The Interface Between Manufacturing Executives and Wall Street Visitors —Why Security Analysts Ask Some of the Questions That They Do
PHILIP A. FISHER
Many in industrial corporations who do not have close association with the investment community do not realize that those interested in selecting which stocks to purchase come from two rather unlike groups with quite different fundamental objectives. One group feels that the intelligent way to handle stock purchases is to study the various factors that should cause a particular stock to rise in the near future, buy it before that rise has gone very far, sell it when the rise has run its course, and then look around for another vehicle or even the same one to repeat this happy set of circumstances again and again. The time horizon of such stock buyers is relatively short. Their period of holding runs anywhere from a few weeks to a year or two. Such holders are essentially short-range in their goals. The other group, which under the psychology that exists today is much smaller but probably has total holdings at least comparable in size to the short-term group, looks upon stock ownership in a very different way. Investors in this group feel that in today's inflationary world ownership of unusually well-run corporations that are both low-cost operators in their industries and offer strong possibilities of growth is an excellent way to store wealth. Such investors will remain stockholders in the companies they choose until they see a fundamental change in the characteristics of the particular company.
No accurate statistics are available as to the value of the ratio of total outstanding shares owned by either group versus the other. Both are very
large. However, from the standpoint of the number of transactions occurring in any given period, the short-range goals of the first group imply that those buyers will initiate many times more transactions than the long-range holders. Therefore, it is only logical that those who represent the large number of brokerage houses that earn most of their income from commissions on completed transactions, together with the many other investment management firms receiving counseling fees for advising or managing funds desiring this type of management, result in the majority of Wall Street type visitors to industrial corporations asking questions that are quite short-range oriented.
Short-range buyers are not nearly as interested in the fundamentals of the business. The element that causes a stock to rise or fall in the immediate future is the general realization of some significant favorable or unfavorable factor not previously recognized by the general market and therefore “not in the price of the stock” until it does become recognized. Nevertheless, there is less risk in buying stock for a near-term gain if the fundamentals are really secure. This means that an intelligent analyst even with short-range goals will pay some attention (but usually not much) to the fundamental strength of the company. Similarly, even the most long-range potential investor wants to purchase at a time when a stock is not at a short-range peak or facing immediate bad news. Therefore, such long-range holders will also pay attention to the immediate future but give it less weight.
In my personal view, for management to give any more attention than necessary to short-range buyers makes about as much sense as it would for a construction company to use blocks of ice to build a bridge across a river in the tropics. Short-term holders surge in and out of a company's shares, usually doing so at just the time when it will accentuate the price fluctuations that are inherent in any widely traded stock. This works against the corporate good. It detracts from the feeling of both key people and all employees that long-term holding of company stock is of real benefit to them. It deceases the value of stock ownership as a tool for recruiting key people and improving the morale of all employees. In this way, short-term trading erodes the loyalty and productivity of a company's employees, at just the time when these qualities are most needed, because accentuated declines in the value of their own holdings will accentuate employees ' fear and lack of confidence.
There are several reasons why top corporate management gives as much time to some of those whose interest is purely short range as they do. They may not know how to recognize from which group a particular visitor comes. They also may be dazzled by some of the “big names ” of short range visitors or even more by the large size of purchases that such visitors frequently are prepared to make, with the resulting increase in the market price of the shares. They may be concerned that if they do not give as much time to one
investment representative as another, such a policy may very well be frowned on by the Securities and Exchange Commission. The irony here is that speculators, because of the nature of their interest, are more likely to ask the kind of questions that, if answered, would be considered inside information because it might have an immediate effect on the price of the shares.
Most sophisticated financial people know the rules and, for example, for some weeks before a quarterly statement is to be issued to the public, will not ask company officials how the sales or earnings for that period have gone. Similarly, they will shy away from asking about the receipt of especially large orders or contracts that are very big in relation to the size of the company. However, with their basic objective of a near-term increase or decrease in stock prices, which nearly always change when something is revealed that is contrary to the prior thinking of the financial community, short-range investors are overwhelmingly dedicated to finding out such information if they can do so by indirect means. This is why they ask about such matters as total production capacity and the percentage of capacity currently in use, because the subsequent discussion may well throw significant light on near-term trends.
Why are the questions of long-term investors quite different? It certainly is not because long-term investors are less eager to make big money right now, that is, this month or this year, than anyone else. Rather it is because many decades of experience have shown that those who are constantly trying to profit by getting in and out of stocks over short periods are playing a game that is almost completely unwinnable. The factors affecting a short-term change in stock prices are so complex and cover so many influences beyond the quality of the company itself that they are not subject to a consistent source of gain, regardless of the training, brainpower, or computer power of the speculators. I would suggest that those tempted by what looks like a logical means of increasing wealth look around and see the number of people who have amassed real wealth in this way compared to those who have done it by finding unusual companies and sticking with them for a long period of years and until such time as a fundamental change in the character of the particular company may occur.
Appraising the manufacturing competence of an industrial company is a significant factor in judging not only the important contribution that the manufacturing arm can give to the total success of the company but also an excellent way of judging the competence of top management itself. To understand this point, it is necessary to go back to basic business fundamentals. What must a company do to become a successful long-term investment? A company must make a better product less expensively than the competition and provide a better service.
It is because the importance of the manufacturing arm of a company is so great in contributing to superior total overall results that Wall Street
visitors to key manufacturing executives ask some of the questions they do. One question almost sure to come up concerns quality. What has been the rate of improvement in eliminating defects, expressed sometimes as improvement in yield? How has it been brought about, and what further improvements are being planned? Superiority in this area is a double winner. “Making it right the first time” causes costs to go way down. Simultaneously, causing customers to feel that products shipped to them can be depended on in a way that competitors' products cannot, nearly always results in increased market share. Through economies of scale, these increases in market share usually cause costs to go down still more with a further increase in profit margins.
However, these happy results do not come of their own accord. Neither will they continue unless the conditions that bring them about are carefully nurtured by management. Therefore, the bulk of the questions from a financial visitor primarily interested in truly great long-term growth will center on the management's actions that initiate these conditions and then ensure that they continue. These matters overwhelmingly are involved with the handling of people. Contrary to popular belief, capital investment, while helpful, usually is less significant than “people leadership.” This is because no matter how brilliant the top management of a company may be or how high the IQ of its industrial engineers, it has been shown time and time again that these brilliant people peering down from above do not see ways of making operations more efficient that can be pointed out by some people who are in the midst of doing these things themselves. Furthermore, if small teams of people have confidence in the overall fairness of their company and are permitted to set their own goals and, even more important, have confidence that they will be personally awarded a fair share of the savings to the company that better productivity brings to the earning statement, production will rise to levels far higher than it would seem reasonable to attain by any yardstick set from above. The climate for this type of cooperation cannot be achieved by the manufacturing executives alone although they may play a very significant role in accentuating a favorable atmosphere created by higher authority. Awareness of these factors can cause a financial visitor to have far more interest in the answers to some of the questions he asks manufacturing personnel than that of just judging the abilities of such personnel themselves. The answers can have great significance as to the quality of the company as a whole.
These questions of good “people relationships” go far beyond those I have just covered which essentially involve the relationship of blue-collar workers with their immediate bosses. Great as are the variations between one company and another in the degree of productivity from this area, the variations are probably even greater between companies in the unbelievable costs that arise when there is lack of real cooperation between manufactur-
ing and research. When research or engineering simply designs a product and then “throws it over the wall” and says to manufacturing, “Now, go make it” the result usually is that countless dollars and even more valuable time is wasted until the two groups work out a method whereby a product is manufacturable at a competitive price. Furthermore there is the even greater danger that, in the time delays that this causes, a competitor will get to market first and have all the advantages that being there first usually brings with it. A similar tale of misadventure can occur if the marketing arm of the company is not in close touch with the various stages of inventing and making the new product. Again revisions may then have to be made to satisfy customer needs. This wastes still more money by “having to do it twice.” It can open up time to market advantages to a competitor who has made it right the first time. Unfortunately, in too many instance these failures of real cooperation do not just exist between the various major divisions of the company but also occur within manufacturing itself. This is when parts or components are made by one plant under one manager and then shipped to another division which uses them in their assembly. Human pride and the NIH factor are so deep within most individuals that it takes a truly superior overall management and an equally superior manufacturing staff to open up the advantages which a really well-run company can attain by getting genuine cooperation between all phases of a company's activities.
If a financial visitor asks some questions pertaining to these matters in too direct a fashion he may receive a pleasing answer rather than a factual one. This is why some of the questions posed to manufacturing people may be asked for reasons other than what may appear on the surface and may produce some of the puzzlement among manufacturing executives of why they are asked some of the questions they are.
What are some of the results that can be obtained by the right management climate and a superior motivation of people other than the superior yield and high output per worker that I have already mentioned? One is a sharp reduction in the production cycle time, that is the period from the time raw materials are left at the receiving dock to when product is shipped to a customer. Savings here, aside from the obvious one of freeing working capital through smaller inventory requirements, are numerous. The customer can usually get faster delivery of a new product. There is also less danger from theft about which nobody likes to talk but which is highly costly to most businesses since the products are that much less exposed to the danger of thievery. The cost of tool cribs and the workers employed therein are reduced since it is unnecessary to lock up as much each night.
When continuous progress has been made in matters like these something else has been attained that I believe is even more important. This is that the average person working in all types of positions throughout such a
company feels that just not the heads of manufacturing but top officers as a whole are really competent and KNOW WHAT THEY ARE DOING. All levels of personnel will listen and cooperate when some new and different way of doing things is presented to them by their bosses. Just a decade ago such techniques as have proven so successful as statistical quality control and shortening cycle time were virtually unknown. Today, their results are recognized. The competitive pace of the 1990s will surely produce more and different ways of making major competitive improvements. In some companies most personnel recognize that this type of innovation has been both successful and has benefitted them personally. They will be ready to change their ways and cooperate in some other and today undreamed of methods of still further improving efficiency that are sure to show up in this new decade. It will be very much more difficult to bring about such advances in other companies where this type of basic respect for top management has not occurred. These are not easy matters for a financial visitor to obtain truly realistic answers. However his need of obtaining such answers can well explain why some manufacturing executives who are in the very midst of seeing these things happening are asked indirect questions the reasons for which they may not fully understand.
Following the old Chinese proverb that “a picture is worth a thousand words,” the final part of this paper consists of questions of a type which financial people interested in the truly long-range prospects of a manufacturing company might well ask a V.P. of manufacturing. With each is a comment as to why the financial visitor may be asking what he does. For my own investments and those I handle for others, I am interested only in companies that recognize that competition is steadily improving, so that it is incumbent on these companies continuously to improve their own efficiency and never to be satisfied even with the quite magnificent strides that some of them have made in recent years. I try to set the same types of standards for my own work. Therefore, with this in mind and because many who may read this paper are far more expert than I am in the mechanics of some of the matters I have tried to cover, I would be greatly interested if any of such people would care to comment to me on their answers to either or both parts of Question No. 13 on the following list.
Questions That Might Be Asked (But Usually Are Not) by SecurityAnalysts When Questioning a Senior V.P. of Manufacturing:
1. QUESTION: In regard to Statistical Quality Control, when did you start putting the first part of your operation under this technique, what percent of production is using this method now, how great are the benefits, and what further gains do you see ahead from this method?
COMMENTS: Statistical quality control is not new. It was one of the first techniques adopted by leading edge American manufacturers when it was realized drastic action was needed to survive against Japanese competition. It also is something that takes time to develop to its maximum potential. Learning when it was first started may indicate how far along the company is in this key matter. It also may furnish a clue as to whether the company will quickly take advantage of other improvements that may appear in the time ahead because an innovator or early adopter of this technique is apt also to be a leader with others.
2a. QUESTION: (For companies primarily selling to other manufacturers) How many customer awards have you received so far this year, and how many in the past two years?
COMMENTS: These awards are customarily given to the relatively few companies that are capable in two successive quarters of delivering zero percent defects and 100 percent on-time delivery. Such action usually convinces a customer that it is unnecessary for him to undergo the essentially additional expense of providing inspection on the arrival of a shipment. At the same time, it enables him to take the full advantage in inventory savings of just-in-time delivery. Such awards are usually followed by an increase in the market share of those who receive them at the expense of less efficient competitors. Consequently, they are frequently an accurate indicator that the market share of the recipient will increase.
It might interest manufacturing personnel to know of a reverse twist by which an unusually able investor relations manager of an outstanding manufacturer uses this subject. When he is first visited by a representative of any large financial institution about whom he knows very little, he deliberately brings up the subject of the vendor awards his company has received. When he finds that on talking of this subject his visitor 's eyes glaze over and the visitor endeavors to change the subject to what the investment relations officer considers will be next quarter sales in one of the company's more glamorous lines, it provides a strong clue that his visitor's interest is purely short-ranged and speculative. Consequently, he tends to get rid of the visitor as quickly as diplomacy will permit. On the other hand, if the visitor shows real interest in the subject he concludes that here is a representative of a genuine investor who has a long-range interest in the company. He exerts himself in every possible way to try and provides the information his visitor seeks!
2b. QUESTION: (For manufacturing companies selling primarily into the consumer markets) Does manufacturing regularly receive information concerning ALL customer complaints that are in any way related to the nature
of the manufacturing process or which are matters about which manufacturing may be able to take some remedial action?
COMMENTS: This question should immediately lead to a discussion of what actions have been taken and can be taken against complaints. A general knowledge of the shift in percentage of sales against the U.S. automobile manufacturers and in favor of those from Japan and certain European competitors should indicate to anyone the importance of pursuing this matter which at least in part is a manufacturing concern.
3. QUESTION: How early is manufacturing brought in by engineering or R&D in the development of a new product or a modification of an old one and is sales or marketing also working closely with manufacturing and engineering on these matters?
COMMENTS: This question should naturally lead into the key matter of the coordination between engineering and manufacturing not just at the initiation of a new product but all through the steps until the new product is turned over to sales. Only in this way can costly waste be avoided by making it unnecessary later to modify designs so that they can be manufactured at optimum efficiency. This is a place where rather a huge burden of waste occurs in many businesses not only through the extra cost of having to rework designs after they have first been set but through competitive losses resulting from other companies getting their product to market first.
4. QUESTION: How many quality control people do you have in your organization now, did you have three years ago, and how many six years ago?
COMMENTS: This is deliberately devised as a “trick” question so as not to get an answer that may be colored somewhat by what the person being questioned thinks the security analyst may want to hear. In recent years it has been proved conclusively that the old idea of having quality inspectors examine products either part-way through or at the end of the line is an extremely inefficient one. It soon becomes a game for the people on the line to see how smart they can be in getting products by their adversaries. The Japanese have taught us that a vastly better way is to ensure that every employee in the production process regards the person at the next step in the process as the “customer” in the same sense that another company is the customer when the product is finished. At the same time the person one step more advanced on the production line considers it his or her job to be sure the quality is right in the partially worked products that they are receiving. The savings by getting production people enthused over this sort of responsibil-
ity is quite significant and of sufficient importance to justify learning the real facts by asking a question that brings up this matter indirectly.
5. QUESTION: Exclusive of foreign plants in countries where unions are specifically required, what percent of your manufacturing employees are unionized and what percent non-union? On the same subject, how many strikes have you had anywhere around the world in the last six years and what was the reason to cause them?
COMMENTS: For the creation of truly efficient manufacturing with little waste and abnormally high yield nothing is more important than the good will and effort of all elements of the personnel. This again is a matter about which it is sometimes quite hard to get a true picture by direct question. This is but one of several questions designed to approach the matter from various angles.
6. QUESTION: How many vendors do you have today, how many did you have three years ago, and how many five years ago?
COMMENTS: Not so many years back it was considered good management to have half a dozen or more vendors bid on each job, stimulate them to compete at the lowest price possible with the thought that this will improve profit margins. Again, we have learned from the Japanese. A far more profitable long-range course is to select a very few vendors who can be depended on for superb quality and on-time delivery. Equally important, such vendors are ones who can be trusted to keep confidential long-range plans for new products so that they are both prepared and may have contributed ideas for the development of such products rather than being asked to bid at the last moment when they are not really sure of what they are doing. Therefore, a favorable answer here should show a sharply decreased number of total vendors over this time period even though the business itself may have been growing nicely.
7. QUESTION: Who are three of your vendors whom you could consider outstanding and why have you chosen them?
COMMENTS: The answer to this question can have a double benefit for the security analyst. From it he may learn of an unusually attractive potential investment about which he had previously been totally unaware. More directly affecting his immediate study of the company being questioned, frequently such a vendor will have a deep knowledge of the company about which the analyst is seeking information and may be able to point out elements of strength or weakness of which the company's officers them-
selves are not fully aware. One spectacular example of this was information furnished a security analyst about two companies each of which are internationally preeminent and both of which are among the Fortune U.S. 100 corporations. Both companies were facing the type of new product problem the solution of which is invariably found in time but delays are always highly costly. This vendor indicated that both companies had outstandingly capable engineers but that Company A would solve its problems in a considerably shorter time than Company B. This was because the A Company's personnel, if they gave an unconventional suggestion for solving the problem, were not the least afraid that their jobs or promotions would be jeopardized if in any particular instance their suggestion proved spectacularly wrong. In contrast, in B Company the engineers were sufficiently concerned that if they made a mistake they would be penalized that their tendency was largely to avoid the spotlight and keep their thoughts to themselves!
8. QUESTION: What have been your results over the last three years in reducing cycle time (total elapsed time from when the raw materials or components are delivered at the receiving dock to the time the product is ready for immediate shipment to the customer) and what further improvements do you see ahead?
COMMENTS: Reducing the cycle time, something on which enormous strides have been made in the last couple of years by alert companies, has several significant advantages. It obviously saves working capital. An unbelievably high expense for many companies is, unfortunately, theft. The shorter the period of time that materials are in the jurisdiction of the company the smaller the opportunity for such theft. Finally, it enables faster delivery to the customer without having to keep large inventories on hand. It is matters of this sort where big progress has been made by some companies in recent years that give important clues to which companies are progressing and which ones are not.
9. QUESTION: How many calls per quarter do you or people in your company's manufacturing arm make to customers to learn where your service to the customer can be improved?
COMMENTS: Because manufacturing is normally not on the front line of those calling on customers this question is not so much a check on manufacturing but on top management's attitude toward how concerned and ingenious they are in attempting to keep their customers pleased with their activities and even occasionally hitting the goodwill jackpot by performing beyond the customer's highest expectations!
10. QUESTION: So far as manufacturing is concerned, what capital expenditures are you planning over the next two or three years that should increase your profit margin? Are such expenditures primarily involved in more capacity to take care of an expanding market or are they of a nature that will reduce costs on what you are doing now?
COMMENTS: This question should always be accompanied by a statement by the questioner that he does not want to ask something that might be considered company confidential in that it would be of benefit should a competitor learn about it. If there are indications that a significant part of contemplated capital expenditures in the time ahead are of this nature it may be possible to get an idea of the growth that might lie ahead without in any sense jeopardizing such confidentiality by asking what percent of contemplated capital expenditures fall in such a class and what percent do not.
11. QUESTION: Trying to avoid the buzzwords “Japanese Quality Circles” what are you doing to stimulate all levels of manufacturing personnel to contribute both ideas and effort to improving the efficiency of the manufacturing operation?
COMMENTS: This is one of the most important, if not the most important of matters involved in judging the investment appeal of the manufacturing arm of a company. A discussion of this subject should lead to information on such matters as whether each relatively small production unit within the company is setting its own goals on results it expects to achieve in the period immediately ahead and whether the degree of attainment of these goals is publicized in relation to and in competition with other comparable units. Similarly, it should be ascertained whether meritorious results of individual small units are rewarded financially through some type of previously devised “profit sharing” plan, not rewarded at all, or an in between course is followed such as a company sponsored party for particularly successful units. A basic concept here that should be examined carefully is whether management believes that the majority of manufacturing personnel has sufficient confidence in overall management so that when a new and significantly different technique is proposed, all levels of manufacturing employees tend to follow enthusiastically, or whether there is a strong tendency toward foot-dragging and continuing doing things as they have previously been done.
12. QUESTION: What have you been doing to take advantage of leading edge technology to keep your own production facilities ahead of competition?
COMMENTS: Achieving lower costs, better quality or being able to satisfy customers by making variations of existing products in small lots at relatively slight extra cost all are ways that a company may benefit spectacularly from superior manufacturing skill. Technology can be a major tool in attaining such results. Because in only a few industries such as semiconductors is this a way of life, such needs are often not even recognized by either equipment vendors or their customers. Yet it is in industries where the pace of technological change is slower that the greatest competitive gains may be made by the company leading its industry in such matters. Therefore supplementing this general question, more specific questions such as the following might be asked when applicable: Ratio of pilot to production lines? Frequency of process patents that have been awarded or applied for? Are you working with vendors to develop improved equipment? Through vendors or other sources are you learning what competitors may be doing along these lines? Is top management aware of the competitive significance of these matters and are they giving recognition and rewards to those producing tangible benefits in these ways?
13. QUESTION: What other questions do you, Mr. Senior V.P. of Manufacturing feel should have been asked and were not? Are there any of these questions that you feel are essentially not truly important and should not have been asked in the first place?