Be Careful Who You Get into Bed With
It has always surprised me that investors don’t pay greater attention to who they get into bed with. Of course, I am referring to the share register rather than sleeping companions, whom I am sure are (almost) always carefully vetted.
Looking at a share register tells you a lot about a company and even more about the investment. Buying a stock without checking on your fellow shareholders is risky: better than skydiving without a parachute check, but potentially more painful than going to the beach without your sunscreen. Let me explain.
When I talk about the shareholder register, many of my students immediately think of WhaleWisdom and similar websites that use 13-D filings to track investors’ holdings in US stocks. It’s popular to use these as a source of idea generation and it’s not a dumb strategy. Checking the shareholder list is an essential step in my process when I do an initial review of a stock (a process I have coined as the First Pass Financial Profile or FP2)
When I was at hedge funds, I would look at a shareholder register and hope that nobody of note owned the stock, as it meant that we had an undiscovered idea with a greater longer-term upside. Also, the more popular the stock, the less smart I was going to look to my boss – and possibly the less likely that the stock will go into the portfolio. The supposition being that the first gains have been forgone, or even that it’s a crowded trade.
But as a private investor, there is safety and comfort in numbers. You don’t want to be on your own and you certainly don’t need to be. Therefore, when you look at a shareholder register, you should hope to see certain characteristics. I like to see family ownership and I like to understand any external large shareholdings.
1 Concentration of Ownership
Founder-led companies outperform. Credit Suisse found that family-owned companies have outperformed non-family-owned peers on average by 370 basis points a year from 2006 to late 2020, with smaller companies (sub-$3bn market cap) outperforming globally by twice as much as larger companies.
Founder-led businesses outperform
Yet one hedge fund manager I know, who has been highly successful, refuses to buy family-owned businesses on the grounds that they are much less likely to be the subject of a takeover bid. Such businesses do carry some different risks from “normal” businesses, notably succession planning and what happens when the founder steps down. Sometimes families find it difficult to agree on the strategic direction of the business. It’s fair to say that the alpha (or outperformance) enjoyed by the group can at times involve some unusual questions for external investors who have to gauge the psychology of a family group. And we all know how families can fall out and become bitter, intransigent and irrational. But the odds are certainly in your favour when buying a family-owned business and you should have some of these in your portfolio.
2 Unusual or Large External Shareholders
I had the idea of writing this after reading a Financial Times article in February 2022 about the possible separation of Porsche from Volkswagen. Now VW, like BMW, is in effect ultimately controlled by the family of the founder – in VW’s case with a more than 50% shareholding, and in the case of the Quandt family, a collective holding of more than 40%.
But VW’s share register is more complicated than the simple family ownership because the State of Lower Saxony has a holding. When the company was privatised, Lower Saxony held a voting share of 20.2 per cent, which gave it the ability to veto major decisions and prevent takeovers by other shareholders, regardless of the extent of the ownership. In 2007, it invested further capital to maintain that voting interest.
Lower Saxony is guaranteed two out of 10 investor seats on Volkswagen’s supervisory board and has been criticised for prioritising jobs in the region and thwarting reforms. Its loose association with the unions means, in effect, that the unions – if not actually in control of the company, as some critics claim – have an even greater influence than at competing manufacturers.
Such a set-up is unlikely to be optimal for quick wins for shareholders and can slow down decision making which in times like these, with the move to electrification, is unlikely to be the most conducive to either short-term share-price performance or longer-term survival.
Companies with more complex capital structures like VW require particular care, as do younger tech companies where the votes may be highly concentrated. It’s important to look at the distribution of votes across the register rather than simply the division of share capital. Because when a crunch comes, it’s the votes that matter.