Few stockmarket stories have been more spectacular than that of Domino’s Pizza – the crusty fast-food franchise that transformed itself into a quasi-tech play with a valuation on par with tech heavyweights Google or Facebook.
From blueprints for drone-enabled pizza deliveries to “gamechanging” menu tweaks that left customers confused, chief executive Don Meij has a reputation for hyperbole.
But high expectations bring high risks as, investors found out on Tuesday. Shares in the company fell more than 20 per cent after earnings missed the lofty guidance he set the market. Mr Meij has since worked his magic to restore some faith and stem the decline, with shares rallying 5 per cent across Wednesday and Thursday.
But the harrowing sharemarket reaction underlines the challenges chief executives have with setting the expectations of investors and the costs of failing to deliver – which can linger well into the future. A wild ride on the stockmarket, induced by a hyper-enthusiasm, could shake out longterm investors, leaving a fickle, confused share register and the unwanted attention of short-sellers.
Selling the story
So is it the job of a CEO to get their share price as high as humanly possible? Most experts say not.
“We always say it’s not the CEO’s job to spruik but to educate. It’s about getting fair value for the share price,” says Ronn Bechler, the managing director of Market Eye, an investor relations firm.
“It really should be about education and getting the market to make an informed judgment. You have to be forthright about what is right, and what is wrong.”
Bechler says constructing a sustainable share register is important for management and shareholders.
For instance, if the register is dominated by growth investors and the company with a high valuation fails to meet lofty expectation, there could be a fair amount of time before value investors are prepared to step in.
“A stock price can be stuck in no-man’s land with long-term supporters exiting and short term too expensive for what they regard as fair value.”
How a CEO sells the story depends on their personality, but also on the way they’re rewarded by the board. An executive with short term incentives tied to the stock price is more likely to spruik aggressively, versus one with pay skewed towards long-term incentives.
Overs and unders
And a turbulent share price could create turbulence for the management team too.
Global equity investor Wayne Peters of Peters McGregor made the point in an interview with AFR Weekend.
“An overvalued share price can be just as bad as an undervalued price, because shareholders judge management on price movements,” he said.
“I’ve seen numerous occasions where management have come in, done an outstanding job, but because the share price was much higher than it should have been and subsequently dropped, and they’ve been sacked.”
A chief executive presiding over a surging stock price will lap up the accolades and win the adulation of shareholders and the media. But in time it could attract the wrong sort of attention – from media again, regulators and quite often short-sellers.
It may seem like “tall poppy syndrome” at play, but for the shorters it’s just business.
Hedge funds are trained to look for overvalued stocks and chief executives who they regard as overly “promotional”. That’s born out of extensive experience in tracking the fortunes of faddish stocks.
A case in point is Valeant, the controversial US drug company that had a spectacular run before it’s share price collapsed. Valeant’s business model involved acquiring drug manufacturers and jacking up prices of vital treatments, leaving patients will little choice but to cough up.
“That story worked so long as they stayed under the radar because this is not a story they could tell openly,” said New York University valuation expert Aswath Damodaran in a recent talk explaining why he was too bullish on Valeant.
“They got too ambitious. When they tried to raise the price of the drugs people noticed and the whole company unravelled.”
Damodaran said they underestimated the importance of corporate sustainability in the valuation process.
“They did so much damage to their reputation that nobody trusted them.”
In some cases, spruiking the story is everything, particularly in the venture world. The more compelling a story for a start-up, the more cash they can raise to cover the growth funding burn. The better the spruik, the longer the runway.
That applies in spades to Elon Musk and Telsa. To find his seemingly limitless ambitions to battery power cars and just about everything else, he needs as much capital as he can get.
While he’s often accused of grossly over-hyping the prospects of Tesla, in doing so he supports a high valuation, cheapens the cost of capital and gives himself a better chance of achieving those ambitions.
But it can’t go on forever. Eventually, the day will come when investors that have bought his story will have to confront the price they paid.