Just Who's In Charge Of Your Money?

Published in Investing on 11 December 2012

Investors looking for market-beating returns could do a lot worse than this idea.

"Shareholder-friendly companies are ultimately focused on building a sustainable business. That means treating employees fairly, creating compelling products and services for customers that keep them coming back for more, and sharing the spoils evenly among shareholders. As investors we tend to focus on that last part more than the other two, but without them the returns falter eventually – it's just a matter of time."
– Nathan Parmelee

You've heard it a thousand times: shareholder-friendly companies make for very Foolish (big F!) investments.

But what exactly is shareholder-friendliness, and how do you go about finding it?

The single most shareholder-friendly thing a company can do is increase the value of your investment by more than you could have achieved elsewhere.

For me, it all starts at the top – and trickles down through every part of an organisation.

Management is there to run a company so that it increases shareholder value – a fact many CEOs and shareholders seem to have forgotten – and, as such, should make decisions that benefit you and me.

For instance, a few years ago Unilever (LSE: ULVR) (NYSE: UL.US) made a change to how it communicates with shareholders to reinforce its long-term commitment to growing the business.

"It said it was going to put less information in its quarterly reports in terms of short-term profit performance, so that shareholders could concentrate more on how its long-term strategy was developing," says Stuart Watson, premium editor here at the Fool.

"This is perhaps an example of tough love, but it sends the right message about where its focus is."

What's good for the shareholder is good for management, so while I like to see management keeping investors' eyes on the long term, I also like to see the same message in-house.

Of interest to us Fools is, how should we incentivise management to best look after – and grow – our money over the long term? The standard for FTSE 100 companies seems to be to pay CEOs shedloads of cash. However, evidence that this works is scant.

I mean, you don't want your CEO paying himself an exorbitant salary that's out of touch with the value he brings to the business.

Bad bankers

Just look at, well, any bank over the past decade. You'll see compensation schemes that rewarded outsized risk with no consequences for destroying billions in shareholder – and eventually taxpayer – pounds.

Along with salary, you also don't want to see management and employees showered with so many options that your share in the business is being constantly and significantly eroded.

Additionally, if you see a company announcing share buybacks, but you don't see the outstanding share count dropping in conjunction, it likely means the only shares being bought back are those being created by stock awards or options.

That means shareholder (your) cash is being used to enrich company insiders who can't be bothered to hold onto the shares they're being given.

Eat your own cooking

As a Fool, you should want to see a management team that has meaningful ownership in the company. This way, their interests – the success and growth of the business – are aligned with yours and mine as shareholders.

I chatted with Motley Fool analyst Nate Weisshaar about the topic, and he asserted:

"I like Hargreaves Lansdown (LSE: HL) because as an investor I'm invested alongside the founders. Peter Hargreaves and Stephen Lansdown still own over 50% of the company between them. Additionally, the Board shares the company's ample cash flows with shareholders by upping the ordinary dividend 30% per year since 2008 and consistently declaring special dividends on top of that."

Getting scientific

Nate raises a good point. A rising share price is not the only way a company can reward us.

We can also partake in a company's success through its dividend, should it choose to pay one. For reference, all but a few of the companies on the FTSE 100 – the 100 biggest public companies here in the UK – currently pay a dividend.

But like a stock market virtuous circle, the income generated from a dividend isn't the only benefit to shareholders. A few years back a pair of researchers – Rob Arnott and Clifford Asness – broke shares into deciles and measured profits growth over the next 10 years.

Until this report, it was generally accepted that paying a dividend meant a company had less money to invest it its growth, and so shareholders were trading growth for income. However, to the surprise of many, Arnott and Asness found the highest-yielding shares also boasted the highest subsequent profits growth.

"It doesn't make sense – unless you realise that wasteful corporate spending is rampant," says Motley Fool Share Advisor analyst James Early.

"Simply put, managers have far fewer truly profitable growth opportunities than they'd care to reckon. You've probably rightly guessed the takeaway: remaining disciplined and returning cash to shareholders is amongst the most shareholder-friendly things a company can do. That's why shares paying robust dividends automatically catch my eye, and why managements with the self-sacrificing gumption to pay one-time special dividends also deserve an extra look."

The Foolish bottom line

Here at The Motley Fool, our goal is to find companies that will help a portfolio beat the market over the long term. Investors looking for market-beating returns could do a lot worse than putting their money in the hands of management teams that are looking out for the best interests of shareholders.

Shareholder-friendly companies can be found in every sector and come in every size, but they have some common traits. A management team that is focused on – and rewarded for – the long-term success of the company as well as a Board of Directors that shares the spoils with the company's owners (you, me and all the other investors) are two strong signals of shareholder-friendliness.

Unilever is one of several dividend outperformers on the London stock exchange. There's one man who's as keen as I am to find, and invest, in them. I suggest you read all about his best investment ideas now in this free, time-limited report, while you have the chance: "8 Income Plays Held By Britain's Super Investor". This free report analyses the £20 billion portfolio of legendary high-yield expert Neil Woodford. Click here to discover his favourite dividend opportunities with good growth potential.

The Motley Fool owns shares in Hargreaves Lansdown and has recommended shares in Unilever.

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The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

goodlifer 12 Dec 2012 , 10:11am

" However, to the surprise of many, Arnott and Asness found the highest-yielding shares also boasted the highest subsequent profits growth."

Doesn't surprise a simple soul like me.
Isn't it blindingly obvious?

ANuvver 12 Dec 2012 , 9:18pm

On a related point, I see a couple of high profile fund management whizzes have just received the golden axe...

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