Beyond the Next Quarter

Published, Summer 2004

I’ve heard it many times: Social investors may have their hearts in the right place, but that’s a poor starting place for making money in the stock market. Conventional investors do better. They look at the cold facts of profit and loss and aren’t distracted by sentimentality.

I beg to differ. Here’s an outrageous claim: Social investors are better equipped than most to grasp the importance of the creation of long term value, the only thing that drives sustainable investment returns.

You don’t have to cite the proponents of social investing to understand just how self-defeating some of the tactics of mainstream (a.k.a. Wall Street) investors have been. Warren Buffet, regarded by many as America’s premier investor, shares our impatience with the standard approach, finding that Wall Street’s advice is simply not worth the time (“We never look at any analysts’ reports…I don’t understand why people do it.”). Buffet further complains that when “managers dance to Wall Street’s tune,” as many do, they wind up following “operating and capital allocation policies far different from those they would choose if left to themselves.” A terrific recent book by New York Times reporter, Alex Berenson, makes a similar case. He attributes the market debacle of recent years to the obsessive primacy Wall Street analysts placed on the so-called “Number”—the earnings per share figure reported to Wall Street which, purportedly, encapsulated all one needed to know about a company’s profitability. Berenson reviews in exquisite detail Wall Street’s narrow and short term focus, how this impelled managers to make foolish business decisions, and how this self-reinforcing cycle often temporarily led to skyrocketing stock prices. We know, of course, how this all ended: Companies that damaged their own futures and investors with plenty of losses to show for following conventional wisdom.

How then, do I support my claim that social investors are better equipped to be successful? By pointing to my conviction that successful investors are more inclined to worry about the health of the entities they own rather than whether or not a quarterly earnings report pleases Wall Street. True, that inclination may often be motivated by a social or ethical concern, or the interests of a broader group of stakeholders, but it provides the proper starting point for identifying long term value. Think about some of the value destroying things that some companies have done that Wall Street frequently ignores (or even applauds) if it helps bolster short term profits: scaling back employee health benefits, reducing research and development, treating environmental risks cavalierly, borrowing more funds than otherwise prudent to sustain a faltering project or enable repurchase of pricey shares.

Consider this contrasting example from our own experience. Costco, the warehouse retailer, and long term Walden holding, recently saw its stock decline briefly but sharply when one analyst criticized the company, subsequent to a quarterly earnings shortfall, for providing workers a best in industry package of wages and benefits. Of course, high labor costs did limit recent earnings, but investors with a broader, longer term perspective understood that Costco’s industry-leading past success and future prospects had been built on a low turnover, well motivated workforce. It is no surprise that Costco has a sensible executive compensation policy as well.

Even big technology companies, once Wall Street favorites, sometimes fail to get sufficient credit from conventional investors for conserving shareholder value. Intel, for instance, has made a point of addressing the adverse environmental effects that are inherent in semiconductor manufacturing. Given the volatility of the company’s earnings, and the obsession Wall Street holds for forecasting to the penny each quarter’s report, most investors probably don’t pay much attention to such a long term concern. But we think Intel is among a growing group of companies that is protecting shareholder value in this area, something that may prove vastly more important than next quarter’s earnings report. Perhaps it is just a coincidence, but Intel’s management has a similar long term focus in its employment practices. The company is regularly included in Fortune’s list of “100 Best Companies to Work For.”

Of course, I know that it would be foolish to push my “outrageous claim” of the superior talents of social investors too far. Statisticians can argue about performance results, but I suspect that the issues are far too murky to be settled conclusively. And, no doubt, attentiveness to the creation of long term value is not the exclusive preserve of social investors. Still, I feel confident learning from the analysis of a social investor who starts by asking questions about the vibrancy and sturdiness of the organization under consideration for an ownership stake. If instead the first question asked is, “Will this company beat the Wall Street earnings forecast next quarter?” I think it’s time to put my profit seeking cash back in my pocket. —Bill Apfel