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Column

Gary Sutton
Author
‘The Six-Month Fix’

Good Directors Ignore the Stock Price

It’s too distracting, and it’s not what really matters anyway.

By Gary Sutton

He’s an icon. The Ultimate Director. You know his name.

In one of those random encounters that should never happen, he and I ended up sitting next to each other at a banquet. We shook hands. Heads turned. He sat and the rest of the room followed suit.

I asked how one of his companies was doing.

“Terrific,” he replied, obviously pleased I knew he was on their board. “The stock’s been above 50 for almost a month.”

I asked what the P/E ratio was.

“You know, I’m not sure,” he said, thrusting out his jaw.

I inquired about the operating cash flow.

“Oh, we don’t watch those details,” he said. “Management manages and directors direct.”

How tragic. One more empty suit.

Of all the trivial distractions directors should ignore, the stock price is number one. Your daily value is mildly interesting yet totally irrelevant, except in one case, which we’ll discuss shortly. But even then, the premise wobbles.

First, let’s review the reality of public stocks. There are no investors anymore. We are all owned by traders. Most investment funds report more than 100% turnover per year. Take the average daily volume of your favorite blue chip, divide that into the total shares outstanding, and you’ll see this again. Your conservative company is probably changing ownership totally once every year.

Sure, day traders and hedge funds do much of that. But don’t get fooled when IR shows you that Fidelity and T. Rowe Price and the others have held the stock for years and years. Because what those guys do, since they get bored every Monday, is called “trading around the core.” That means when the price drops under a certain low point, they buy some, and each time it climbs over another number, they sell some. This keeps them busy. It also automatically defines the trading range.

So why should you care, as a director, about the price? There’s only one circumstance, a semi-legitimate one, which we’ll cover in a minute.

But first, do all stocks stay within a range? No. They crash through those arbitrary floors when something awful happens, and the short sellers drive it down farther and faster. And they’ll bust through the ceiling when the fundamentals, like growing cash or increased net earnings, finally make the P/E ridiculously low. That draws the outside investors, not your existing traders, and the short sellers have to cover. And this makes the dramatic leap even bigger.

That’s why net earnings and operating cash flow trends are all that matter. They’re the baseball game. The rest aren’t even balls or strikes.

The public stock market is a cheap source of capital -- a wonderful thing. Unless you plan a secondary offering or are fueling growth through acquisitions -- whereby you issue new stock to acquire others, which is one of Wall Street and Mr. Ponzi’s favorite scams -- the stock price doesn’t matter. If that’s what your company is all about, then yes, overfeed data to the analysts and turn up the volume. Issue more news releases. Redefine your business to fit each fad du jour. Just understand the music will stop one day.

Shouldn’t directors be rewarded when the stock soars? No.

Directors should get quarterly options at market prices. They should vest over several years. Directors should be allowed to exercise and sell no more than half their vested options on a predetermined schedule. That way the weirdness of the trading is neutralized in their compensation.

With at least half their stock frozen, they capture something closer to a true value over the longer term. But that happens only when operating cash flow dramatically moves the trading ranges up or down. So now our board “selfishly” worries about the business fundamentals, and little else.

When directors are compensated that way, they shrug off the rumors of the day, the unexplainable spikes and drops, and focus on what matters. When the price spikes up, their options get more expensive, and when it plummets, their options are cheaper. When they’re holding on to half, at minimum, distractions go away. Temptations to account aggressively, take excessive writeoffs for later recapture, over- and underaccrue, or spend too much time schmoozing analysts disappear.

So avoid watching your stock price. Trust me, you’ve got plenty of friends who will let you know every time it moves anyway. Let them spin their wheels.

Oh, the Ultimate Director? The media report he’s been added to two more Fortune 100 boards in the last year. Go figure.

Gary Sutton has served as a CEO and director of a number of public and private companies in his career as a specialist in startups and turnarounds. He is the author of The Six-Month Fix: Adventures in Rescuing Failing Companies, published by John Wiley & Sons, and writes the “Sutton’s Laws” column in each issue of Directors & Boards. He can be contacted at garysutton@san.rr.com. His Web site is http://www.sixmonthfix.com.