Fund managers are constantly assessing the performance of companies in search of attractive value. While we ultimately come to our own conclusions about the performance of a company, what we find interesting is how management assess their own performance.
There’s always going to be a positive bias underlying each CEO’s appraisal – it’s simply human nature to focus on the good and glaze over the bad. But investors must have a clear idea about the performance they expect of management – it’s only in this way that you can determine whether management are acting in your best interests.
Let me illustrate this point by contrasting the assessments of two CEOs from the most recent reporting season. One manager was rather critical of their performance, while the other manager was assessed to have significantly increased shareholder value.
The humble manager
Our first example is a very well known investor and one whom many value investors’ investment philosophies have been influenced by. Warren Buffett is a founder of one of the world’s largest companies, Berkshire Hathaway. Every year Warren Buffett writes a detailed letter to his shareholders in which he assesses the company’s performance and whilst we are not investors in Berkshire Hathaway, we read each letter with a keen interest. Here is an excerpt from Warren Buffett’s annual letter for 2012:
“When the partnership I ran took control of Berkshire in 1965, I could never have dreamed that a year in which we had a gain of $24.1 billion would be subpar … But subpar it was. For the ninth time in 48 years, Berkshire’s percentage increase in book value was less than the S&P’s percentage gain.”
Buffett demonstrates that managers are accountable for building shareholder wealth at all times. Buffett’s responsibility is to outperform the market, and if he cannot achieve this, then it is cheaper for investors to put their money into an indexed fund. Even though shareholder wealth grew by $24 billion, and even though it was achieved with no additional debt and no capital raisings, Buffett was critical of this performance.
The mighty manager
Let’s contrast this with the assessment of our second CEO, who operates far closer to home. Marius Kloppers has been the CEO of BHP Billiton for the past six years, and announced his retirement from the company during this reporting season. The chairman of BHP, Jac Nasser, gave a very positive review of Marius’ tenure: “Marius and his team have delivered for shareholders, significantly outperforming our peers in terms of total shareholder returns”.
On the surface, it seems like a far more glowing review than Mr Buffett’s personal self-assessment. But it is interesting that his performance was gauged relative to his peers rather than to the performance of the market. Many miners have indeed struggled in the post-GFC period, but did Marius Kloppers actually deliver value in total shareholder returns?
When Kloppers started his reign at BHP, the company was generating a profit of $16.6 billion. This financial year, BHP is forecast to generate a profit of $13.8 billion. So analysts are expecting no profit growth between 2007 and 2013. Yet over this period, both the equity contributed by shareholders and the debt taken on have doubled.
Kloppers received a golden farewell that has been widely reported. Upon leaving BHP, he is to receive approximately $75 million in performance bonuses. To his credit, Marius did forfeit his short-term bonus last year, given the disappointing performance of its shale gas acquisition in the US.
But there has been no mention or suggestion that he will be foregoing this final bonus, which would lead us to assume that he considers the amount reasonable, based on his overall performance. I’m not sure if Berkshire Hathaway shareholders would share the same view.
It’s not all relative
Having spent over two decades in the market, I have seen a lot. Selective benchmarking and historical revisionism (managers who call themselves founders when they weren’t) are all too common in this world where genuine humility is rare.
It is important to assess a company’s performance relative to a benchmark and to peers, but above both, the number one focus should be absolute returns. It’s no good saying that you have outperformed the market by 1% if in fact the market itself has fallen by 10%. That’s like standing on shore watching all the ships in the ocean sinking, and claiming that the captain whose boat is sinking the slowest is the best performer. It’s all very well if you are standing on land but not so great if you are on the ship.
With value investing, it’s important to see through the short-term fluctuations of a company’s results and focus on long-term value creation. Investing is inherently risky, and there will be times of underperformance. But ultimately as investors, you are entrusting your money to management with a view that your overall wealth should increase. This should be your main consideration when assessing the performance of companies in which you have a stake, regardless of how positively management describes their performance.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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