With stocks near record highs and Wall Street smiling again, here's a counterintuitive idea about the value of those shares: Investors suffer when a company focuses too much on pleasing them.
By trying to boost their stock price in the short term, companies undercut their performance in the long term, says Lynn Stout, a Cornell Law School professor and author of "The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public." They spin off divisions, buy back shares, and cut costs at the expense of research and development. It's like fishing with dynamite, she says: It gets quick results but spoils the pond.
Take Kraft. The longtime corporate icon unexpectedly split itself into two, creating Kraft Foods and Mondelez last year, in a move applauded by hedge funds and others who'd been clamoring for higher share values. But the two companies have stumbled along since with little change in their stock prices. They reported poor earnings in February.
In the face of a volatile stock market and lackluster returns over the past 15 years, socially responsible investors say companies need to temper concern about shareholder value with attention to the environment as well as their workforce and community. In theory, this so-called triple-bottom-line approach should minimize the risks of unforeseen labor or environmental problems and boost profitability. The challenge is that in practice it's very hard for management to keep a long-term perspective – and the results don't always show up in share prices.
"It's difficult because the long term is long, and it can be very hard to keep your hands off [potential] short-term profits," says Steven Lydenberg of Domini Social Investments in Boston.
It's also hard for investors to take the long-term view. Some may worry companies are too willing to sell the geese that laid their golden eggs in a bid to grow market capitalization. But they also don't want to be left behind every time others harvest short-term profits. An LPL Financial analysis found that the average holding period of a stock has fallen from eight years in the 1960s to around five days in 2012.
Mr. Lydenberg strives to find companies that sustain long-term profitability while forgoing short-term temptations to pump up stock prices. He likes consumer products conglomerate Unilever, whose focus on developing nations means forgoing potentially higher margins in developed markets. He also likes Campbell Soup Co., which he credits for declining to get into high-margin, low-nutrition snack foods.
The two companies illustrate the difficulty of predicting performance based on a triple-bottom-line perspective. Unilever is a winner. In the past 10 years, its stock has climbed 120 percent versus 80 percent for the Standard & Poor's 500 index. But Campbell's has underperformed, climbing only 60 percent, although offering steadier performance than either Unilever or the S&P.
Some academics and economists question the basic thesis that corporate attention to stock prices has dragged down returns.
"Corporate profits are outstanding" as a share of gross domestic product, says Steven Kaplan, professor of finance at The University of Chicago Booth School of Business. "People are complaining that corporations have too much cash. Too much cash means you've made a lot of money.... So the view that there's something wrong [for shareholders] is very, very strange."
Instead of investing in single stocks, investors can invest in specialty mutual funds, such as the Green Century Equity Fund, which reflects the triple-bottom-line bias of the MSCI KLD 400 Social Index. The index often outperforms its MSCI USA benchmark, in part because of risk-management strategies, says Tom Kuh, executive director for environmental, social, and governance indexes at MSCI, an index and risk analytics firm based in New York. But investors, who can't invest in the index, might also have to settle for lower returns. Performance of Green Century Equity Fund lags behind the S&P 500 over one-, three-, five-, and 10-year intervals.
Another approach is to use mutual funds that hold high-quality companies whose businesses enjoy high barriers to entry and consistently large margins, according to Morningstar analyst David Kathman. Funds in this vein include Vanguard PRIMECAP Fund, Yacktman Fund, Dreyfus Appreciation Fund, and the Jensen Quality Growth Fund. The Jensen fund, for instance, looks for stocks that have delivered 15 percent return on equity for 10 or more years.
Companies in Jensen's fund provide relative stability in down markets, he adds, but routinely underperform in frothy markets as more aggressive funds rack up bigger gains.