Corporate reputations and the implication for investors
With the ever greater focus on matters like corporate governance and social responsibility in the world of business, the reputations of companies are increasingly in the spotlight. A recent study by the Reputation Institute about the reputation of the tw
A good reputation may benefit a business in numerous ways. But perhaps the most important advantage (at least from an investor’s point of view) that a good reputation may bring is that it may be a reflection of clients and customers’ willingness to do business with the company. A business with a good reputation could therefore perhaps be expected to deliver better financial results in the future than one with a worse reputation. But will this also lead to better returns for the investors in the shares of such companies?
The evidence on this front appears to be mixed. The best study on this topic that we are aware of was by Anderson and Smith (2006). In this study, the authors compared the investment returns delivered by shares of the companies featuring in Fortune Magazine’s annual list of Most Admired Companies (as rated by numerous senior business executives, directors and security analysts) from 1983 to 2004. Being on the list of Most Admired Companies is probably as good a proxy as any for having a good reputation. The authors’ conclusion was that these companies outperformed the market as a whole significantly. But interestingly enough, in a subsequent study (Statman, Fisher, Anginer: 2008) the conclusion was that the shares of companies on the Most Admired Companies list that were rated most highly on the attribute of Long Term Investment Value (one of the attributes on which companies on the list are rated) underperformed those ranked lowest on this measure. The highest ranked shares typically featured higher multiples of earnings and cash flow than the lowest ranked shares, but also higher past sales and earnings growth. So it appears that knowledgeable people are good at identifying good investment opportunities, but they are bad at capitalising on them – they fall prey to the siren song of rapid historical growth and overpay for such businesses.
At RE:CM, we have always placed emphasis on owning high quality businesses: businesses that earn excess returns on capital and have barriers to entry that protect them from competition. Some of the qualities that give a company a superior reputation are also likely to result in it being a high quality business. In fact, there may well be an argument to be made that companies that have done well due to a strong business model become successful and large and therefore people are more familiar with them. Familiarity in turn appeared to be a strong driver of the reputation of a business in the Reputation Institute study mentioned earlier: the more familiar people were with a business the more likely the business was to receive a high score for reputation. This is an interesting manifestation of the affect bias: people tend to view things with which they are more familiar more favourably than other similar items, even if there is no objective difference between the items.
When we research investment opportunities, we do our best to remain unemotional about the business at hand. Things like media reports, that can have a strong impact on the reputation of a company in the eyes of the public and investors, can easily cloud one’s judgement about the investment prospects of a company. We do our best to focus on facts and cross check opinions. It is often at points in time where a company’s reputation has suffered a severe blow in a short period of time that very good investment opportunities arise: the examples of Old Mutual’s solvency scare late in 2008 and BP’s Macondo oil well disaster early in 2010 are two examples that come readily to mind. At such times it is usually only the conviction that comes from having done the work that an investor will be able to look past the short term panic and seize the long term investment opportunity.
The top five companies in the Reputation Institute study were Woolworths, MTN, ABSA, Standard Bank and Vodacom. RE:CM clients currently do not own shares in any of these businesses, but have owned shares in most of these businesses at some point over the past nine years. While we consider all of these businesses to be high quality businesses deserving of the good reputation that they enjoy, our assessment of their intrinsic values lead us to the conclusion that their shares do not offer good value. And in investing, low price trumps lofty reputation over time.
