Is A Bad Reputation A Bad Investment?

By Greg McFarlane | January 18, 2012 AAA
Is A Bad Reputation A Bad Investment?

Can you invest while keeping an eye on social concerns, or should the two be mutually exclusive? The objective of any investment strategy is, obviously, to maximize returns. The objective of life, one might argue, is to do good while avoiding evil. Therefore, some investors' interpretation of the latter goal means compromising the former one.

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Some investors, indeed the managers of some
mutual funds, refuse to place their money with tobacco companies, casino operators, firearms manufacturers and/or military contractors. Others take a positive approach, seeking out wind power companies and their ilk. Then there's USA Mutuals, with its candidly named Vice Fund (Nasdaq:VICEX) that picks up specifically those stocks that their more restrictive counterparts want no part of.

Scandals?
If any company remains in business long enough, and achieves some modicum of profitability, sooner or later some interest group will accuse it of exploitation. Some groups advocate that McDonald's makes children fat. Environmental groups go after American Airlines for producing greenhouse gases, International Paper for destroying the rainforest and Exxon Mobil for poisoning the air.

Even what is arguably the best-loved company in America isn't let off the hook. Apple's (Nasdaq:
AAPL) mammoth vendor Foxconn, the company that actually made your iPad and iPhone, achieved notoriety in 2010 for a series of employee suicides. But Foxconn is so enormous, with 920,000 employees in China alone, that a handful of suicides would seem statistically inevitable.

What's more, Foxconn isn't under Apple's auspices. It supplies just about every tech giant you can think of, including Microsoft (Nasdaq:MSFT), Cisco (Nasdaq:CSCO), Dell (Nasdaq:DELL), IBM (NYSE:IBM), Hewlett-Packard (NYSE:HPQ), Motorola (NYSE:MSI), Toshiba (OTCBB:TOSYY) and Amazon (Nasdaq:AMZN). But Apple is Foxconn's highest-profile customer, and Foxconn itself doesn't plaster its own logo on every item that leaves its factory, therefore it's Apple that bears the brunt of the criticism.

However, purely from an investment standpoint, does being indirectly tied to employees jumping off buildings mean anything? Mere months after the Foxconn suicides began, Apple bypassed Exxon Mobil (NYSE:XOM) to become the world's largest corporation by book value. (For more insight into analyzing companies with less-than-great repute, read Playing The Sleuth In A Scandal Stock.)

PR Nightmares
There are few words as loaded to First World sensibilities as "sweatshop." It conjures up images of downtrodden laborers operating under the hand of an angry floor boss; or worse yet, that of a cold and impersonal corporation populated by empty suits on the other side of the world.

In the 1990s, critics saw Nike as the primary beneficiary of cheap labor, allegedly exploiting innocent workers in Southeast Asia while marking up prices extravagantly. It could be argued that for many people in Cambodia, a nation where 58% of the populace work as subsistence farmers, a Nike factory job is seen as a good career.

In Cambodia, few prospects are as enticing as indoor employment, where you get to sit down, work set hours and have days off. Given the purchasing power of the nation's currency, a Cambodian job that pays less than American minimum wage may still provide a decent standard of living.

Still, for a clothing manufacturer, even the faintest association with the word "sweatshop" means devoting resources to a defensive public relations campaign and fending off accusations. Even today, Nike remains an easy punchline, largely because of the company's name recognition.

Negative PR, justified or otherwise, has minimal impact on a company's long-term prospects. In the early 1980s, before tamper-resistant packaging became commonplace, a murderer in Chicago added potassium cyanide to several bottles of Tylenol and killed seven people. It's hard to imagine a worse development for a company than that, yet today Tylenol maker Johnson & Johnson (NYSE:JNJ) remains a staple of the Dow 30. (For more on how bad public image can affect a company, read Does Bad PR Make For A Good Investing Opportunity?)

To our knowledge, no company has suffered lasting damage as a result of opening a factory in a poor country, printing its catalogs on paper from old-growth forests, or in the case of Tommy Hilfiger, having its founder falsely accused of racism.

When a company has its ethics called into question (excluding business ethics and adherence to law, a completely different subject), it's rarely the end of the world. Usually, all the company needs to appease the indignant (and get back to making money) is a brief mention on the company website about its commitment to corporate responsibility, loaded with words like "virtues," "stakeholders," "ethical," "progressive" and "fairness."

The Bottom Line
Borders Group never incurred the wrath of any nationwide protest movement; it merely sold books and coffee. Hollywood Video had business practices as ecologically sustainable as anyone else's. Lehman Brothers didn't produce anything physical, nor did it hire people at slave wages (far from it, in fact.) Yet all three went out of business in spectacular fashion in the last couple of years, because of obsolescence or excessive leverage. Unsustainable leverage, if you will.

Thus, it may not sound palatable to investors who espouse social responsibility, but non-economic objectives have little correlation to a company's bottom line. (For more on companies with a rough history, read Stock Scandals: Why Some Companies Survive.)

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