In the wake of the financial crash ten years ago, there has been renewed interest in how to value a company. The complex financial derivatives that appeared to be powerful tools for financial growth before the crisis turned out to be worthless. No one wants to make the same mistake again.
When in 2009 Paul Polman, during his first results presentation as chief executive of Unilever, announced he would not be providing the customary quarterly forecast of the firm’s future performance, the company’s share price plummeted. Here was a CEO, some analysts thought, who having taken the reins of one of the world’s consumer goods behemoths appeared clueless as to the future direction of the firm. Others took the opposite view: why would they lambast somebody for refusing to pretend to know what the future holds? Being in it for the long term does not, as many financial analysts think, simply equate to discounting today’s cash against tomorrow’s future value.
It was an early warning shot, and now nearly a decade later the markets are beginning to catch up with Polman. Among the recommendations of his 2012 review of the excesses of Britain’s stockmarket culture, John Kay, professor of economics at LSE, suggested an end to the cycle of reporting quarterly results to shareholders in a bid to discourage short termism. Many firms have since scrapped the process. Crystal ball-gazing - or “forward guidance” in formal parlance – is being left to the eight out of ten financial analysts who express a preference for such market dowsing.
Others have echoed Polman’s sentiment. In a recent letter to blue chip company bosses, Larry Fink, CEO of Blackrock, the world’s largest investment management firm, urged firms to look to long term value. Fink is seeking to ensure companies understand that long term growth stems from sustainability of the business model and operations, attention to environmental factors that could affect the company, and recognition of the company’s role in the communities in which it operates, including matters such as employees’ personal development and financial security. As Blackrock manages trillions of dollars of investments in public listed companies, it is among the largest single investor in these firms – and so has clout to make its feelings known.
People and profit
What matters to people – be they employees, shareholders, customers or collaborators – are the social footprints companies make when going about their business. People may not wish to work for a company they see operating in ways they disagree with. Nor may they want to buy its products or invest in it. Firms are judged by the company they keep, and billions of dollars are being pulled and reinvested elsewhere on the basis of the long term strategy – or lack of it – the business model and financial horizons a firm might adopt.
Consequently, investors and society more widely are beginning to wake up to the need for long term and sustainable business practices that pay attention to these so-called environmental, social and governance factors. And here, too, Unilever got in early: its Sustainable Living Plan, launched in 2010, aims to double revenue while halving the firm’s environmental footprint.
Unilever sells two billion products around the globe every day, everything from deodorant, soap and washing powder to margarine and ice cream. That involves a lot of plastic bottles, aluminium tubes, plastic tubs, and paper cartons – a formidable amount of material that would keep Sir David Attenborough awake at night. But it’s also what makes Unilever’s employees get up and go to work in the morning: not just to make Unilever’s shareholders money, but to save the planet. They now have a purpose that fosters their longer-term commitment to the company.
New ways of measuring value
The challenge is to articulate, and then calculate the net value of that purpose. Fink encourages companies to “articulate a path to financial performance”, while understanding “the societal impact of your business as well as the ways that broad, structural trends – from slow wage growth to rising automation to climate change – affect your potential for growth”. Companies, he laments, have not been specific enough about their long term strategies. Nor have they been specific enough about the long term value.
This represents an equally daunting ask for the accounting profession. At best, only half the value of a typical firm can be recorded. The other half – the difference between the book value and market value – is intangible. We need to quickly evolve accounting and audit practices if they are to capture the wider sentiment that drives a commitment to long term value created by purpose.
The good news is that work is already underway and initial results are in. They make interesting reading: according to a recent study by the NGO FCLT and consultants McKinsey, around 167 of the 615 non-financial US companies (comprising 65% of the market value of US companies) adopt a long term value approach. Judged against their peers, these companies invest more, have higher quality earnings, and generate higher margins.
Had the rest of the publicly-quoted firms in the US adopted a similar approach this would have added another US$1 trillion in asset value, increased total US market capitalisation by 4%, and added 5m more jobs to the US economy, in turn generating an additional US$1 trillion in GDP. Maybe a focus on long term value also creates short term, and sustainable, rewards.