A number of academic studies profess that if the sample size is decent, the consensus estimate is the best estimate to use when solving for an unknown. In practical terms, the consensus opinion is often correctly used in political futures, sports betting, best traffic routes, guessing jelly beans or beating the stock market.
Based on this premise and personal experience, the best way a CEO can run a corporation is to maximize transparency and listen for market feedback. In essence, a CEO should let the market help him or her do the job. As an investor, if you can identify CEOs who do this, you may be on your way to finding outperforming stocks for your portfolio.
How Would CEOs Do This?
The goal of the CEO should be to become very transparent. This would be a CEO who pushes for full disclosure of accounting and other operational items. It could also be a CEO that is visible, meeting with investors, analysts and the greater investment community. Essentially this CEO would strive never to leave the analysts befuddled about anything. (Read Disclosures: The Good, The Bad, And the Ugly for information on transparency.)
For a CEO, transparency involves:
- Listening to Feedback
If the CEO is successful on the first point, the investment community would be armed with great information to determine the best plan of action for the company. Thus, all the CEO would have to do is listen to and facilitate feedback. A CEO might do this by reading research analyst reports, combing for ideas and concerns, and asking questions of the analysts.
The CEO could also look beyond analyst estimates and into their assumptions. Moreover, CEOs should be visible and inquisitive by taking full advantage of visiting their shareholders at events like investor conferences.
Additionally, CEOs can review market actions. For example, if a peer company undergoes a strategy shift, the move could be viewed in conjunction with market response. If the relative move of the stock is up, then the market liked the strategy change; if the relative stock market move is down, it can be concluded that the opposite was true.
- Filtering Out Market Noise
While this information can really equip a CEO with market intelligence that can be used to guide the respective company, the chief executive needs to filter out the market noise and start to look for consensus themes. In essence, he or she needs to build a strategy mosaic. At this point an adept CEO can use the market-suggested path and couple it with the internally known mechanics of the organization, thereby maximizing decision-making performance.
Do CEOs Do This?
CEOs do have a choice between running their own agendas in a vacuum or listening to market counsel. Some CEOs do listen to the Street very well, while others take a combative response, viewing analysts as meddlers. Because of hubris, some CEOs take an almost opposite tact as dictated by the Street in order to prove their independent decision-making skills. Academically, this is the opposite of the wise approach, which is to use market intelligence.
The chief executive role is a position of power, and with it comes the vulnerabilities to traditional power mistakes like empire building. Many CEOs would rather add to their kingdoms by pulling in more assets through mergers and acquisitions than focus on being efficient with the resources they already have. Investment bankers can often fan the flames in this regard because they are often well-compensated when hired by a company.
Finding Street-Savvy CEOs
Thankfully for the investor, there are companies that listen to wise counsel. They think before they act. They visit with analysts and shareholders to learn their thoughts and then start to build their consensus strategy, always keeping an ear to the Street. How do you identify these CEOs? Here are a few indicators to watch for.
- Assess Transparency
The key characteristic to assess is transparency. One way this can be subjectively measured is by reviewing EPS announcements. Is the release thick with a lot of detail or is it three pages? (For more insight, see Assess Shareholder Wealth With EPS.)
Second, look for presentations done by the company on its website. If it is holding conferences, it should have a good number of these - at least one per quarter. Most importantly, listen to the conference calls. Are CEOs straightforward in addressing analyst questions or are they circuitous? Are the analysts confused after question responses or enlightened? If the CEOs seem like they are keeping their cards too close to their vests, this is usually a negative sign. (To learn more about how to assess a conference call, read Conference Call Basics.)
- Compare Corporate Strategy and Market Sentiment
Next, match up what analyst reports say are good moves to corporate strategy. These could be things like timely merger and acquisition opportunities, cost cutting, dividend reductions, stock buybacks etc. If the analyst community consistently recommends courses of action and the CEOs seem to heed the advice, this is a good sign.
Lastly, match up whether corporate policy goes with the grain or against it. For example, does the company raise its dividend when everyone else is cutting? If so, this could give insight that the CEO is turning a naked eye to the environment (market convention) and is singularly focused on inward opinion.
As an interesting rule of thumb and good reference, most of the companies Warren Buffett invests in are likely to have a CEO that keeps an ear to the Street. Corporate governance is a big deal for Buffett and he really doesn't have room for hubris in his portfolio of companies. Names like Coca Cola (NYSE:COKE) and Wells Fargo (NYSE:WFC) come to mind as examples of strong industry performers for many years.
While their respective industries may go up and down with economic cycles, they traditionally seem to outperform their peers. (Take a look at our article Warren Buffett's Best Buys for an idea of the type of companies he invests in.)
The Bottom Line
Academic studies indicate that CEOs who listen to the Street are often connected to stocks that generally outperform their markets. This is neither common sense for CEO personalities, nor is it operationally fettering. In essence, the CEO's role is to determine how to steer the corporate ship in the turbulent market waters where assessing market wave patterns (market consensus) greatly helps in the navigation process. In looking for outperforming stocks, the investor would be wise to look for CEOs that run their businesses in such a fashion. (For further reading, check out Is Your CEO Street Savvy?)