a judgment about their optimum target investor.

Positioning

The final step in the three part marketing process is positioning – what is the appropriate information about what the company is and where it’s going and that can be presented to the target investor that will resonate with the investor’s style, portfolio constraints and investment philosophy. For example, new, quickly growing companies will be presenting to growth investors who will want to know about market growth, new products, research and development spending and other items that will further enhance growth. On the other hand, mature companies will likely be marketing to Growth at a Reasonable Price or value investors and will choose to emphasize financial returns, margins and operational efficiencies.

There you have the basic marketing principles applied to investor relations in a nutshell – segment your investors, target the most attractive segments and position your company message to fit the investor profiles you have targeted.

The efficient market hypothesis is a key concept covered in finance classes during the first year of business school. Because it is considered a finance concept, you rarely hear it discussed in the context of investor relations, but it has a key role to play.

In its simplest form, the efficient market hypothesis states that security prices fully reflect all available information. The implications of this seemingly simple statement are profound, because if current stock prices reflect all relevant information, then prices will change only when new information arrives. New information, by its definition, cannot be predicted ahead of time, and therefore stock prices cannot be predicted ahead of time, and will be random.

There are actually three versions of the hypothesis: The Strong form, which posits that ALL information, both public and private, is embedded in a security’s price; the Semi-strong form, which holds that all widely available public information is reflected in the stock price; and finally the Weak form, which says that a stock’s price reflects all information that is contained in the past prices of the stock.

Of the three forms, financial economists are pretty much in agreement that the Strong form, that security prices embed all information about a stock, both public and private, overstates the case. If it were true, insider trading would not reap abnormal profits, which it clearly does. Most settle on the Semi-strong form of market efficiency as their preferred thesis. Since Eugene Fama initially wrote about efficient markets in 1969 literally hundreds of event studies have been done showing that markets rapidly react to widely available information.

So, you may ask, what has all of this got to do with investor relations? The key here is that investor relations has a fair amount of discretion over what information becomes widely available. Forget for a moment what you have to disclose because of regulations and quarterly filings and think instead about other things that make up your company.

Just to take one example, think about corporate culture. Nothing in the regulations or disclosure requirements require you to talk about your company’s corporate culture. Yet that very same culture may be a big reason behind your company’s performance and its future prospects. Wal-Mart comes to mind as a company that puts its culture in front of investors by letting them attend Saturday meetings in Bentonville and welcoming them to the extravaganza they have each year at their annual shareholders’ meeting. Another example that comes to mind is quality of a company’s management team. If you don’t get the management team in front of investors so that they can judge how great they are, that information is not widely available and the market will never know about it. If investors don’t know how good the entire management team is, they can’t build that into their expectations of future profits and therefore it will not be reflected it in your stock price.

What you choose to disclose above and beyond the regulatory requirements is entirely up to you. Every company is good at something – sales, brand management, product innovation, distribution or operations, to name a few. Disclosing selected data of this nature with investors can help them more efficiently value your stock. The key is that the information has to be widely available. This means that you have to have a consistent effort to disclose those pieces of information, both in good times and in bad, to all your investors.

Do that, and you will have done your part in making the markets more efficient.

This Spring marked the fifth anniversary of my leaving the corporate world for the much less structured world of teaching, consulting and writing.

I like to think that the change has brought some perspective, as I’ve had the opportunity to step back from the day-to-day pressures of investor relations and really think about what it is IR practitioners do, or attempt to do, in their interactions with investors.

Couple this with the opportunity I was presented to develop a MBA level investor relations class at the Jones Graduate School of Business at Rice University, and it presents a rich area for thought. Never being one for keeping my thoughts to myself, over the course of the coming posts I plan to set forth some of the thinking I’ve done on how the practice of investor relations intersects with the theories of finance, capital markets and corporations.

My thinking here is that if people have a better understanding of the theory, the practice will improve. By way of example, you don’t have to be a mechanical engineer to drive an automobile, but an understanding that it is powered by an internal combustion engine that requires periodic maintenance will result in better operation and upkeep of the car.

When you think about the discipline of investor relations, it incorporates aspects of marketing, communications, finance, law and the capital markets. It requires a thorough knowledge of the company and its industry and the regulatory environment in which the company operates. Further, the audiences it affects go far beyond just investors to encompass employees, customers, suppliers, creditors, bondholders and governmental entities, among others. When you throw into the mix that there are some schools of academic theory that hold that active investing and investor relations activities add no value, there’s quite a bit that can be discussed.

Just by way of a teaser for some of the topics I will cover in coming posts, here are some of the things I plan on writing about:

• Finance – most stock valuation models are constructed using discounted cash flow techniques, and how they work has a significant impact on your company’s stock price. Beyond the modeling technique however, there is a significant takeaway to think about.
• Marketing – a lot of investor relations literature talks about targeting investors, but that is only one-third of the three crucial steps to marketing. Further, how marketing should inform your thinking about the sell side and where you should spend your time with buy side investors.
• Capital Markets – understanding how the markets work and who gets paid for what, will help investor relations practitioners sort through the competing demands of the buy and sell side.
• Communications – there is a lot of really bad IR communications out there, much of it in the form of PowerPoint slides. I look at examples from some of the biggest corporations to see what they could do better and the hidden subtext of the slide. (In order to protect the guilty, we will not identify the guilty.)
• Law – lawyers are taught to think in a particular way, and regulatory lawyers have a unique take on that. As someone who practiced law for ten years, I will attempt to bridge the communications gap between lawyers and IR practitioners.

I’m somewhat of an evangelist on bringing more academic rigor to investor relations and I hope the upcoming series will cause people to think seriously about what they do on a day-to-day basis in IR.