The No. 1 Way to Annoy Wall Street

Joel Litman

Paul O'Neill didn't give investors what they wanted...

Back in my consulting days in the 1990s, one of my biggest corporate clients was Alcoa (AA).

The aluminum producer was also one of my favorite clients. So I still remember my surprise when a Wall Street executive told me Alcoa's CEO annoyed investment analysts.

Imagine strolling the halls of a Wall Street research firm during earnings season. Everyone would be getting ready to tune into a management call about a company's quarterly or annual performance.

You'd see rows and rows of cubicles filled with these young analysts... fingertips at the ready above their keyboards, waiting to plug management's numbers into their fancy financial models.

Most management teams wouldn't dream of deviating from this path. They're trained to give analysts tidy numbers for their tidy reports.

Not O'Neill. He refused to play by the rules.

Instead of opening with earnings guidance... or margin percentages... or capital expenditures... his focus always started with safety. 

Unable to type "safety measures" into their thousand-row spreadsheets, the sell-side equity analysts would attempt to steer the ship back on course. They'd ask questions that fit their way of looking at companies and profits.

And yet, if they had been more open-minded, these analysts could've seen what O'Neill was doing... and they would've told their investors to buy every share of Alcoa they could.

Today, we'll cover how O'Neill's focus on safety and shareholder returns set Alcoa apart... and why Wall Street missed out on such a great corporate success story.

O'Neill was adamant that employee safety and shareholder returns aren't mutually exclusive...

At his very first meeting with investment analysts, the CEO touted his unconventional approach to performance in front of a Wall Street crowd.

According to Charles Duhigg's The Power of Habit, O'Neill insisted...

I'm not certain you heard me. If you want to understand how Alcoa is doing, you need to look at our workplace safety figures. If we bring our injury rates down, it won't be because of cheerleading or the nonsense you sometimes hear from other CEOs.

That kind of statement really does annoy Wall Street analysts. They're focused on their earnings reports and getting their short-term forecasts to Bloomberg or CNBC. They simply don't know what to do with a CEO who doesn't follow convention.

It's one reason why these folks are so bad at recommending stocks. They aren't focused on the real long-term drivers of business valuations... as reflected by their largely abysmal track records.

In Alcoa's case, aluminum production can be dangerous. O'Neill knew that lots of employees got injured every year in the industry. Not only was it humanitarian to focus on workplace safety... he also knew it reflected his business's foundation of efficiency.

According to O'Neill, high injuries meant "we're not doing a good job, not just for the lives and health of our people, but also for our investors and shareholders."

So he emphasized safety before discussing revenue, income, or anything else.

That emphasis helped to add $24.53 billion in market value during O'Neill's tenure as CEO... and led to a roughly 10-fold return for shareholders. Today, Alcoa still has a reputation as one of the safest aluminum companies.

Maybe every CEO should focus on safety.

While O'Neill's safety proclamations were unconventional, all management teams are required to share where they're focused...

If you want to know what a company is going to do in the future... what keeps management up at night... and what drives the team's motivation... you shouldn't look at the annual 10-K report.

The big issue with the 10-K is that it's backward-looking. Other than some relatively small sections about risks or analysis, the overwhelming majority of data is historical.

Longtime subscribers know we prefer a different document... a proxy statement called the DEF 14A. It's probably the most important financial report most folks have never heard of.

Many of my clients would say it's actually more valuable than the 10-K.

In the DEF 14A, the company is required to disclose who's on the board and management team... how much they're paid... and how they're paid.

My friends, compensation is crucial to forecasting performance and estimating valuation. If you want to understand management's strategy, look at compensation metrics. If you want to ensure the board is putting its money where its mouth is, look at compensation metrics.

Incentives dictate behavior. Management will do what it's paid to do. Full stop.

The DEF 14A tells you how a company defines wealth...

In Alcoa's case, we can see that O'Neill's legacy lives on today. A huge chunk of management's annual bonus is still tied to employee safety...

  • 10% of the bonus is based on having zero fatalities on the job. If anyone dies from unsafe working conditions, there goes this portion of the bonus right away.
  • Another 10% is based on serious injuries. If there are more than five serious injuries in a given year, this portion falls to zero.

While I joke that all companies should adopt Alcoa's heavy emphasis on safety, the ideal metrics vary based on industry and circumstance.

That being said, here are some of our favorites...

If you want a company to grow, look for a focus on revenue growth... earnings before interest, taxes, depreciation, and amortization ("EBITDA")... or just sheer number of new stores or customers.

Many management teams are paid for growing the business, regardless of profits. While these folks may talk about earnings on quarterly calls, if they aren't paid based on true economic earnings metrics, they simply don't focus on them.

Metrics like return on assets ("ROA") or return on invested capital ("ROIC") will direct management's attention toward improving margins and asset efficiency. However, that might mean less focus on growth.

Remember, the DEF 14A is public information. Anyone can and should access it.

Take a look through the compensation plan before investing in any company. It'll help you make sure management is doing the right things for the business and shareholders.

You might even find the next Alcoa... while Wall Street analysts are burying their heads in spreadsheets.

Wishing you love, joy, and peace,

September 8, 2023