The annual shareholder letter, ostensibly penned by a company’s chief executive officer, might seem lost amid the ubiquitous graphics and numerical overload of the digital age. But an emerging field of investment research known as financial linguistics informs us that those yearly correspondences could actually impart valuable clues about a company’s prospects — or lack of same — and should be considered required reading for all current and prospective investors.
Rittenhouse Rankings developed a proprietary model based on 100 topics organized into seven categories, including accountability, vision and candor. For example, a letter lost points for what Rittenhouse considered “negative candor” or “F.O.G,” a clever acronym for “fact-deficient, obfuscating, generalities.” The results of the Rittenhouse study are eye-opening: Between June 2007 and June 2016, the 25 companies in the top quartile of the rankings outperformed the S&P 500 in all but one 12-month period.
Notably, that performance gap widened significantly over the last four years of the survey, perhaps in response to the role a perceived lack of candor played in underwriting the Great Recession. Over the full 10-year period, companies ranked highest for candor generated an annualized total return of 18.1 percent, compared with 7.1 percent for the S&P 500 index.
A review of the 377 readily available letters from companies composing the S&P 600 SmallCap index by securities analyst Elizabeth Howell Hanano produced similar findings. Howell Hanano ranked each letter on a scale of 1 through 10 (with 10 being highest) on the basis of criteria drawn, in part, from practices employed by the widely acknowledged master of the shareholder letter, Berkshire Hathaway CEO Warren Buffett. Companies to which Howell Hanano assigned a 10 rating outperformed the index over each of the one-, three- and five-year periods through Oct. 23, 2017. The results, she concluded, “makes it clear that reading shareholder letters truly is an important part of the investment process.”
A forthright CEO letter isn’t by itself a reason to own a stock, just as an opaque version would be insufficient reason to pass. Still, assuming an annual shareholder
letter is available, its language could contain valuable pieces to the investment puzzle. Consider the few minutes it takes to read the letter time well spent.
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