McKinsey Quarterly

The equity story you need for the long-term investors you want

| Article

The old adage that you never get a second chance to make a first impression applies precisely to an equity story. Investors will review your company’s equity story and make one of two decisions: yes, this company deserves our capital, or no, it doesn’t. Some company leaders—particularly in cases of IPOs or divestitures, when investors are scrutinizing a business for the first time—believe that maybe could be a third outcome. But maybe results in sloppy messaging: if we just include language about a trendy noncore business line or sprinkle in the right buzzwords, the thinking goes, maybe we can attract investors’ attention or validate a higher stock price.

It won’t happen. While it may take several months, a company’s market value will eventually reflect the value that the analyst and broader investor community place on it. Moreover, even the strongest companies experience periods of short-term volatility. How patient will your investors be? Large, sophisticated investors—particularly intrinsic investors, the investor segment with the greatest effect on markets—are the most inclined to maintain their positions through short-term volatility compared with other investors. Yet these investors will avoid companies whose equity story lacks clarity; a fuzzy equity story signals that the company itself lacks focus. Indeed, for senior company leaders, the need to distill a complicated business or portfolio of businesses into a clear narrative is a forcing mechanism to prioritize what matters. Intrinsic investors look for management teams that can explain how they realize their strategy. Of course, even if an equity story is flawless, investors can still decide against investing; a company may, for example, be in an industry that the investor is underweighting or avoiding.

Fortunately, three of the most important reasons why intrinsic investors review an equity story and choose not to invest result from missteps that are entirely in a company’s control: believing there is a “model” equity story that a communications team can simply take care of, muddling the messages with nonessential information, and failing to place an equity story in broader context. By avoiding these mistakes, senior leaders can put their company in the best position to attract investors that support leadership teams through periods of volatility and enable the company to achieve its long-term goals.

Know your audience—know yourself

There’s no question that delivering a compelling equity story will require the support of your investment communications team. Yet sometimes, companies make the mistake of allowing an equity story to be communications driven. For example, your team may want to make images or photographs a prominent part of your presentation or seek to liven up a road show with imaginative mementos. We’ve yet to meet any intrinsic investors, however, who don’t go first to the financials, or make an investment because of the deal toys. Relying on “the sizzle, not the steak” of an equity story suggests that you’re seeking to distract rather than enlighten. Indeed, intrinsic investors view an unattractive equity story as the greatest risk to an IPO (Exhibit 1).

Intrinsic investors identify an unattractive equity story as the greatest risk to an IPO.

Your target audience is not communications professionals; it is the sophisticated investors who review scores of other equity stories. While these investors want to see common elements—core value drivers, key trends, and unique capabilities—they don’t want a cookie-cutter approach, or to read a model story. Instead, they want to hear your story. The best way to communicate it is to imagine that you are addressing your senior-management team, a seasoned board member, or an experienced analyst. Make clear what the company intends to achieve in the long term, how it is going to meet its objectives, and why it is uniquely positioned to succeed. Provide a clear, fact-based description so investors can make an informed, evidence-driven choice.

Although providing details will be a matter of your own words, you should always make sure to communicate these essential elements:

  • a short description of the company, ideally made more concrete by providing key milestones in the company’s history to demonstrate its positive trajectory
  • market dynamics and competitive framing, which typically includes key trends and market dynamics, made tangible with clear data (such as the size of the addressable market, historical growth, and reasonable growth assumptions) and a description of the competitive environment
  • competitive position of the company, such as the company’s market share or other rankings, and a description of the differentiating capabilities that demonstrate the company’s “best owner” advantage
  • concise strategy, grounded in the company’s strengths and showcasing how the company will benefit from and respond to the market forces at work
  • financial statements, both historical and with expected long-term targets; these targets should be neither “conservative” nor “aggressive”—instead, they should present the most probable, scenario-tested results that the company will most likely achieve

Precisely because intrinsic investors are so experienced, they’re skeptical of canned presentations and short-term market fads. Instead, they want to hear you articulate the company’s plan for long-term value creation and the tangible steps it has taken so far.

That’s why intrinsic investors are keen to understand your description of KPIs; they know that these metrics will differ from those of other companies, even among industry peers. In our experience, investors pay as much attention to the metrics you choose to prioritize as they do to the KPI numbers themselves. As a rule of thumb, companies should strike a balance between industry-wide essentials (such as margin, ROIC, and growth), industry-specific indicators (such as sales per square foot and same-store sales, in the case of retailers, or average payload or cost per ton, for mining companies), and company-specific KPIs (such as total cardholders or renewal rates for Costco, or paid net additions and average revenue per membership, in the case of Netflix).

Remember, analysts and investors build their financial models to derive a target valuation. To do so, they need clear links between a company’s earnings statement, balance sheet, and statement of cash flows. If your equity story includes metrics that don’t ultimately link to your financial performance, they shouldn’t be included. Moreover, your company should be able to quantify the impact of each metric in a rigorous way. Even something as simple as subscriber growth comes with associated costs; show how more subscribers can lead to more cash (it may not be a simple multiple or a linear trajectory). Or consider forecasts from geographic expansion: one company identified expanding its presence in China as a key growth driver. Yet because it hadn’t budgeted sufficiently for associated costs, such as hiring a local sales force, its actions ultimately undermined confidence in its management and strategy.

If you can’t anticipate and address basic pushback, your equity story will fail. An equity story, in fact, is more than just a story; it’s a forcing mechanism for managers to rigorously think through their strategy and demonstrate discipline to deliver long-term performance. While advisers such as bankers and consultants can help sharpen your story and anticipate questions that may arise, they haven’t walked in your shoes and can’t deliver the story as well as you. Sophisticated investors quickly realize when a management team is disconnected from what it’s presenting. We recommend that management teams spend significant time aligning on key messages, rehearsing their presentation, fielding potential questions, and becoming completely comfortable presenting the story in their own words.

Talk about what matters—and stay away from everything else

How does your company create value? What are its capabilities? Which trends affect it most? And what are the two or three most important factors to maximize and sustain cash flows? If investors can’t readily answer these questions, they’re almost certain to filter your company out of consideration. It’s impossible to have an effective equity story unless you clearly spell out your company’s positioning, capabilities, and distinctive sources of value creation.

Start with the basics. Investors won’t be able to “follow the plot” when an equity story jumps straight to a niche analysis and fails to explain the contours of the company’s industry, where the company is situated in the value chain, or other essential details that management may assume everyone knows (but actually doesn’t). Remember, however, that intrinsic investors do have some perspective already, particularly at the industry level. Know your audience: an effective equity story should be neither simplistic nor esoteric. Give your perspective of the market and segment in which the company competes and why it makes for an attractive investment.

For large corporations with several business units, the equity story should identify the few value drivers per business that are most important to performance. That means carefully describing about two to five drivers per business—not ten. Companies with multiple business groups should also clearly explain how their strategy is advanced by owning all the divisions together. It’s essential to demonstrate not only that the company is the best owner for each business but also that there are clear ownership advantages that enable the businesses to create value in a portfolio and directly advance strategic priorities in the foreseeable future.

Every moment your equity story spends on businesses or initiatives that aren’t clearly connected to your strategy is a wasted moment—and a reason for investors to move on to other opportunities. For example, avoid talking about noncore businesses or small corporate venture capital divisions; there’s a time and a place to manage these effectively, but they won’t drive a meaningful percentage of your cash flow in the next two to five years. And despite what you may hear about investors seeking the right keywords, don’t lard up your story with terms or concepts that might be trendy. Buzzwords are a warning sign that senior leadership is distracted or spouting platitudes. Commonly abstract and overused terms such as “disruption,” “holistic,” and “exponential” can indicate a lack of strategic rigor.

A compelling equity story, moreover, shows as it tells. It is a tool for management to connect with current and future shareholders who comb through past performance to track the company’s record against its strategic aspirations, targets, and plans (Exhibit 2). It’s also essential to demonstrate what your choice of wording means. Consider, for example, another commonly used term: ecosystem. Ecosystems can be critical for value creation, as we’ve highlighted for years. But value is derived from careful strategic thinking and concrete action—not from merely including the word “ecosystem” in the hope that it’s on an investor’s checklist. One company’s value creation strategy, for example, is deeply linked to its ability to continue to innovate. Its equity story—which prominently features ecosystems—resonates because it describes its ecosystem in clear terms and goes into detail about the technology partnerships it has formed with universities, smaller technology companies, and customers within that ecosystem, demonstrating that the company truly is at the center of a fast-evolving market. The level of detail, in turn, provides investors with confidence that the company will remain well positioned as key technologies within the ecosystem rapidly develop.

Track record and a concrete plan for value creation are key equity story elements.

In some situations, a company may have a compelling strategy but lack a multiyear track record to back it up. This can be the case, for example, for large corporations that are shifting into new businesses, or companies that have been spun off and suddenly receive much more scrutiny than they had when they were part of a bigger enterprise. One chemical company that faced this challenge made a determined and successful effort to build a clear track record well before it crafted the legal and marketing materials for its intended IPO. Working backward from a potential listing date, it looked at its management plan and defined KPIs at a much more granular level than just the business unit level; senior leaders monitored those KPIs at least monthly to address performance shortfalls as they arose. Investors appreciate both the conviction and the transparency.

Get out of the weeds

As important as it is for company leaders to present an equity story that coherently explains company-specific details, they also have to pull themselves and their audience away from “just” a financial model and place the equity story in context: What are the broader industry trends? Where is this company situated in its growth trajectory?

For companies conducting an IPO, an equity story requires more attention to introducing the company to investors. For companies that are already public, freestanding enterprises, telling an equity story will be iterative, particularly when it comes to key strategic shifts and acquisitions and divestitures (such as why the company has acquired or divested and how integration is progressing). Because competitive dynamics and company performance are always changing, the key points of detail and focus will continue to evolve.

Even well-recognized companies with long track records may find that investors don’t grasp their objectives as firmly as the executive team might expect. For example, one industrial company was certain it had developed a compelling growth strategy and had already begun to significantly shift its portfolio of businesses. The executives deeply understood the company’s markets, positioning, competitive advantages, and progress toward reaching clearly defined aspirations. Yet the market didn’t understand the company’s strategy. As a result, the company’s shares traded down; investors’ valuation was in line with the company’s traditional, lower-growth sector, rather than with the high-growth markets where the company was increasingly and successfully competing.

That mismatch is the sign of a poor equity story. While the company had committed not only to identifying significant opportunities but also to allocating significant resources to follow through, it failed to go the final mile and explain its strategy to investors in a clear way—and to demonstrate that it was delivering on its growth strategy. To address the disconnect and bring the stock price in line with the company’s intrinsic value, the company reset its equity story, using clear KPIs, describing previous portfolio shifts and its track record for building businesses, and detailing its competitive advantages. Critically, the CEO and CFO made sure to present the story in their own words and ensure that analysts and investors understood the company’s short- and long-term priorities.

Sometimes, of course, a company may be in resilience mode, recovering from poor performance. Don’t sugarcoat: intrinsic investors will see through attempts to turn bad news into happy talk. Instead, be clear about what went wrong and identify the specific actions you are taking to address it, supporting your strategy with metrics and reasonable benchmarks. For example, one consumer goods company misread competitive dynamics and made several acquisitions that wound up destroying value. But it forthrightly identified its mistakes, explained why its thinking was flawed, and described the significant measures it was taking to reset its strategy—in particular, to sell an acquired business and reinvest in a specific core business. Investors welcomed the rigor, and the stock price improved.

Every business is unique, and no company’s equity story will resonate with all investors. Moreover, almost all companies will at some point face periods of volatility. When they do, it’s far better to have long-term-minded investors in their corner. To attract these sophisticated investors, company leaders need a clear equity story, which they should be able to present in their own words. Patient capital seeks out great strategies—built on comprehensive analyses, demonstrated by meaningful actions, and communicated with clarity.

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