B) Estrategia Financiera
1. Objetivos Financieros Estratégicos y Específicos
The failure of specialist analysts to anticipate a Dutch corporate collapse comes as no surprise
It is often said that one can learn more from failure than from success. Having experienced a fair number of failures in our European portfolios over time, we can confirm that this maxim applies to investment. Looking at the fail- ures of others can also be instructive (and replete with Schadenfreude). The case of Ahold, the Dutch-based international food retailer, provides one of
Europe’s most significant implosions of shareholder value in recent years.1
Fortunately, our small team of generalist investment professionals spotted in advance the dangers created by capital misallocation, mismanagement and murky accounting at the world’s third largest supermarket group. The ques- tion remains why teams of highly specialized (and highly paid) analysts failed to do so. We have retrospectively examined research on Ahold, published by some of the leading brokers. To our mind, this research reveals systematic flaws in the specialist analyst model, which largely derive from the relation- ship between research analysts and the companies they follow.
1. Too close to management
There is always a danger that an analyst is “captured” by management. This risk rises for specialist analysts who spend most of their time covering a small handful of companies, whereas a generalist might cover a few hundred. Capture poses the threat that an analyst lands up becoming the mouthpiece of management. In the case of Ahold, capture was a real and present danger. Take, for instance, the titles of one brokerage analyst’s reports: “Live From Zaandam” (the company’s headquarters), “Visit with Stop & Shop,” and “A day with top performing CT Stop & Shop team and a night with the CFO.” The analyst’s choice of titles reveals, to our minds, an unhealthy proximity to Ahold’s management.
Ahold was also notoriously opaque when it came to disclosure. By occa- sionally giving privileged information to particular analysts, the recipient may have felt (consciously or not) that he or she owed management a favour – what is known as “reciprocation tendency.” And when things started to go wrong, the weird and wonderful effects of Stockholm syndrome – whereby the hostage becomes the mouthpiece for his captor – may have taken hold.2
2. Too much information
Having more information doesn’t necessarily improve decision-making. We know from studies of horse racing that when handicappers receive more information about the horses and riders, they become proportionately more confident even though they are no more likely to pick the winner. When 1 On 24 February 2003, shares in Royal Ahold fell 63 per cent on the NYSE after the Dutch supermarket group announced earnings had been overstated by close to $500m. The accounting problems related to the operations of its US foodservice business.
2 In The Economist (27 February 2003), a brokerage analyst complained of Ahold man- agement’s “attempt to frighten us.”
analysts have too much data, there’s a danger they won’t see the wood for the trees. Obsessing over Ahold’s quarterly like-for-like sales per square foot and a multiplicity of other metrics did not provide a good insight into what was to come. Analyzing the company’s cash flow over a five-year period, on the other hand, got one quickly to the key point that Ahold’s management had failed to generate cash from its core business.
Then there’s the danger of “cognitive dissonance,” when information which conflicts with a previously formed conviction is blocked out. This appears to have afflicted one broker who, having reached the conclusion that Ahold had been unfairly derated (in valuation terms) after diversifying into the foodservice business, subsequently appeared blind to negative informa- tion about the company. It later transpired that the profitability of the food- service operations had been fraudulently misstated. Our racecourse punters apparently become more confident of their opinion after having placed their bet. The danger is that the analyst reaches a conclusion based on a single line of thought and then sticks with this view, come what may.
3. Living in a cocoon
Specialist analysts operate in a cocoon, in which they are overexposed to company management and peer analysts and underexposed to what is going on in the rest of the world. Herding instincts may tend to reinforce similar opinions among peer analysts. Their thinking starts to reflect what Daniel Kahneman calls the “insider view.” In the case of Ahold, the specialist retail analysts spent a great deal of time comparing the company’s performance, on a range of measures, with US peers such as Albertson’s and Kroger. As global investors, however, we find it more useful to compare the returns of a company in a particular industry with those in other industries and coun- tries. A specialist analyst couldn’t say whether Ahold was a good investment relative to, say, a Scandinavian paper company or a Thai cement plant.
4. Poor incentives
Management has a huge influence over the capital allocation of a business. Decisions taken by senior executives are likely to be influenced by their incentives. Yet specialist research rarely addresses the key issue of incentives. (In the brokerage reports on Ahold, there was no comment on the subject of incentives.) Perhaps, this oversight on the part of sell-side analysts relates to their own incentives and the bad feeling that such a discussion might provoke
with their colleagues across the Chinese Wall in corporate finance. While there was a good deal of spin from Ahold about the introduction of incentives schemes based on Economic Value Added (EVA), we were told that the chief executive was primarily rewarded on the basis of earnings per share (EPS) growth – a metric which can be boosted with acquisitions and by the use of leverage. This did not give us a very warm feeling, given the malleability of Dutch GAAP accounting and Ahold’s acquisition roll-up growth model. Things appeared even worse when we discovered that the CEO owned fewer than 1,700 shares (worth $70,000 at their peak) in the company.
5. An even worse performance metric
Unsurprisingly, in the light of these incentives, Ahold turned out to be excep- tionally good at delivering earnings per share (EPS) growth. The company achieved the notable feat of 23 consecutive quarters of double-digit EPS growth. This record turned out to be too good to be true: Ahold’s annual results for 2000, 2001, and the first three quarters of 2002 were all restated. Why do specialist analysts pay so much attention to earnings per share? One reason relates to short measurement periods. As we observed above, quarterly cash flow statements are relatively meaningless. Using the principles of accrual accounting, management has a certain leeway in what numbers they report. Unfortunately, there is a good deal of scope for cheating. Quarterly EPS figures also play a role in a stock market game. Once analysts set the market’s EPS expectations for the next quarter and management beats the expected num- bers, the share price can be expected to rise. We have previously discussed the futility of this game, vulnerable as it is to “Goodhart’s Law” (namely, that once a data point is widely used as a measuring stick, it ceases to be reliable).3
The above is not to say that specialist analysts are without merit. We call on them to help us cut through the jargon that each industry produces and to help us stay abreast of key industry trends. At the same time, we have no intention of importing the specialist analyst model in-house because of the dangers we have outlined above. The difficulty we have is in persuading others that “expertise” (i.e., a lot of knowledge) doesn’t necessarily lead to superior investment results. The reasons, we believe, are subtle and complex. The sorry tale of Ahold sheds some light on what can go wrong.4
3 See Capital Account, pp.209–12.
4 Marathon subsequently acquired shares in Ahold in mid-2014, after the company had shrunk its business and shifted the focus of executive remuneration from an EPS target to return on capital employed.