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Companies are stuck in a delicate ‘balancing act’

(25 Views) May 7, 2016 10:06 am | Published by | No comment

tightrope

Reuters

Freddy Nock of Switzerland walks on a tightrope during a competition in Wulong County, Chongqing

Nothing is easy in business, and no one ever claimed it would be.

The challenge that companies now face may be a little more difficult than usual, however, according to Mike Thompson chairman of S&P Investment Advisory services.

“Running a publicly traded company is a serious balancing act,” Thompson told Business Insider. “You have to appease both long-term and short-term investors in order to keep yourself around and that’s incredibly hard.”

Thompson, whose firm provides equity research for S&P and has $ 30 billion in assets under advisement, said the current economic environment is particularly tricky for companies.

There’s little growth, choppy markets, and rampant uncertainty so knowing where the line for short- versus long-term is a tough task.

Right now, according to Thompson, most companies are rightfully leaning towards the short-end. Buying back shares and appeasing investors with debt financing makes sense since interest rates are so low. Once the macro-environment turns around, said Thompson, companies should lean harder on equity financing to pay down that debt.

Thompson, in fact, had a radical thought on what companies should be doing right now.

“I question the value of having a public company right now,” Thompson told Business Insider. “This is the type of environment to stay private, work off of debt, and then go public when that’s no as accessible.”

The tricky part of that is knowing when these factors are going to turn around. For one thing, the Fed’s interest rate outlook is perplexing and there is conflicting data on whether or not it is harder to get loan.

Additionally, as we’ve noted in the past, falling off either side of this tightrope is getting more and more dangerous for companies. If you focus too much on the long-term, the penalty for missing on earnings is severe. Whereas, if you go too short-term, this can draw criticism for financial engineering. Striking the balance is key according to Thompson.

The solution, in Thompson ‘s opinion, is that companies (and investors) should focus less on their earnings per share or price to earnings ratios and more on one number: return on invested capital (ROIC).

ROIC is a measure of return to the company made on each dollar invested, whether it be on a buyback, hiring an employee, or building a factory. Companies with increasing ROIC, according to Thompson, typically outperform the market.

“Basically ROIC is like if you were to wake up in the morning and everything goes right,” Thompson told us. “You get the perfect parking spot at the train station, you arrive right when the train gets there, you get in to work at the exact right time. If every decision you make turns out really well, that’s a good analogy for a high ROIC. It’s a referendum on your decision-making.”

In his opinion, as long as the company is growing their ROIC, they are succeeding in their balancing act.

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