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Strategic investing: let big guys do heavy lifting

In theory, you own the companies in which you hold shares. The presidents, chief executive officers, chief financial officers and other top managers are your employees. But the reality is quite different.

Over the years large corporations have become owned by hundreds or thousands of shareholders. Most of these shareholders own a few hundred or a few thousand shares. This dispersion of shareholder power weakens their ability to replace poor management with top-notch management. This effectively increases management’s power.

Some managements treat the strategic investment objectives of shareholders like you shabbily. Rather than pay dividends and raise them or buy back shares, some have chosen to richly reward themselves—at your expense. These managers take a cavalier attitude towards your money. They spend it on company jets and costly offices adorned with pricey paintings and furniture. They go out with customers and associates to the best restaurants and nightclubs. As we point out from time to time, it’s best for you when top managers are cheapskates and are careful with your money.

Aligning management, owner investment strategy

Past management at Key stock BCE Inc. (TSX─BCE) should have milked this cash cow and passed along the money to the shareholders. But management thought it had better ideas for that cash. Over the years BCE bought companies such as Teleglobe Canada and Montreal Trustco, among many others. Most of these acquisitions ended badly. For instance, BCE paid $875 million to buy Montreal Trustco in 1989. In 1994, it was sold to Scotiabank for $290 million. But BCE is now doing a better job and remains a buy.

Schemes to align management’s strategic investment plan with yours, like stock options, sometimes fail. Often they give management a short-term focus while losing sight of the company’s long-term prosperity. Cutting research and development, for instance, can temporarily boost a high-tech firm’s profit. But it jeopardizes the firm’s future. For instance, Key stock Open Text Corporation’s (TSX─OTC) large investment in research and development is a point in its favor.

Short-term jumps in reported profits and share prices sometimes coincide with the exercising of management’s stock options. We prefer it when management buys shares. This is a positive signal. It also makes management’s strategic investment objectives similar to yours.

Insider buying is a reliable signal

In fact one of the best buy signals you can find is heavy buying by insiders—that is, by a firm’s directors, officers, their families and anyone who owns more than 10 per cent of the shares.

That’s because most insiders buy for the same reason you do: they see the stock satisfying their strategic investment objectives. In most cases, insiders buy heavily when they know favorable developments are coming that are liable to increase the stock’s price.

Heavy insider selling, by contrast, is a less reliable signal. Insiders may sell because they want to diversify or for personal reasons such as an urgent need for cash or estate planning.

Prudent investors take heavy insider buying and selling as an indication that they should investigate further. Then, if the facts support the signal, they buy or sell as the case may be.

Institutions sometimes replace managers

In the past, if you didn’t like management and the arrangements that it made in its own interest, you could only ‘vote with your feet’ and sell.

Since the 1990s, however, big institutional investors like mutual funds and pension funds have invested hundreds of billions of dollars in stocks. As a result, they’ve gained considerable leverage in boardrooms. This is good for you. In pursuing their own long term strategic investment plan, they also help yours.

When management’s mistakes hurt a company’s stock, it also hurts the returns of the institutions. This could lead to the firing of an institutional money manager. Thus, they take a company’s mistakes seriously. In some cases, institutions have replaced inept managers. A case in point is Key stock Canadian Pacific Railway (TSX─CP), now run by E. Hunter Harrison.

For many of these institutions, selling is difficult. After all, disposing of their large holdings can cause the shares to plunge. Besides, where are they going to reinvest the diminished proceeds?

To the extent that big institutions demand more of corporate Canada, you’ll profit.

 

The Investment Reporter [1], MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846