July 1 1994 by Donald W. Mitchell
Two years ago, I proposed an investment strategy that reaped excellent returns in 1992 and 1993. The Chief Executive CEO 100 Index-a set of companies with continuous, outstanding CEO leadership-advanced 10.3 percent in 1992, while the S&P 500 Composite Index gained 4.5 percent. In 1993, the CE 100 expanded 11.8 percent, while the S&P Index grew 7.1 percent. The double-digit return for both years would have placed the CE 100 ahead of more than 75 percent of professionally managed portfolios, excluding management fees and trading expenses.
Interestingly, we discovered a wrinkle to the initial idea. The 1992 CE 100 grew only 3.6 percent during 1993, the second year. So investors would have done better to sell the first list at the end of 1992 and buy the new list than to have held the original list for two years. On the other hand, the 1992 list still outperformed the S&P 500 (14.3 to 11.9 percent) over the two years. In future articles, I will continue to examine the multiple-year results experienced by each of these lists.
In 1993, I expanded the criteria to include CEOs of companies with an equity market capitalization of $500 million or more at the prior year-end and the same CEO in place for the three years being measured. This year, of 5,000 companies in the Value Line database, 1,387 fit our capitalization criteria. Of these, we located the top 132 that had a single CEO in place over the three-year period from 1991-1993. From this group, we selected the top 100 companies based on superior stock-price performance.
Because 1992 and 1993 were terrific years for smaller-cap stocks-those with a capitalization under $1 billion-the index this year reflected an extraordinary three-year appreciation of 602 percent. By comparison, the S&P grew 41 percent. If the past is any indication, the index this year should again outpace the S&P 500. Impressively, 31 companies repeat from the 1993 list with an average three-year gain of 636 percent. We will monitor these companies separately and disclose the results next year.
The new CE 100 leaders (see graphic) are Terence Matthews of Newbridge Networks (telecommunications equipment), Phillip White of Informix (software), Neal Patterson of Cerner (data services), John Zrno of ALC Communications (long-distance telecommunications), and Louis Nicastro of WMS Industries (games).
Other top performers are Gentex (car mirrors and smoke detectors), Best Buy (retail superstores), Cisco Systems (computer internetworking products), American Power Conversion (power supplies), and. Advanta (financial services).
Implicit in the CE 100 investment model is the idea that a first-rate CEO can quickly build shareholder value. Generally, we hypothesize, such a CEO places a high priority on stock-price performance, selects strategies that support the stock price, and has superior management skills.
To test this presumption, we surveyed 27 CEOs from this year’s index on the topic of stock-price improvement. Combined, the stock prices of companies of the CEOs we interviewed climbed 578 percent over our three-year period.
ESTABLISHING A DIALOGUE
One key measure of CEO performance is the amount of time spent talking with analysts and portfolio managers. The CEOs polled spend a cumulative average of 24 days each year on such activities. That is approximately 10 percent of the normal working year, though for CEOs who work more than 40 hours a week, the quotient may be somewhat lower.
Don’t underestimate the importance of communicating with the investment community. “The CEO should take time to speak with shareholders, especially significant shareholders,” says Robert Vukovich, CEO of Roberts Pharmaceutical. “There should be a dialogue and a feeling of trust in establishing these relationships. I advise other CEOs to speak with shareholders fairly routinely.”
We also asked those polled to gauge the most important factors in their companies’ stock-price performance. The tabulation of their responses appears in the graphic on p. 78.
Most CEOs in our subgroup said they attempt to restrain investor expectations through candid communications and presenting the future conservatively. This perspective is consistent with research done by the Share Price Growth 100, a research consortium, in which hundreds of portfolio managers, investment committee members, and analysts expressed concern about the candor of corporate communications, particularly those from the CEO. As a result, analysts tend to favor companies that communicate honestly and effectively and to discount the value of those that fail to provide a realistic view of their risks and problems.
Small-cap stocks, in particular, are sensitive to “any news, good or bad,” says Michael Birck of Tellabs, though he notes his own company has grown out of that category. “Analysts read a lot into what you say,” Birck notes. “You might be tempted not to be as open and forthright with analysts, but you can’t. Don’t withhold bad news. Establishing a reputation for candor and honesty serves well in good times and bad.”
Keeping expectations in line is an ongoing task, says Lewis Rubin of Xtra Corp. “You try between quarters to have discussions with analysts where business is trending,” he says. “You give a sense of whether things are improving, getting worse, or staying the same. Then you keep in line with expectations. The worst thing that can happen is that expectations get out of line, and too much is expected.” John Gifford of Maxim Integrated Products takes that idea one step further.
“I share anything that could materially affect our performance,” he says.
DON’T BE SWAYED
Meanwhile, the more successful the company, the more unrealistic investor expectations may be. “Analysts tend to want to get management to commit to bigger and bigger numbers,” says Walter Forbes of CUC International. “Keep it under control. Don’t promise more than you can deliver. If you know you’re going to make a dollar, don’t let analysts say $1.10.”
Obviously, the companies in our mini-survey rank among the most successful nationwide. In communicating with outsiders, how do they keep things in perspective? One answer comes from John Klein of Zenith Laboratories.
“You as a company, or president, don’t control what price the investment community will put on your stock. You do influence how you do in terms of growth and profit,” Klein says. “The lesson is to concentrate on your company and what vision you want the company to have, and present it in a quantitative type of format that meets objectives and satisfies the investment community. If you try to micromanage your stock price, you will lose sight of what your true role is, to grow the company to ensure value for your shareholders.”
Charles Schwab of discount brokerage Charles Schwab Corp. believes “commitment to the customer is above all else and must be combined with commitment to technology, service, and employee training to serve those customers. To make the right investments…you must place your customer’s long-term interests before next quarter’s profits. Wall Street doesn’t always like that in the short-term, but it’s the only way to ensure a winning formula that keeps your service promise to customers and makes it possible to build stronger, more profitable relationships with your customers over the long term.”
While the 27 chief executives surveyed work for prosperous companies, they remain eager to further improve stock-price growth. The most popular strategies include better communications, more time-efficient investor relations, and a changed shareholder mix. We will ask the same questions next year of a CEO subgroup and compare their responses with those of this year’s respondents. To be sure, the CE 100 isn’t the only investment approach that focuses on the role and performance of the chief executive. Some pundits argue that certain underperforming or new CEOs are better bets. (Skeptics may want to consider the track record of Allied Signal’s L
If trends hold true, odds-on favorites to crack the top 100 next year are CEOs at the top and bottom of this year’s list. Stephen Kaufman of Arrow Electronics and Gian Fulgoni of Information Resources, respectively, were at the top and bottom of the last two lists. Can they repeat for a third consecutive year? No one has done so yet. But as CEOs learn more about what it takes I to stay on top, perhaps we will see more continuity in our list from year to year. In turn, that would improve the value of the CE Index as an investment and management tool.
Donald W. Mitchell is chairman and chief executive of Mitchell and Co., a financial and management consulting firm in