What factors show a company is really thinking about the long term?
Last week, I looked at the corporate world's obsession with short-term thinking, citing a new McKinsey study by Dominic Barton.
This idea isn't totally new of course. Among other organisations, London-based Tomorrow's Company has for years been a banner-waver for more far-sighted corporate behaviour. But McKinsey has tremendous pull around the world and thus Barton's conclusions are important. And he did spend 18 months touring the world and talking to 400 top sources.
But how hard is it to pick companies and funds with far-sighted strategies? In fact, it may not be too difficult, just as long as you don't stop at the analysts' reports.
So here's a few tips a la Barton:
Key drivers
When evaluating technology-based companies, take a long hard look at the budgets that ought to create long-term revenue.
For instance, techie companies that starve their boffins of research and development funds (R&D) are sacrificing future profits. As for sales, general and administration (SG&A), while a lean company is clearly a good thing, so is a well-rewarded sales staff with all the essential back-up.
As IBM chief executive Sam Palimisano told Barton, "I can easily make my numbers by cutting SG&A or R&D, but then we wouldn't get the innovations we need."
Check other investors
Check out the horizons of institutional investors such as pension funds, sovereign wealth funds and insurance companies.
Barton likes the strategy of the giant Canada Pension Plan Investment Board whose executive vice-president says he invests "for the next quarter century, not the next quarter."
If that kind of investor is well represented on the share book, that's an encouraging sign.
Managers who've seen it all
In investment funds, look for those with portfolio managers who've been around a while.
"Fund trustees, often advised by investment consultants, assess their money managers' performance relative to benchmark indices and offer only short-term contracts," Barton complains.
Thus asset managers are routinely fired if they return 10% instead of, say, 12% for the relevant benchmark index. Not, of course, that there's anything wrong with 10%.
Concentrated portfolios
Distrust funds with thousands of stocks.
Although it runs against the current preoccupation with tracker funds, Barton thinks it may be time for fund managers to hold "fewer than 100" stocks so they can engage with those companies in the interest of long-term performance.
In short, many funds are spreading themselves too thin.
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Look beyond the numbers
Instead of rushing to the profit and loss part of the annual report, turn to the pages that analysts usually spurn.
They're the ones that describe community activities because, says Barton, that's where a lot of future revenues lie. This is more than sponsoring a sports team or too (although that's great for pubs); it's about activities that deliver real, long-term corporate as well as social returns.
He cites Verizon that created a phone and calling plan specifically for older and disabled people, and ended up selling 400,000 of the phones while grateful "seniors" doubled their spending on Verizon's wireless products.
Chatting up the Board
Look for heavily involved boards. In Britain, the average director spends about 12-20 days a year which, according to a recent UK government study he cites, isn't nearly enough. Something between 30-36 days is about right.
What's really needed is more chat time with the executives. Under chairman Carl-Henric Svanberg, BP (LSE: BP) seems to be heading in this direction.
Interestingly, the non-execs of private equity firms typically spend 54 days a year on company business, most of it in the kind of informal meetings that Barton believes are the way to go. He also thinks more directors should have got their hands dirty in the industry concerned. (This also happens to be the German way and look how well their exports are doing).
The right pay structure
Put the microscope over the remuneration scheme. These should be tied to long-term performance, something stock options don't do because they "incentivise the wrong [short-term] behaviour."
In practice, that might mean the pay structure would carry the "consequences for failure", just as though the management were shareholders, and be based on rolling three or five-year performance.
Barton rather likes the idea of the CEO putting some "skin in the game" in the form of, say, a year's salary.
The loyalty factor
Finally (some hope) try and find a company that rewards loyal shareholders. While some French companies give two votes to people who have held shares for more than a year, Barton thinks thought should be given to supporting shareholders who buy and hold.
Now, haven't we heard of somebody who does that? Ah yes, Warren Buffett.
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