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Sunday, March 24, 2013

Second of Three Rambling Posts

The January-February, 2013, issue of the Harvard Business Review had two somewhat interesting articles. I was reading a print issue while waiting for my wife's car to be serviced. Unfortunately, one can't read the entire article on-line without a subscription. But here are my notes. One of the two articles was titled "Total Shareholder Return: The Grass Isn't Greener," by Evan Hirsh and Kasturi Rangan.

The authors looked at approximately 50 sectors in which one can invest, such as oil and gas, chemicals, commercial banking, leisure equipment, water utilities, utilities (non-water), etc.

The authors were exploring the question what a new CEO should do to improve shareholder return. The authors suggest that a lot of (new) CEOs look to other sectors when trying to improve shareholder return rather than concentrating on their own core competency. Moving into another sector can be done a couple of ways: start a new business from scratch; or, buy another company.

The authors provide a very revealing graph. They plot shareholder return over time by sector, and then within sector by company. The median shareholder return across all 50 sectors was incredibly unvarying: the median was pretty much 17% across all 50 sectors, and throwing out the two outliers, the sector with the lowest return and the sector with the highest return, made the median return even more consistent across all sectors. So, whether the sector is leisure equipment or chemicals, the median return of the sector was about 17%.

However, there was a completely different story within sectors. Some sectors varied from highly negative returns to highly positive returns. Other sectors had very narrow differences.

It was not surprising to see the utility sector with the least variability. The worst-performing utility was not a whole worse than the best-performing utility, at least compared to the oil and gas sector in which the spread between the worst-performing oil and gas sector and the best-performing sector was huge.

The sectors with the largest spreads: commercial banks, chemicals (huge spread), and oil & gas.

The sectors with the narrowest spreads: energy equipment, utilities, water utilities, life equipment , packaging, road and rail, and leisure equipment.

The article was written for CEOs and consultants when faced with the question what to do when looking to increase shareholder return. Their conclusion: don't look outside one's own core competency. On average, if a company moves into a new sector, the company will very likely simply meet the median for shareholder return; worse, moving away from their core competency and it could be much worse.

And that's where the article ended.

But, for investors, there might be another takeaway. It seems obvious, but if one wants to increase the odds of improving one's personal investing return, invest in a sector with a larger spread on shareholder return. If one invests in utilities, one almost doesn't need to do a lot of research looking for the best utility. The spread between the best and the worst is very narrow. But if investing in commercial banking, one must be a very, very good stock picker (or very lucky). The spread between the best commercial bank and the worst commercial bank is huge.

With regard to oil & gas, one suggestion. The authors should have separated out oil-centric oil & gas companies from natural-gas-centric oil & gas companies. I assume the spreads would have been much different than the very wide spread for oil & gas companies in general.