I am writing from somewhere over the US as I fly home from a very productive three week trip. I spent time canoeing with my dad, witnessed a close friend get married and visited a whole lot of companies along the way. Normally, when the last flight out of Toronto is three hours late, you can expect to miss your connecting flight. A better run airline probably would have had me sleeping on the floor in Charlotte—but not US Air. Like clockwork, my connecting flight is five hours late. I may be arriving in Miami at 4 am, but at least I will be arriving. God bless systematic corporate incompetence.
During this trip, I have been able to visit with a number of fascinating businesses. I am always amazed at the psychology of the public CEO. After surviving the debacle in 2008, these men struggled to hold their businesses together. Now, when it is obvious that things are turning, when the best investor opportunities are to be had, they are the least optimistic publicly. After having witnessed the same manic cycle multiple times—from euphoria, to depression to outright gloom, I have learned to read the telltale signs. I think a quick character sketch is in order as this phenomenon often leads to the best investment opportunities.
Let’s start at the beginning. Life is good and business is growing. The share price is moving up and everyone is happy. The CEO is confident and also very popular. He is verbose on conference calls. He moderates industry conferences and has shareholder dinners. He is accessible and enjoys the notoriety. His best friends are the Wall Street analysts who continually congratulate him with upgrades. Life is good. In fact, he has gotten so carried away that he misses the signs that his business is faltering.
Suddenly, business is not doing too well. Our CEO claims it’s a short term blip. As the shares begin to slowly slide, he becomes even more active publicly. He is defiant and sometimes combative. He acts as if sheer force of will can hold the share price up. “Be patient. All is well. This is a buying opportunity”
Eventually, reality sets in. Hard decisions must be made. Costs get cut and the business is right-sized. This always involves one time charges which inevitable reoccur for a few quarters. Investors become skeptical and the CEO becomes defensive. Why are my former admirers so hostile?The CEO tries to keep a stiff upper lip. “Next quarter we will see progress. This is the bottom.”
You can only call the bottom so many times. Eventually, you lose all credibility. On conference calls, analysts mock you. Large shareholders dump shares after publicly berating you. All your friends who once were rich with your stock refuse to talk to you. You become a pariah. You retreat into your business and ignore the outside world. “If they all hate me, I will ignore them until I can prove them wrong. Let them sell. I will be right in the end”
Eventually, the real bottom is hit a few quarters after the CEO has predicted it. However, there is no rejoicing. Hardly anyone goes on the conference calls any more. Your Wall Street analyst buddies no longer call you because they dropped coverage months ago. In fact, after embarrassing yourself so many times by calling the bottom, you keep silent. In fact, you begin to doubt the recovery. You are so beaten down by investors that you mostly ignore the market for your shares.
Slowly, the business begins to recover. The shares bounce a bit from the nadir and then stagnate. Trading volume is anemic. The world has simply lost interest. Month after month, business get better. However, you doubt yourself. Past upticks had proven to be false. You feel bad for those who lost money on your past prophesies and you refuse to offer positive guidance. Gone are the halcyon days when you would press release every new victory. Now you mostly ignore the wins and dwell on the negatives. Your few public utterances are reserved and subdued. You do not want to lead anyone astray. Your lack of interaction with public shareholders begins to impact your shares. After a short-lived bounce, they begin to droop again on no volume. No one is really selling shares any more, but no one cares to buy.
Ironically, at this moment, just when investors should be buying, just when a CEO should be telling the world what a great investment his company is, just when the shares are most appealing, no one says a word. Analysts have dropped coverage, other shareholders mostly just want to sell the first bounce and the CEO is too ashamed to even bother. I understand why this happens. Ironically, the lack of publicity actually means that the shares get cheaper. This is the perfect time to buy. Even more importantly, it is one of the few situations when you can get non-biased and honest answers from a CEO. Most CEOs will tell you the truth, but it will always be the most optimistic truth. At this special moment, just when the business is turning, you will get the most down to earth and honest assessment of the business. The CEO may wonder why you even want to buy shares. It creates a perfect investment set up. You can hear all the negatives and you can buy a company on the mend at a silly price.
Amazingly, most investors wait until things have improved substantially, not just at the business, but in the CEOs presentation of that business. Eventually, the CEO can no longer hold out. It is obvious that business is recovering. The shares start to climb—people begin calling to hear the story. The CEO gets his confidence up and goes out to conferences again. The share price starts another multi-year cycle. You can own the shares until something doesn’t feel right. Hubris takes over and you have to trust your gut.
I’ve gotten to know some of these CEOs over multiple cycles. It’s the same thing always—I don’t even know if they realize they’re doing it. You literally see a company go from 5 press releases and a road-show each quarter, to not even bothering with a conference call after earnings. It’s a bit manic really.
Of course, there are false dawns. Sometimes it’s darkest right before it goes completely black. You need to judge the business along with the CEO. However, I do find it repeatedly ironic that just when you want to be buying shares in a business—that’s the only time the CEO doesn’t want to tell you the story about why you should be buying those shares. Look out for these moments as investors. Especially look out for the first burst of optimism from a company. After months of silence, the first time the CEO is confident enough to tell the story again, it probably means that things are going real well. It is a strange process, but CEOs are human just like everyone else.