Chapter 22

How Companies Communicate with Shareholders

In This Chapter

Attending annual shareholder meetings

Looking at the responsibilities of the board of directors

Keeping abreast of corporate special events

Listening perceptively to analyst calls

Getting information from company websites

Investing through company incentive programs

Happy shareholders don't necessarily make for a happy company, but they're a good start. Although a company collects most of the money generated from stock transactions when the stock is first sold to the public during an initial or secondary public offering, shareholders still hold a bit of power over management. Angry shareholders showed what their wrath could do when their lack of support for Disney CEO Michael Eisner helped oust him from the chairmanship of the board in 2004. In August 2013, at the time of this writing, another very public fight to oust the chairman of the board and interim CEO of J.C. Penny Company was being led by a hedge fund manager, among others.

Sending out quarterly and annual reports aren't the only strategies companies use to keep their shareholders informed and happy. Other activities include analyst calls, special meetings, website services, e-mails, stock-investment plans, and individual investor contact. In this chapter, I review the steps companies take to inform their investors of operations and to respond to any investor concerns.

Making the Most of Meetings

At the very least, a company must hold an annual meeting for its shareholders. These events are often gala affairs that are more like a carefully orchestrated pep rally than a place where you can get solid information. The company's top officers make presentations highlighting what they want you to know and put on a show that closely resembles what you find in the glossy portion of an annual report.

The big advantage of being at the company's annual meeting is that you can ask questions, which you can't do if you just read the financial reports at home. Prepare yourself before the meeting by reading the recent financial reports, as well as annual reports from the past couple years, so that you're fully armed with details about what has gone on in the past. Make a list of questions that you want answered by the company's executives so that you're ready to ask them when the opportunity arises. Note that if shareholders are unhappy with the corporation's board or its executives, annual meetings can turn into major shouting matches when the floor is opened to questions and comments.

If you're a shareholder, the company notifies you about the date and location of the meeting. In addition to asking questions, shareholders vote on any open issues. Almost every annual meeting includes the election of at least some members of the board of directors. Most companies stagger the election of board members over a number of years so that the entire board doesn't change in one year. Other issues that involve major changes to the way the company does business are also voted on, such as a change in executive compensation.

Sometimes shareholders add their own issues to the agenda. For example, environmentalists who own stock in a company may seek a shareholder vote on how the company gets rid of its waste (to ensure that controls to protect the environment are in place) or how it develops land it owns near a wildlife preserve (to be sure wildlife is protected during and after construction).

Sometimes a corporation calls a special meeting if the shareholders must vote on a significant issue before the next annual meeting. A possible merger is one of the most common events to spur such a special meeting.

Innovative companies see annual meetings as a way to communicate effectively with their investor base. The problem for many firms is that most shareholders don't show up. But the Internet can help reach them — some companies place all their meeting materials on a website, and companies may even webcast the meeting itself and archive it for shareholders to watch at their leisure.

Checking Out How the Board Runs the Company

Corporate governance is the way a board of directors conducts its own business and oversees a corporation's operations. Ultimately, the board of directors is liable for every decision the company makes, but in reality, only major shifts in the way the company operates make it to the board for decision. For example, if executives recommend that the company take on a new product line that involves a large investment of cash, they consult the board for this decision. However, most day-to-day decisions are left to the company's executives and managers.

Watching the directors

The shareholder landscape changed dramatically after the corporate scandals of the 2000s exposed severe corporate governance problems, beginning with the collapse of Enron. Today shareholder groups — many led by institutional investors such as pension plans and mutual funds that own large blocks of shares in various companies — closely watch the following four major issues in the companies in which they own shares of stock.

Composition of the board of directors

Shareholder groups monitor the makeup of the board, how board members are chosen, and how many members serving on the board are truly independent — meaning that they're not directly involved in the day-to-day operations of the company. Outsiders prefer that a majority of the board members be independent because independent board members can be more objective (they aren't protecting their own jobs and their own income).

Compensation packages for board members and CEOs

These details are on public record now. In addition, shareholders must approve of or be notified of any major benefits or compensation offered to the company's executives, such as stock option plans (offers to buy company stock at prices below market value). Shareholders complain bitterly if they believe executives are receiving excessive compensation.

Takeover defenses and protections

In some cases, board members place defenses against the possibility of a company takeover. For example, Comcast unsuccessfully attempted a hostile takeover of Disney during the battle between shareholders, led by Roy Disney, who was attempting to oust Michael Eisner. Sometimes these defenses help protect shareholders from a corporate raider who wants to buy the company and sell off the pieces, which can leave shareholders with stock that's worth very little.

Other times these defenses prevent a takeover by some other company that may benefit the shareholders but not the current management team and board of directors (especially if the leadership ranks would change under the new owners and they could lose their jobs). Shareholder groups watch whatever takeover defenses or protections the board puts into place to be sure their best interests are protected, not just the best interests of the directors and the management team.

Audits

The primary responsibility of the board of directors is to review the audits of the company's books to be certain that both the internal accounting team and the external auditors are accurately handling them. Today the Securities and Exchange Commission (SEC) requires that independent board members make up the audit committees.

Before the Enron scandal, many audit committees weren't as independently run, which allowed company insiders to control not only how money was spent, but also how it was recorded in the company's books and how the financial results were reported to outsiders. This insidious practice allowed top executives to more easily hide any misdeeds or misuse of funds.

Speaking out at meetings

Shareholders can voice their opinions during annual meetings and during any special corporate meetings the board of directors calls to address a specific issue. At these meetings, shareholders cast weighted votes, called proxy votes, based on the number of shares they hold. If board members aren't responsive to shareholder concerns on any of the issues in the preceding list, they may find themselves defending a major challenge at the annual meeting.

Before the Enron scandal, a shareholder rarely brought forth an issue for the rest of the shareholders to vote on; most often, the corporation's board of directors controlled what the shareholders voted on. If a shareholder issue even made it to the point of being voted on by the other shareholders, it rarely had a chance of passing. Today shareholders are more successful at getting issues on the agenda to be voted on at an annual meeting; sometimes they win the proxy vote, and sometimes they lose.

A proxy fight can cost a corporation millions of dollars, no matter who wins, as illustrated by Hewlett-Packard's pricey battle in 2001 and 2002 (see the sidebar “Hewlett-Packard's costly clash”).

Moving away from duking it out

Since the success of the shareholder fight to oust Michel Eisner from the chairmanship of Disney's board of directors in 2004, corporations have been finding ways to negotiate with unhappy shareholders to avoid fighting it out in a proxy vote.

To avoid a costly proxy fight, boards of directors negotiate with unhappy shareholders by meeting with them quietly behind closed doors and discussing the issues on which they disagree, with the hope that they can find a solution that both sides can accept. If the shareholders and the board fail to find common ground, a proxy fight is likely. Knowing that a proxy fight can cost millions, more corporations are wising up to the fact that they need to listen to their shareholders.

One of the major leaders of proxy fights is large institutional shareholders, along with the help of other state retirement systems and some mutual funds. These large institutional investors hold large blocks of stock in their pension or mutual fund portfolios, so they have a lot to lose if a company doesn't do what they believe it should do.

Many times, the issues include how the board of directors operates and how many independent directors serve on the board and its various committees, particularly the audit committee. New rules about independent directors were adopted after the Enron scandal. Under revised SEC Rule 10A-3, a public company must appoint independent directors to the audit committee, and the committee must establish procedures for complaints regarding accounting, internal accounting controls, or auditing matters, including procedures for employees to confidentially and anonymously submit concerns regarding questionable accounting or auditing issues.

Sorting through Reports

Mailing out reports on an annual and quarterly basis is the primary way a corporation informs its shareholders about its performance. Many companies allow shareholders to opt for electronic reporting. Instead of sending a paper report, they notify their shareholders that the report is available online. Not only does this save money for the company, but it also enables shareholders to access the report more quickly. Some companies are experimenting with mobile apps, but as of this writing, it was not yet prevalent.

The corporation usually mails the annual report before the annual meeting, along with information on the proxy votes that will take place at the meeting. Proxy information is a critical part of the annual report package because voting by proxy is the primary way shareholders get to voice their position on board decisions. Many companies also provide for online voting at their website.

The mailing also includes information about the board's position on any issues that will be presented at the annual meeting. If the board brings an issue to the shareholders for a vote, the board explains the issue and its position. If a group other than the board brings the issue to the shareholders, the board states the issue and discusses why it's in favor of or opposed to the issue. In most cases, the board opposes issues brought by outside sources.

An outside group raising or opposing an issue is also likely to mail its position to the shareholders. Walter Hewlett spent about $15 million mailing information to Hewlett-Packard shareholders in an attempt to stop the merger with Compaq, which I discuss in the earlier sidebar “Hewlett-Packard's costly clash.”

Catching Up on Corporate Actions

Corporations must report special events to their shareholders as soon as the event can materially impact the company's results (affect the profits or losses of the company). The most common special events include the following:

• Acquisitions: Before a company can finalize plans to acquire another company, it must report those plans to its shareholders.
• Class-action lawsuits: If a company is the defendant in a class-action lawsuit that can have a material impact on its results in the future, the company must report the lawsuit and discuss its potential impact with shareholders.
• Mergers: If two firms plan on merging, the firms’ management must inform shareholders and also ask them to vote on the merger. If shareholders in either company vote against the merger, the deal is likely cancelled. Sometimes companies may revise the deal and attempt a second shareholder vote.
• Dividends: Whenever the board decides to pay dividends, it has to report that information to the shareholders. Of course, dividends are one of the few items boards enjoy reporting, so they usually make a very public announcement to shareholders about the dividend payments.
• SEC investigation: If a company discovers that the SEC is investigating it, the company must report this knowledge to its shareholders in a timely manner.
• Stock splits: A stock split occurs when the board decides to make one share of stock worth more than one share. For example, a stock split may be two shares for one, which means that each shareholder gets two shares of stock for each share that he holds. Most times, a company announces a stock split when it believes the price of its stock has gotten too high for the market. So a stock that sells for $100 before a two-for-one stock split sells for $50 a share after the split.

In short, a company must give its shareholders the lowdown on anything that materially impacts the business's value. In fact, companies must report to the public and to financial analysts within 24 hours of telling any company outsider about a major event, such as the ones I list in this section, that may impact a company's net income materially.

Culling Information from Analyst Calls

Today investors get information not only by reading press releases or newspapers, but also by attending company calls for analysts, which used to be open only to financial analysts and institutional investors. Companies usually sponsor these calls when they release their annual or quarterly earnings reports. But special events — such as a change in company leadership or the purchase of another business — can also prompt companies to set up analyst calls. By listening in on these calls, you usually get more details about whatever issues are being discussed.

The company CEO, president, and chief financial officer (CFO) typically participate in these calls. They usually start the call by discussing the recently released financial reports or by explaining the impact that the special event has on the company; then they usually open the call to questions.

The question-and-answer part of the call is often the most revealing, as you can judge how confident senior managers are about the financial information they're reporting. Questions from the audience usually elicit information that press releases or the annual or quarterly reports haven't revealed. Most times, analysts and institutional investors ask the questions; in many situations, individual investors don't have an opportunity to ask questions at all, but you can still learn a lot by listening to these conversations. And don't hesitate to write or call the company's investor relations department to get an answer to a specific question you may have about the financial report or the special event discussed during an analyst call.

The language participants use in an analyst call differs from the language you use every day. Familiarize yourself with the most commonly used terms before listening to your first call. I list most of the key terms and abbreviations used during analyst calls in Part III of this book, where I discuss analyzing the numbers. Get comfortable with terms like earnings per share (EPS), EPS growth, net income, cash, and cash equivalents. Check out the sidebar “Decoding analyst-call-speak” for more on analyst call lingo.

If you hear a term you don't understand, write it down and research it after the call. Then the next time you listen in on one of these calls, you'll have a better understanding of what's being discussed.

Listening between the lines

Pay attention to how the executives handle the call and to the words they use. When management is pleased with the results, you usually hear very upbeat terms, and they talk about how positive things look for the company's future. When management is disappointed with the numbers, they're more apologetic, and the mood of the call is more low key. Instead of talking about a rosy future, they'll probably explain ways they can improve the disappointing results.

You most likely need to listen to more than one call hosted by a particular company before you start picking up the nuances and moods of the executives. Try attending as many of these calls as you can or listening to a recording of a call after it occurs. Many companies actually post recordings of their analyst calls on their websites, just like they post press releases.

Take the time to read the financial reports before the call so you're at least familiar with the key points that management discusses during the call. After you listen to a few calls for the same company, you'll find that the information management discusses is much clearer.

Earnings expectations

All calls about a company's financial results include information about whether the firm has met its own earnings projections or the projections of financial analysts. If a company misses its own earnings projections, the mood of the call will be downbeat, and the stock price is likely to drop dramatically after the call.

Of course, you don't have to sell the shares you own if you happen to be a shareholder. If you're listening to the call because you're thinking about buying the stock, you may want to do so after the bad news drives down the stock price. The key for you as a shareholder or potential shareholder is to analyze what's being said and whether you think the company has a good chance of turning around the bad news. Good news, on the other hand, can drive the stock price higher. Be careful not to jump on the bandwagon right after major good news is announced. Usually, the stock price falls back down to a more realistic price after the initial rush to buy is completed.

Revenue growth

Listen for information about the company's revenue growth and whether it has kept pace with its earnings growth. Growth in revenue is the key to continued earnings growth in the future. During an economic slowdown, watching revenue growth becomes very important because a company can play with revenue numbers to make them look better. In fact, some companies practice what's called window dressing (using accounting tricks to make a company's financial statements look better) to make sure their earnings meet expectations. Earnings growth is easier to manipulate than revenue, so earnings usually become part of that window dressing. I talk more in Chapter 23 about how a company can manipulate its results.

If you hear numerous questions from the analysts about revenue growth figures, it may be a sign that they suspect a problem with the numbers or are disappointed with the results. When you repeatedly hear analysts’ questions about revenue or any other issues, take a closer look at these numbers yourself. Do further analysis and research before you decide to buy or sell the company's stock.

Analysts’ moods

Listen carefully to the analysts’ tone as they ask their questions. Take time to assess their moods. Do they seem downbeat? Are they asking very probing questions, or are they upbeat and congratulating the executives on their performance? When analysts are disappointed with a company's results, they dig for more information and ask for more details about the areas where they see a problem. The call's discussion focuses on past results and how management can improve future results. When analysts are happy with the results, they encourage further discussion about future results and plans.

You may find it difficult to judge the mood of the analysts or company executives when you listen to your first call, but as you listen to more calls for the same company, you'll be able to judge more easily how the mood differs from that of previous calls.

The right facts

You can judge whether the executives are confident in their reporting by how quickly they answer the questions. When executives are comfortable and confident in the numbers, they answer questions quickly, without rustling through papers. If they're cautious with their answers and are constantly taking time to look through their papers, you can be sure they're not comfortable with the report and must carefully check themselves before answering the questions.

If company executives seem unsure or respond slowly, take this as a red flag that you need to do a lot more homework before making any decisions about buying or selling that company's stock.

An eye to the future

Listen to the vision that the company's executives portray for the future. Does the vision they present inspire you, or are they unclear about their vision for the company's future and how they plan to get there? If you find the executives uninspiring, they may not be doing a good job of inspiring their employees, either. If you see a downward trend in the company, this may be one of the reasons for that trend. When executives lack inspiration for the company's future, you have good reason to stay away from investing in that firm.

Employee satisfaction

Keeping employees happy is important for the future of any company. During the call, you can judge whether employees are satisfied by listening for information about the success or failure the company's having attracting new employees or retaining existing ones. If the business reports a problem with either of these two areas, trouble may be on the horizon. High employee turnover is bad for the growth of any company, and a firm that has trouble finding and recruiting qualified employees may also face a difficult future.

Don't ever plan to buy or sell stock based only on what you hear during analyst calls. Use the calls as one more way to gather information about a stock that you're thinking of buying or for tracking stocks that you already own.

Knowing when to expect analyst calls

To find out when a company plans to host an analyst call, check out the investor relations section of its website. Some companies just post a recording of the call on their website. A few companies don't even mention the calls; in this case, you can call the investor relations department and ask whether you can attend their analyst calls. Some firms do ban investors from analyst calls.

Some companies offer investors a service that alerts them to upcoming events. If the companies you plan to follow don't offer these services, your best way of tracking upcoming analyst calls or listening to previous calls is through one of two websites: Yahoo Finance (http://biz.yahoo.com/cc/) and Earningscast (www.earningscast.com/).

Staying Up-to-Date Using Company Websites

The Internet provides an excellent way for companies to stay in touch with their investors. Companies can include an unlimited number of pages on websites that investors can access whenever it's convenient for them. Because investors can print multiple copies of the information provided online for free, businesses can save the expense of providing thousands of pages of information to their investors.

In addition to basic information — such as company headquarters, mailing address, phone numbers, and key executives — many companies post their firm's history, market share, vision and mission statements, credit ratings, and stock dividend history. Many companies also post all the information from their annual meetings, financial reports, press releases, and key executives’ speeches, and they allow investors to order paper copies of previous annual and quarterly reports up to five years old. So the Internet is a handy tool that gives investors greater access to company activities and helps the firm keep its investors better informed — which improves the company's long-term relations with its investors.

Regarding Reinvestment Plans

Another way a company can build better relations with its investors is to offer them stock directly so they can avoid broker costs on every share they buy. Some companies offer their investors dividend reinvestment plans and direct stock purchase plans. Both plans provide companies effective ways to maintain direct contact with their shareholders instead of going through a broker.

Dividend reinvestment plans

Dividend reinvestment plans give current investors a way to automatically reinvest any dividends toward the purchase of new shares of stock. To take advantage of this plan, shareholders must register their stock directly with the company instead of opening an account with a broker.

Shareholders can reinvest all or just part of their dividends through the reinvestment plans. Many times, these plans offer investors the opportunity to buy additional shares by using cash, check, or a debit that's automatically taken from the investor's bank account. This option gives small investors a way to steadily increase their ownership in the company. Many firms also allow investors to access their dividend reinvestment plan on the company website, making maintaining accounts and managing transactions even easier.

Direct stock purchase plans

Through direct stock purchase plans, companies can offer stock directly to the public so that investors don't have to contact a broker to purchase even the first share of stock. Prior to these programs, investors had to buy stock through a broker before they could participate in a dividend reinvestment plan.

Today shareholders can buy all their stock directly from a company, if it offers the service, and avoid paying any broker fees. Direct stock purchase plans also provide the same features as dividend reinvestment plans, such as the ability to reinvest dividends.

Depending on how a company sets up its program, the shareholder or the company may pay the direct stock purchase plan's fees. Some companies offer this service for free; others charge a fee for every transaction, which can amount to more than what a broker charges. Be sure you understand the fees involved if you buy directly from a company, and compare those fees with the cost of buying through your broker to make sure you're getting a good deal.