Do your top priorities include certain behaviors that tend to make investors happy, like tightly controlling general and administrative expenses and spending a lot of cash on share buybacks? If so, consider making a new priority list.
That viewpoint is suggested by research from corporate research and advisory firm CEB, which was recently acquired by Gartner Inc.
CEB identified a group of 60 companies that were in the top quartile of their respective industries as measured by “efficient growth,” defined as growing earnings by expanding both revenue and profit margin. It also constructed a 60-company control group by pairing each of these “efficient growth leaders” with another company in its industry with similar product lines and no more than a 25% revenue differential.
As would be expected, given the outperformance in both revenue and margin expansion, the first group provided a substantial (7.5%) total shareholder return (TSR) premium. But, notably, the group did so even though its selling, general, and administrative (SG&A) expenses were 16% higher than those of the control group. High SG&A is something that investors typically object to.
CEB, in fact, has arrived at a similar conclusion a number of times, although CFOs, for their part, are apparently still not warm to the idea. “There’s something very controversial about this, and it’s been a slowly brewing battle [between CEB and] finance executives for the past five or six years,” says Dennis Gannon, a principal executive adviser with the firm. “No matter what filters we use, we always come back to the fact that the best-performing companies tend to carry more SG&A than their peers do.”
He adds, “Companies that win in the market have G&A resources available to actually hire people on the ground, for example, or connect [disparate] systems because they have IT business partners. We’re not saying G&A is something you should just let run wild, but it’s not something to just always be managing downward unilaterally.”
Further, despite spending more on SG&A, the efficient growth companies had 15% more cash (as a percentage of total assets) on hand than did the control group.
“Investor relations officers hear every day that companies have too much cash and should be spending more of it on share buybacks,” Gannon says. “But [the study suggests] there’s a strategic value to cash on the balance sheet in terms of being able to move quickly on an acquisition or bridge a capabilities gap in short order, without having to wait for the market to allow you to do it.”
On top of higher SG&A spending, the efficient growth companies had 36% lower working capital turnover and a 4% higher effective tax rate than did the control group. All of those would typically be expected to exert a negative drag on TSR, all else being equal. But given the above-mentioned TSR premium that the better-performing companies enjoy, investors may see greater value in other, more-positive metrics applicable to such companies, like 32% greater return on assets, 10% greater return on invested capital, 28% less debt as a percentage of total assets, and a whopping 79% greater return on R&D spending.
Efficient growth leaders “get there by focusing much more on the big, chunky growth bets and less on sweating the year-to-year operational efficiencies,” says Gannon.
Finally, the efficient growth companies gave 22% less guidance than did companies in the control group. That, according to Gannon, shows that it’s more important for a company to tie its messages to long-term performance than become beholden to short-term expectations.
Companies tend to reduce the frequency of guidance in response to external factors, Gannon notes. Currently, the SEC’s strong focus on disclosure, particularly related to non-GAAP reporting, is the newest driver of the trend, he says.