Thursday, December 4, 2008

The Intelligent Investor: Chapter 19

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Graham is a big supporter of shareholder activism, urging shareholders to demand explanations for poor results, and to support the removal of poor managers.

Many shareholders fail to be active enough, but Graham says this is alright, because a new mechanism has been created to do the same thing. Graham is referring to the market for corporate control. Poor management leads to poor market prices, which paints a big red target sign on the company for potential acquirers. The price that is bid is generally the amount that the company would be worth if it had competent management. This has become increasingly important in today’s market, where highly capitalized hedge funds are ready to gobble up underperforming companies.

Conclusion: Companies with poor management may have poor valuations, which make them targets for acquisition. This is good for investors who will see a control premium added to their share price upon acquisition. But, going back to the AOL-Timewarner example, make sure the company acquiring is not trading its own overvalued shares for your undervalued shares, otherwise you may end up in an even worse situation.

Also recognize that, as a shareholder, you become an owner of the company. Act like you would if you were owning a small restaurant and had hired a manager to run. If that manager performed poorly, you would demand results. You would be vigilant in overseeing that manager. Don’t lose sight of your position as owner of the company.

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