Tuesday 03 May 2016 5:01 am

Investors win as activism invades the boardroom

By: Jake Cordell

Activist investors have become a fixture in capital markets over the last several years, causing many to raise questions about the long-term value of a style of investing that puts a premium on short-term gains.

It’s a phenomenon S&P Global Market Intelligence has studied closely to better understand the relationship between activist investing and corporate management decision-making.

Ultimately, we found that the activist approach of pushing for aggressive capital allocation to maximize a company’s growth potential has become so prevalent among today’s publicly traded companies that it starting to affect the way executives and boards of directors behave, with or without the presence of actual activists. Generally speaking, that’s good news for investors.

Read more: Activist investors close in on record 2015

To truly understand the trend, look no further than the return on invested capital (ROIC) performance of S&P 1500 companies over the past ten years. This relatively simple calculation measures a company’s efficiency at allocating capital toward profitable investments.

Companies with increasing levels of ROIC are making smart investments and, essentially, maximizing their available capital to drive profitability. Companies with flat or shrinking ROIC are, by contrast, not making the most efficient capital allocations.

The rise of the activist

In the age of the activist investor, ROIC has become a critical determinant of stock market performance for public companies. In our analysis, we found that increasing annual rates of ROIC are directly correlated to above-market rates of return on both a short- and long-term basis.

Specifically, the top 20 per cent of S&P 1500 companies with the highest rates of ROIC growth outperformed the broad market by 3.5 per cent over one year and 2.6 per cent over a five year period.

What’s most interesting about those findings, however, is that many of the companies exhibiting this type of performance were doing so without the presence of activist investors.

It appears, based on our research, that activist investing has increasingly become a style of management decision-making that is being rewarded by investors, independent of a formal activist campaign.

The top 5 US targets

Digging further into the data to isolate the influence of true activism, we found a similar performance trend among companies that were targeted by activist campaigns. Overall, stocks displaying the highest combined degree of improvement in ROIC and activist share ownership saw the most significant outperformance versus the broad stock market, suggesting that the presence of activists does in fact catalyze growth.

However, it is important to note that not all activist campaigns were created equal. Our research also found that, on average, activist investors hold significant positions in individual companies for a much shorter time period than the tenure of senior management at those firms. This raises questions about the alignment of some activist interests with those of executive management and other long-term shareholders.

The lesson for investors in all of this is that it has become critical to think like an activist. It is not enough in the current environment for corporate management to simply run the company well; they must also be constantly looking ahead and making moves to maximize growth potential if they are going to outperform.