Why investors should beware of corporate waffle
When top executives try to retreat behind impenetrable jargon, investors should be very sceptical, says John Stepek.
Corporate jargon is an irritating fact of life. But it can also damage your investment returns, if a new study is to be believed, reports John Authers in Bloomberg. Analysts at investment bank Nomura looked at the language used by top executives at America’s biggest listed companies (those in the Russell 1000 index) in conference calls discussing their annual and quarterly results, going back to 2014. They used a readability tool to rate the communications for complexity (readability tools analyse aspects such as sentence length and choice of words). They found a strong correlation between clarity and returns: share prices of the stocks whose executives used the clearest language in calls far outperformed those who waffled or used lots of impenetrable jargon.
This makes logical sense. If someone can’t explain their business strategy clearly, it usually means one of two things: either they don’t know what they’re doing, or they do know what they’re doing, and they’re trying to hide it from you. Neither is a good prospect for an investor. What’s more, the analysis backs up previous research into the relationship between corporate communications and earnings. For example, one study published in the Research in International Business and Finance journal in 2016, found that French companies that used more complex language in earnings reports also were more inclined to use debatable accounting techniques to make their results look better than they really were.
Lessons for investors
There are many examples of skilled communicators who have done well for their investors over the years. Warren Buffett’s annual letters to Berkshire Hathaway shareholders are perhaps the most-scrutinised corporate documents in investment history. In his own shareholder letters, Amazon founder Jeff Bezos also proved highly skilled at boiling down a complex business to some key strategic points. Here in the UK, fund manager Terry Smith is admired for his forthright views, while a large part of Simon Wolfson’s success as head of retailer Next is his commitment to explaining very clearly what the company is doing and why.
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Yet you don’t need to hunt down CEOs or managers with exemplary communication skills. Here’s a simple test to carry out on your own portfolio right now. Look at your holdings. Are you confident that you could clearly explain to another interested investor what your reasoning is for owning each fund or stock? Try to sum it up in a sentence for each one. If you can’t, then maybe it’s a sign that it shouldn’t be in there – or at the very least, that you need to do more homework. Give it a go – I suspect you might be surprised.
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