PRLog - June 19, 2014 - ELK GROVE, Calif. -- Simply put, value investors do not buy stocks because they are cheap, but rather for the reason that they represent a good value. Furthermore, their level of involvement will classify them into one of two types:
Passive: These investors buy value stocks and then wait for the value to be recognized by the market. The Investment Committee employs a passive strategy with our investments.
Active: These investors see opportunity in stocks that they feel management is missing. They take an active role in the value creation and will often get aggressive if they feel that action is needed to get a company to change their ways.
Passive investing is relatively straightforward because it’s not much more than a “buy and hold” strategy. On the other hand, active investing can be quite complex and even highly aggressive at times. Here’s how it works:
The activist investor screens for undervalued companies and identifies the reason why a specific company is undervalued. If actions by management can make that value realized, they will acquire the stock. Some examples of potential management actions that can create value include spinning off subsidiaries or underperforming divisions, using cash to buy back stock or paying a larger dividend, sell the company, etc.
Typically, the activist investor will meet with the management team of the company to make their case to unlock value within the enterprise. These conversations often go nowhere given an aversion towards change from management (think about how many CEOs would welcome criticism from an outside party) or due to a fundamental disagreement on just how much value can be unlocked.
If conversations with management are not constructive, then the activist investor will often publicly lobby the Board of Directors to adopt their proposed changes. The Board oversees company management and is established to serve in the best interest of shareholders. Therefore, they have the power to replace managers and force some level of change when necessary.
If both the management team and Board resist an activist investor’s idea(s), a “proxy fight” can emerge. Basically, the activist will lobby other large stockholders in an attempt to get enough shareholder votes to force the Board to make change. All in, the whole process can take years and require a tremendous amount of time, effort, and most of all patience.
Simply put, the main difference between an active and passive investor is that although both strive to identify hidden value in a stock, an active investor will take part in unlocking that value whereas a passive investor leaves that job to the current management.
Activists are tenacious and will publicly fight with management for years when necessary. In fact, many will lobby government officials and even get litigious with Boards. Although many of their tactics may appear hostile, they serve a very important purpose in markets because managers realize that when they destroy shareholder value, activists will likely be there to step in and demand change.
For example, the management team at Apple had been criticized for years over their exorbitantly large cash balance, which exceeded $150 billion at one point. Such a large cash balance sitting in the bank earns no interest, and financial theory states that if a company has no credible growth prospects then they should give cash back to shareholders so they can redeploy that cash into better investments.
Despite shareholder frustrations, Apple was never the target of an activist until their stock fell from close to $800 down to $500 in a matter of months. The pressure on management continued to escalate to the point where two very well known activists, Carl Icahn and David Einhorn, got involved. Both investors are quite powerful on Wall Street and are savvy enough to know how to apply pressure to corporate management and Boards.
The end result has been a much more shareholder friendly Apple, where they now pay a strong dividend and have been buying back shares. The Investment Committee strongly agreed with the activists involved in Apple because the company was not acting in the best interest of shareholders who did not have as strong of a voice as Mr. Icahn.
Although this example with Apple shows the good in activists, there have been several scenarios where the bad, and even the ugly, has emerged. At the end of the day, activists are trying to make money and often their incentives are not aligned with the long-term health of a target company.
Activists have been known to fight to achieve short-term results that will cause only a temporary pop in the stock. The activist will then book a healthy profit by selling the stock with little regard to the long-term fundamental health of the company. Furthermore, activists tend to force managers to spend time and energy fighting them instead of dedicating their focus to running the business.
Article Credit: Global Financial Private Capital, Comprehensive Wealth Management, LLC
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