Cover Story Annual Shareholder Letters by Cheryl Soltis Martel
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Cover Story Annual Shareholder Letters By Cheryl Soltis Martel Wall Street is about numbers: P/E ratios, assets on hand, out- and quality of content in a letter. The company annually ranks standing debt, value at risk, return on equity. All those metrics letters based on high and low measures of candor, and it has carry a wealth of significance for investors seeking insight into a found a positive correlation between candor and share prices. company’s prospects. But shareholders should not overlook an- Rittenhouse says there are several characteristics she looks for in other potential source that taps into the mind of the chief execu- effective letters: strategy statements, capital stewardship metrics, tive: the annual shareholder letter. a discussion of the business model, accountability systems, inno- Annual letters can be mercifully short and simple. But the best vations, leadership, stakeholder relationships and overall candor. annual letter writers recognize that managing a complex enter- Fortunately, there are more than a few CEOs who are visibly and prise has elements of empire building, battlefield risk and quelling vigorously excited about their companies. The letters excerpted on social unrest among shareholders, and they have a knack for the following pages illustrate 10 exemplary communications by bringing investors into these issues with often colorful and candid CEOs, chairmen and, in one instance, a board of directors, that disclosures about the pros and cons of running the business. The provide value to shareholders beyond a simple snapshot of the most effective letters also reveal a company’s spirit or culture; they company’s financial state. Also included are seven letters (including convey optimism (or pessimism) about the future and the com- one from a recent internet IPO) that because of the special circum- pany’s plan for staying the course better than any spreadsheet. stances addressed in a clear, straightforward manner deserve mention. Eric Heyman, senior vice president and director of research at Olstein Capital Management, notes that effective shareholder Selection Methodology letters clearly articulate the company’s strategy and offer specifics NACD Directorship primarily examined annual report letters from about the types of benchmarks the company expects to achieve in Fortune 200 companies filed for 2011. While a few of the selections a candid, open and realistic manner. may raise eyebrows due to recent events, controversy is not equated “A shareholder letter is not only forward looking but backward with bad management. Even when led by the most highly regarded looking,” Heyman explains. “A CEO really has to communicate CEOs, the complexity of these global enterprises may cause circum- to the investment community what took place during the year, stances to reorganize in such a way as to surprise everyone. That is what goals the company set and how it met or didn’t meet those the lesson of capitalism. Letters were chosen based on those com- goals, and what the changes are going forward. Shareholders munications that even in the most challenging times show foresight, need that information to make better decisions on how to view clarity and conviction. Those featured here were evaluated across their investments.” industries using the following criteria: Illustr ■■ A One particular element of a successful shareholder letter is con- A dynamic assessment of the company’s performance tION by greg c sistency, says Heyman. “You want the same candid, clear, concise ■■ Transparency on both positive and negative news communications in good times and in bad times,” he explains. ■■ A clear outline of steps to tackle company challenges ■■ L.J. Rittenhouse, president of Rittenhouse Rankings, an in- A strategic process linked to changes in environment O pel ■■ vestor relations firm, has analyzed shareholder letters for more Insights into the quality of management and its commit- AN than a decade and has developed a model to quantify the amount ment to creating shareholder value d 24 NACD Directorship July/August 2012 July/August 2012 www.directorship.com 25 Cover Story Annual Shareholder Letters The 8 Rules of a Great Annual Letter Rule 3: Bring up succession without sounding like you’re looking at retirement homes. Berkshire Hathaway “your board is equally enthusiastic about my suc- By Jeffrey M. Cunningham cessor as ceO, an individual to whom they have had a great deal of exposure and whose manage- On Feb. 25, 2012, the best oddsmaker in America— rial and human qualities they admire. (We have two who happens to live not in Las Vegas or Atlantic superb back-up candidates as well.) When a transfer City, but in Omaha—penned his annual letter to of responsibility is required, it will be seamless, and shareholders on the bets placed the year before. To berkshire’s prospects will remain bright….do not, translate the dry, quantitative concepts of business however, infer from this discussion that charlie and I into Buffettese is an exacting task, and one that he are going anywhere; we continue to be in excellent approaches with legendary skill. While he takes health, and we love what we do.” credit for performance when it’s due, he is equally enthusiastic about pointing out the errata in his sto- Rule 4: Your shareholders have forgotten all about ried quest for value creation. Both are examples of your business model. Remind them. Letter Writer what sets great chief executives apart: a palpable con- “Our insurance operations continued their delivery Warren Buffett, viction in their vision and a willingness to learn from of costless capital that funds a myriad of other op- Chairman, CEO downdrafts as well as windfalls. In adhering to a rule portunities. this business produces “float”—money Date oN Letter of “anything but truth is unspeakable,” always borne that doesn’t belong to us, but that we get to invest Feb. 25, 2012 by the facts, argued with determination and proffered for berkshire’s benefit. And if we pay out less in losses to shareholders who decide with their wallets, Buffett and expenses than we receive in premiums, we ad- LeNgth of Letter 18,426 words reveals how well he knows his customer. Berkshire’s ditionally earn an underwriting profit, meaning the shareholders expect nothing less than that the boss float costs us less than nothing. though we are sure subject himself to the same fierce scrutiny that he to have underwriting losses from time to time, we’ve demands of his bullish investments. He has been at now had nine consecutive years of underwriting this for more than 40 years, so he’s fairly confident of profits, totaling about $17 billion. Over the same nine the mechanics of the enterprise, yet not a year goes years our float increased from $41 billion to its current by without something that shocks and amazes him. record of $70 billion. Insurance has been good to us.” And when it does, like an excited schoolboy, he can’t wait to bring the new learnings to the attention of his Rule 5: Appeal to universal, not personal, greed, shareholders. Here are the eight rules distilled from because, after all, it is about money. one of the greatest businessmen of our lifetime. “We expect the combined earnings of the four [busi- ness units]—and their dividends as well—to increase Rule 1: Master the art of understatement. in 2012 and, for that matter, almost every year for a “charlie Munger, berkshire’s Vice chairman and my long time to come. A decade from now, our current partner, and I feel good about the company’s prog- holdings of the four companies might well account ress during 2011.” for earnings of $7 billion, of which $2 billion in divi- dends would come to us.” Rule 2: Give your board credit. “the primary job of a board of directors is to see Rule 6: If there’s bad news, hit them over the head that the right people are running the business and to with it. This way your shareholders won’t have to be sure that the next generation of leaders is identi- take notes. fied and ready to take over tomorrow. I have been “I’ve run out of good news. Here are some develop- on 19 corporate boards, and berkshire’s directors are ments that hurt us during 2011: A few years back, I at the top of the list in the time and diligence they spent about $2 billion buying several bond issues of have devoted to succession planning. What’s more, energy Future Holdings, an electric utility operation their efforts have paid off.” serving portions of texas. that was a mistake—a big 26 NACD Directorship July/August 2012 mistake....last year, I told you that ‘a housing recovery will prob- Rule 8: Talk about your team from a shareholder perspective ably begin within a year or so.’ I was dead wrong.” and show why they care as much as the CeO. “For good reason, I regularly extol the accomplishments of our Rule 7: use the specifics of your business to show Wall Street operating managers. they are truly All-stars, who run their busi- how your performance should be measured. nesses as if they were the only asset owned by their families. I be- “charlie and I measure our performance by the rate of gain in lieve their mindset to be as shareholder-oriented as can be found berkshire’s per-share intrinsic business value. If our gain over time in the universe of large publicly owned companies. Most have outstrips the performance of the s&p 500, we have earned our no financial need to work; the joy of hitting business ‘home runs’ paychecks. If it doesn’t, we are overpaid at any price.” means as much to them as their paycheck.” even Warren Buffett Needs an editor carol loomis, a senior editor at Fortune magazine, has edited and that often she has to remove “adjectives that are plowed Warren buffett’s annual letter to shareholders for more than 30 up in front of a noun.” What they sometimes disagree about is a years.