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[sharechat] LEARNING TO INVEST >>>> Guest Contribution

From: "Peter Maiden" <>
Date: Sun, 3 Jun 2001 11:38:22 +1200

As invited by Gerry here is a contribution to his series "Learning to Invest"

Non-financial measures do matter

Why is it that companies such as Baycorp, The Warehouse and Waste Management consistently show superior total shareholder returns over many years when other companies go through ups and downs and only frustrate and disappoint their shareholders?

The performance of these three companies over long periods of time is quite staggering. Baycorp has produced a 70% annual total return to shareholders over the last 10 years. The Warehouse has produced annual returns in excess of 20% over the last five years. Waste Management, who is not one of the darlings of the New Zealand stock market, has returned shareholders an average annual return in excess of 20% over the last 10 years.

I believe what sets these companies apart from the rest is their quality of management. The quality (and stability) of management and the execution of the company strategy has had a great influence on the performance of these companies - performance that has led to the superior returns to shareholders over a long period of time.

I also believe that these companies understand that non-financial measures are very important and it has been the managing of these key non-financial measures that has led to their superior financial returns.

This means that when assessing investment opportunities a prospective investor should find out as much as they can about the non-financial measures that drive the company. Once these are understood then a more considered and less risky investment will be made.

This is not saying that the bottom line does not matter. Of course it does, as does other such vital financial measures as cash flow and P/E ratios.

However financial measures are generally lagging indicators. It is the non-financial measures that drive value in the future.

A proactive management team will have a vision of the future. That team will execute a good corporate strategy, make tough decisions, quickly seize opportunities, allocate resources well, attract talented people (and retain them), drive brand values etc.

Is this belief of mine backed up by research? The likes of Ernst & Young, L E K Consulting and Bain & Co have done a lot of research which supports my belief.

Some of that research has shown that successful companies are more likely to strategically manage key non-financial measures which leads to higher levels of operating performance - which in turn leads to higher share prices.

Simulated studies have confirmed that non-financial data does affect share valuations. What is interesting in these studies is that superior non-financial performance in one area indirectly impacts upon other non-financial criteria. Those studies have shown that if investors like the management quality of a company they tend to judge the company's overall performance more favourably than they would otherwise. - but also they will perceive criteria such as the company's brand image or customer satisfaction levels better even in the absence of hard data on these factors.

It is these incremental changes in perception that have a long term influence. It is closely related to the 'brand halo' effect that has been the subject of extensive academic study over the years. The 'brand halo' effect impacts on both non-financial and financial performance. What this suggests is that all non-financial criteria are fed by performance. and in turn, feed the perception of performance.

Not surprisingly research has also shown that when non-financial data was taken into account earnings forecast were more accurate. This really means that non-financial factors can be used as a leading indicator of future financial performance. More accurate forecasts of future financial performance result in a lower level of risk because the investment decision is made on the basis of more knowledge.

Therefore when considering investment opportunities a lot can be gained from assessing the quality of management and how successfully that management team has guided the company in the past.

This assessment in conjunction with a good understanding of non-financial performance (market share trends, market perception etc) will lead to a far more accurate picture of future prospects.

Hopefully investors will find such investment opportunities for themselves that will enable them to achieve returns like Baycorp, The Warehouse and Waste Management have produced over the years.

Peter Maiden







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