Are you asking people to bet their retirement on your vision?
By Geoffrey Colvin
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A fascinating study by Lisa Muelbroek of the Harvard Business School investigates the common complaint that high R&D spending
lowers a company’s stock price and thus invites a takeover.
She looked at companies that became takeover targets to see if they spent more than others in their industry on R&D.
Nope. They actually spent less. As Muelbroek dryly notes, “One might argue that the low R&D by target
firms in years well before takeover bids indicates that the causation flows from low R&D
to takeovers rather than the reverse direction.”
Muelbroek then took an irresistible further step: If the threat of takeovers supposedly forces managers to stint on R&D,
then adopting measures to prevent takeovers would enable them to spend on it as fully as they like.
Does it? She examined hundreds of companies that adopted various anti-takeover measures and found that,
after adoption, R&D (as a percent of sales) didn’t change significantly.
Indeed, since industry-wide R&D spending tended to increase, companies with shark repellents actually
reduced R&D, significantly relative to the industry.
At this point the whiners’ case against Wall Street is badly damaged below the water line and listing heavily.
But diehards may cite the peculiar modern spectacle of investors savaging the stocks of companies
that miss their earnings estimates for just one quarter, and sometimes not by much.
Surely this is evidence of irrational short-termism? Not necessarily.
In a market with often towering P/Es, each penny of earnings is supporting a skyscraper of price,
so when earnings wobble, it follows that prices may tumble.
More important, those so-called overreactions to earnings surprises aren’t always overreactions.
Consider the most spectacular earnings surprise of Oxford Health Plans’ announcement that it would
report a quarterly loss instead of a profit. The stock dropped from $68 to $26 in one day,
in percentage terms the largest one-day erasure of value by a major company in memory.
But what’s most astonishing is that this plunge wasn’t enough. Far from overreacting,
Wall Street didn’t immediately grasp the extent of Oxford’s trouble.
The stock has since drifted down to around $15.
The larger point is that while Wall Street obviously can’t price every stock exactly right at every moment —
this is real life — it goes wrong in both directions. Academic evidence suggests it under-reacts about as often as it overreacts.
All of which makes it hard to sympathize with managers who cry that they’re grievously constrained by nearsighted investors.
For such managers, the evidence presents a few thoughts worth pondering: “ There’s just no reason to believe
that the capital markets are irrationally biased against long-term investments.
If Wall Street doesn’t like your long-term plan, it isn’t because Wall Street generally despises projects with distant payoffs.
It just despises your project. “
The equity markets have been democratized. If you’re frustrated because they don’t rush to embrace
the bright promise of your coffee bars, your hotels, your casinos as enthusiastically as you’d like,
remember that nowadays you’re asking people to bet their retirement and their kids’ college education on your vision.
Are they really being unreasonable? Face the fact that all those crazed short-termers are people pretty much like you.
If you see a winning investment for your company that Wall Street just doesn’t get, that’s worth money.
The only logical move is for your company to make the investment — after all, you’re sure it will pay off —
and then get yourself more heavily into the company’s irrationally low-priced stock and wait.
Buy it, or take your pay less in cash and more in stock. In short, put your money where your mouth is.
After removing the pacifier, of course.
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