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Video Q&A : Société Générale strategist Fermon on ’CEO value’ stocks

Transcription

EuroBusiness Media (EBM) : Yes, there is a direct connection between share price performance and the value of the CEO and top management. That is what a new study by Société Générale just proves. It is called ’CEO Value and Corporate Governance’. Daniel Fermond, welcome.

Daniel Fermond (DF) : Thank you for having me today.

EBM : You are a strategist at Société Générale. You are also the main author of this new study. In a few words, what was the main purpose of the study ?

DF : The idea of this report is to focus on management, because we believe management is a key asset for companies. Then it looks at corporate governance, because we believe that at one stage, if you have good corporate governance rules, then shareholders can say what they think of the company, and they can make a change in the strategy if they disagree with the strategy. And then we look at the performance, and we combine those three criteria to end up with a list of 25 companies which should face some changes in the coming months — let’s say in the next three years.

EBM : Why focus on top management ?

DF : Basically, as I just mentioned, management is really a key asset for companies. We have many examples where there is a CEO in place, and the stock goes up, up and up, and then he leaves and the stock goes down, down and down. And then he is in a new company, and the stock of the new company is up. We could take the example of Thierry Breton at Thomson, and then at France Télécom. You can follow those two [price] charts regarding both companies, and you see that it follows the trend of the change of management.

EBM : Can you prove that there is a direct connection between share price performance and the CEO as a corporate asset ?

DF : A mathematical proof would be very difficult to find, but you can see that during the quarterly results when the CEO makes a presentation, the volatility of their stock is very high, volumes are very important, and at the end of the day it is probably the key moment of the quarter for a CEO. And then you will see that if he is right, if he is convincing, the stock price will go up. You can see that Renault, for example, had a very good performance following their presentation of their new strategic plan in February 2006, and following this presentation the stock price went up and up. So you have a clear view of the management giving a strong message to the financial community, and at the end of the day good stock performance.

EBM : How is it possible to quantify an intangible asset such as the value of the CEO ?

DF : One way to quantify this is to look at the valuation of the company compared to its peers. If the valuation is very different — if there is a premium — that shows that the impact of the CEO is important. Another way is when a CEO steps down after a bad performance and you have a very strong rebound of the share price. Another possibility to observe this is when you have a new CEO, and the stock jumps after the presentation is made. If you look at Assa Abloy, in February the stock jumped following a presentation by the new CEO.

EBM : What are some examples of stocks that you picked based on CEO value, and why did you select them ?

DF : Basically we have selected 25 companies which fit our four criteria which are the following. A CEO in place for over three years, in order to have time to implement his own strategy. The second criteria is good corporate governance — I’m not saying the best, but fairly good corporate governance rules. Our third criteria is underperformance of the stock compared to their sector in the last four years, that is to say a cycle. And finally, good financial structure such that, if you have a change in strategy, the stock price could rebound. So we have these four criteria, and we pick companies from the MSCI Europe which fit with those criteria. We made a selection with our analysts based on a quantitative approach, yielding a list of over 40 companies, and then we narrowed it down to 25 companies. To give you a few examples, I could mention Royal Bank of Scotland ; L’Oréal, which will very soon change its CEO ; GlaxoSmithKline ; Reuters ; Veolia.

EBM : And finally, looking ahead, wouldn’t it make sense for Société Générale to start tracking, over a long period, the performance of the stocks in your model portfolio based on CEO value ? And in that case, are you confident that we could expect to see consistent outperformance ?

DF : We are going to track it — in fact we are going to list a certificate on this list of 25 stocks — and then we will be able to focus on the performance. The back test we have done is very impressive because, from 2004 until now, the performance of the stocks I was focusing on outperformed the index by 19 percent in two years. So I am not telling you that you will have the same outperformance, but I am really convinced you will have a strong outperformance.

EBM : Daniel Fermon, strategist at Société Générale, thank you very much.

DF : Thank you.