Financial data and when to ignore it

It’s obvious that primary financial markets matter, when a company raises capital following a share issue. However, most activity occurs in secondary financial markets, where investors – mutual funds, pension funds, and insurance companies - trade stocks between themselves and the company itself isn’t involved. It’s tempting to write off the secondary market as a strange sideshow that doesn’t impact real business and real lives, and suggest that the resources consumed by the £120 billion UK financial services industry be reallocated.

But prices do matter. In particular, what matters is not only the level of the stock price, but how much information they contain. Active secondary trading increases the informativeness of prices.

Why should society care about informative share prices?

They’re an incentive

A manager’s reputation is often directly linked to his or her company’s share price and his or her performance rewarded with shares and options. Thus, his incentive to take actions will depend on the extent to which these actions are reflected in the stock price. If stock prices are efficient – if they reflect long-run dimensions of a company’s value, such as corporate purpose - this will increase the manager’s incentives to pursue purpose.

They’re a barometer

A company’s share price is freely available information that anyone can consult. That includes managers. You might suppose that they wouldn’t – or shouldn’t - need to supplement detailed inside knowledge of how their company works but they can still learn from the assessments of outsiders.

The share price acts as an opinion poll of the viewpoints of numerous investors - a thumbs up or thumbs down for the management’s decisions. If the announcement of a proposed merger or acquisition is met with a significant drop in share price, a company may reconsider going ahead with the transaction.

Customers, regulators, credit agencies, employees and suppliers use the share price as a weather vane, their perceptions often translating into actions in the real economy affecting the company’s sales and cash flow. Should an ‘ill wind’ blow a company’s share price downwards then suppliers, fearing they won’t be paid, may cease trading with it and potential employees may decide not to join an organisation whose future looks uncertain.

Looking beyond the share price

Non-financial data - things that can’t be quantified can still be measured

However, if the market is inefficient, the stock price may not reflect the entire value of a company until the very long run. When the Financial Conduct Authority removed the requirement for public companies to issue quarterly interim management statements in November 2015, it freed managers of public companies from being so preoccupied with short-term performance and the share price fluctuations that result.

In today’s volatile world businesses face issues requiring long-term solutions - such as sustainability and social responsibility. Traditionally there’s been a certain amount of scepticism about more holistic business models that take into account value that can’t be captured in financial data - customer loyalty, corporate culture, innovative capability and concern for the environment. Some see them as distractions that can only be achieved at the expense of profit. What you give to improving the world or the lives of your employees, you’re necessarily taking away from your shareholders.

Is this true or just prejudice? I decided to find out.

Managers who look after their workers find that profits look after themselves

I spent four years investigating the list of 100 Best Companies to Work For in America, now published in Fortune. Testing 26 years of data revealed that companies that treat their workers well, do better. Moreover, further tests suggest that it’s employee well-being that leads to superior performance, not the other way round. Of course as with any investment there’s a cost. But, higher pay and a positive work environment will improve staff retention, recruitment, and motivation, and boost your bottom line. CostCo in the United States pays its employees higher rates than they’d earn at its competitors and closes on major public holidays - traditionally peak retail times - yet its profits have topped US$2 billion for the past two years. Further results and implications are in my LBS TEDx talk, “The Social Responsibility of Business”.

Quite simply, if you treat your workers well, the profits will follow.

Ditch the short-term data - investors who consider long-term qualitative measures don’t lose out financially

When choosing which stocks to buy and sell everyone can – and does - look at share prices, dividends and price-earnings ratios. But, since other investors are using this information, it can’t give you an edge. My research also revealed that qualitative criteria are the secret to investing success. Intangible assets, such as corporate social responsibility (“CSR”), not only improve firm value in the long run but also are ignored by the market. Thus, socially responsible investing achieves both social and financial goals. There’s no trade-off: investors can both do good and do well. The Parnassus Endeavour Fund, which invests in companies that ‘offer outstanding workplaces’ , has beaten the market by 4% per year since its inception a decade ago. Indeed, even quantitative funds, who have no social mission and are interested purely in profit, have started to incorporate measures of CSR into their investment decisions.

As well as making financial gains, investors who resist following every bump in the short-term data road and don’t dump stocks at the first sign of trouble encourage managers to look to long-term value and profitability.

Look beyond the short term and the quantitative to the long term and the qualitative

What happens in the financial markets, in particular fluctuations in share price, affects a manager’s decisions about what direction his company should take. In turn this impacts the company’s employees, customers and trading partners – people and businesses in the real economy.

But, while informative, the stock price doesn’t give the whole picture.

Pay too much attention to short-term numbers and you won’t be able to see the wood for the trees. 

Pursuing qualitative strategies creates long-term value. Being employee- and environmentally-friendly is not a luxury, it’s a financial imperative. To reach the land of profit, follow the road of purpose.