To Communicate With Investors, Identify The Target.

This article discusses how to discriminate important investors.

Robert N. Palter, Werner Rehm, and Jonathan Shih

Many executives spend too much time communicating with investors who have no need to pay attention.

In particular, chief executives and chief financial officers often invest too much time with investors in one-on-one talks, attend investment meetings, and participate in other shareholders' communication activities when they do not know which investors are really important.

Part of the reason is that too many companies use traditional methods to segment investors, which only leads to superficial understanding of investors' motives and behaviors.

For example, we often encounter some investor relations teams who imitate the traditional methods of investors used to segment enterprises and try to position investors as growth or value investors.

They expect growth investors to invest more, so if companies can persuade them to buy their own stocks, the share price of the company will go up.

This expectation is wrong because many growth investors are buying after the share price rises.

More importantly, the traditional subdivision method is difficult to reveal the way in which investors buy and sell stocks.

For example, how long does an investor usually hold positions for a stock?

What is the concentration of the investor's portfolio?

Which financial and operational data are most useful to the investor?

We believe that the answers to the above and similar questions can provide a better insight into the classification of investors.

Once an enterprise subdivides its investors according to the correct classification method, it can quickly identify the most important investors.

We call these important investors "intrinsic" investors, who build investment decisions based on in-depth understanding of the strategy, current performance and potential for long-term value of the target business.

Compared with other investors, they are more likely to support the management of enterprises in a short period of turbulence.

If executives can take the initiative to contact internal investors and hand over other investors to the investor relations department to make contact with 2, they can reduce the time invested in investor relations and deliver clearer, more important information.

As a result, the intrinsic value of an enterprise will be better aligned with its market value, which is one of the core objectives of investor relations 3.

Better subdivision

No executive will contact with an important customer without knowing how to make a purchase decision, but many executives often communicate with them without knowing the investment criteria of investors.

We analyzed the general holding period, the concentration of investment portfolio, the number of professionals involved in decision-making, the average paction volume and the degree of detail required by investors when conducting research on target enterprises.

These analyses show that investors can be divided into three types.

Internal investors

Internal investors will make investment decisions only after strict and conscientious investigation of the inherent capability of target enterprises to create long-term value (Figure 1).

Such a review usually takes more than a month.

We estimate that internal investors hold 20% of the assets of the US stock market and account for 10% of the volume of pactions in the US stock market.

We interviewed more than 20 internal investors and found that their portfolios were relatively concentrated - each stock held an average of 2% to 3% of their portfolios and a maximum of 10%, while the average proportion of each investor in the portfolio was less than 1%.

At the same time, the number of shares held by each investor in internal investors is very small (4~10 corporate stocks), and the holding period lasts for several years.

Once they invest, these professionals will support the current management and business strategy to ride out a brief period of turbulence.

Given the various efforts made by internal investors, executives are expected to get their full attention when they are in active contact, because these investors will take time to listen, analyze and put forward insightful questions.

These investors can also have a significant impact on the intrinsic value of an enterprise and its market value.

This effect is immediate, because once they trade, the volume of pactions will be large (Figure 2).

Internal investors will also have a psychological impact on the stock market, because they have a good grasp of the reputation of trading opportunities and enhance their influence on other investors.

A clear proof of the influence of internal investors is that many websites on the Internet, such as GuruFocus.com, Stockpickr.com and Mffais.com, are tracking the trend of the investment of the famous internal investors.

Technology investor

Technical investors include computer operated index funds and investors who use computer models to guide pactions. They make investment decisions according to strict standards or rules.

We also refer to the so-called "closet index fund" in such investors.

The cupboard index funds are large institutional investors whose portfolios are relatively large, similar to those of index funds, but they have not positioned themselves as index funds 4.

We estimate that about 32% of the total assets of the US stock will be held by all kinds of pure technology investment funds.

Because the decision making method of technical investors can not really adopt qualitative decision criteria (such as the strength of management team or the advantages of enterprise strategy), investor relations can not affect these investors to incorporate an enterprise's stock into an index fund.

Similarly, these investors' quantitative decision criteria, such as buying stocks with low price earnings ratio or buying stocks that do not exceed a specific scale, are based on mathematical models of accuracy or high or low, rather than insights based on the basic strategy and value creation ability of target enterprises.

In the closet index fund, every professional investor manages 100~150 stocks on average, so they can not conduct in-depth research. The management of investment target enterprises can not influence their investment decisions through meetings.

Each professional manager manages many stocks, partly reflecting the fact that most of the closet index funds are members of large investment companies. These investment companies distinguish between the responsibilities of fund managers and researchers.

By contrast, managers of internal investors have a deep understanding of every enterprise in their portfolio.

dealer

The professional investors in the dealer group seek short-term financial gains, and they bet on news. For example, quarterly earnings per share (EPS) of a company may be higher than or lower than the market estimate, or a pharmaceutical manufacturer has recently reported that its clinical trial progress is not favorable.

Dealers control about 35% of the stock assets of the United States.

Such investors do not want to really get to know the target business. They are looking for quality information for the purpose of reaching a deal.

This is not to say that traders do not understand enterprises or industries; on the contrary, these investors closely follow news about enterprises or industries, and are often in direct contact with enterprises to seek subtle changes or insights that may have significant impact in the near future.

However, each professional investor of such investors should track 20 or more stocks on average, and quickly buy and sell in order to obtain small profits in the short term (short to several days or even hours).

Therefore, executives have no reason to spend time on dealers.

Emphasis on communication

Most investor relations departments can build the subdivision that we describe.

They should also consider more levels of information, such as whether investors hold (or plan to hold) stocks of an enterprise, or whether they have invested in other enterprises in the industry where they are located.

A thorough segmentation of investors to identify mature internal investors will enable enterprises to manage their investor relations more successfully.

Do not over simplify information issued by enterprises.

Internal investors have made a lot of efforts to understand the target business, so do not simplify the discussion of corporate strategy and performance to newsletters issued by news media or dealers.

The management of enterprises should also be honest about the current performance of the company and its relationship with the enterprise strategy.

As a portfolio manager said, "I don't want to get insider information, but I do hope that management can be honest with me when they talk about their business performance.

If they avoid discussing or unwilling to explain, no matter how attractive the relevant data looks, we will not invest. "

Interpreting feedback in the correct context

Most enterprises agree that it is helpful to understand investors' views when formulating strategies and establishing communication with investors.

However, business management often relies on briefings from investors and seller analysts to get information, which includes everything from strategy, quarterly earnings to stock buyback.

This method is difficult for management to relate the views of investors to their importance to enterprises or to their investment strategies.

The segmentation method clarifies the objectives and needs of each investor, so that executives can interpret investors' feedback in the correct context and weigh all kinds of information accordingly.

Optimal allocation of management time

Chief executive or chief financial officer should only spend time with the most important and knowledge-based investors who are the most knowledge-based investors.

In addition, if the stock analysts have already arranged a visitor list, unless the management thinks that the scheduled meeting clients are internal investors, the CEO should carefully consider whether it is necessary to attend the meeting.

If an enterprise can concentrate on communicating with these internal investors, it will probably gain greater influence in a relatively short period of time.

According to our experience, internal investors believe that executives should spend less than 10% of their time on activities related to investors. Therefore, management should at most only interact with 15~20 investors.

The investor relations department should identify the most important investors, regularly review the list of investors, and keep the management from being disturbed by analysts and technical investors who are not the key communication partners.

Only when stock analysts' reports can provide an important channel for interpreting complex news, executives should communicate with stock analysts. Otherwise, the investor relations department can provide analysts with any relevant data they need.

Marketing executives often segment customer groups according to the decision process adopted by customers, and customize corporate image and large advertising activities for the most important customers.

Enterprises can take similar precise analysis and benefit from investor relations.

About the author:

Robert Palter is a director of McKinsey Toronto branch; Werner Rehm is an associate director of McKinsey New York branch; Jonathan Shih is a consultant of New York branch.

The author would like to thank Jason Goldlist and Daniel Krizek for their contributions to this paper and basic analysis.

Notes:

2 this article only discusses institutional investors, because management usually spends most of their time on them.

3 if this goal seems to contradict intuition, it can be considered in another way.

4 for more discussion on the "closet index fund", please refer to the How active is your fund manager, A A, Martijn, Cremers, and Antti Petajist co authored by the American Financial Association (Chicago), January 15, 2007.