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July 31, 2021, 12:12 p.m. EDT

Smart stock investors know to check this telling sign of a company’s health

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By Lawrence A. Cunningham

Almost every  CEO would agree  that improving their company’s corporate culture would increase its economic value. But figuring out how to do that is  widely viewed  as an executive’s greatest challenge.

For one, corporate culture can be a mystery at the simplest of companies. Plus, cultures vary uniquely by company, so there is no blueprint for design improvements.

Useful general definitions do abound, from the informal “how things are done around here” to the sterner “the values that guide our behavior.” Within such framings, I’ve conducted or read numerous studies of particular companies that reveal recurring motifs in how a company carries out its routine activities and how it responds to crises. While harder to measure than return on invested capital, corporate culture is like team spirit in sports — crucial to success.

A company with a longer-term outlook is better equipped to weather financial volatility. Companies with reputations for thrift and conservatism are less likely to default and so enjoy higher credit ratings and lower borrowing costs. A business known for integrity wins more than rivals who are chiselers.  

Despite culture’s importance, the concept’s nebulousness makes many boards and managers uneasy. As a result, at many companies, when questions of culture arise, there is often a struggle with fundamental questions such as what culture is, whether the leadership understands it, and if culture aligns with strategy. They debate whether to codify “who they are” or let things speak for themselves.

Some companies veer formal, as a traditional mission statement listing philosophy, goals, and practices, drafted with wide input and published in a central location. Others prefer it to emerge spontaneously over time, such as through what tends to get repeated in a series of annual shareholder letters.

Quality shareholders— buy-and-hold stock pickers, a most discerning shareholder cohort —are not dogmatic about the choice, but probe for content. Statements are the obvious first stop. “We are shareholder centric and focus on long-term business outcomes,” is a common formulation and appealing as far is it goes.

But it is also true that such statements can never be complete and application often depends on context. “We sacrificed some shareholder value this quarter in the name of editorial integrity that will be of permanent value,” senior executives of The Washington Post Company once aptly noted.

Berkshire Hathaway’s /zigman2/quotes/208872451/composite BRK.A +0.05% /zigman2/quotes/200060694/composite BRK.B -0.05% statement speaks directly to shareholders, presented as an “owners’ manual” first published in 1996. It represents a substantial, clear, and comprehensive guide, on subjects known to attract quality shareholders. These include insider ownership, long-term goals, capital allocation, communications and rational stock pricing. The statement has been an important factor in Berkshire’s ability to attract a much higher-quality shareholder base than average.

Perhaps the most famous credo is that of Johnson & Johnson /zigman2/quotes/201724570/composite JNJ +0.0061% , dating to 1943. What’s most notable in the J&J credo is the hierarchy of priorities: customers; employees; communities, and then stockholders. The philosophy stresses doing well by doing good: doing good by the other constituencies is the path to doing well for shareholders.

Words are cheap, of course, but J&J has lived by this credo. Most famously, its leadership relied upon it during a 1982 crisis when a sociopath inserted cyanide in Tylenol capsules, killing seven.  National media declared a corporate- and consumer crisis, authorities urged a product recall in the affected local market, customers were scared, and the stock price tanked.

One reaction would stress the lack of blame, deflect critics, make the local product recall, and mollify employees. J&J, in contrast, announced a nationwide recall at huge expense, conducted regular press conferences, and promptly invented tamper-proof containers — and saw its stock price bounce back.

The company  attributed all of its actions  to the priorities stated in its credo, which senior executives had regularly been discussing at intervals during the entire tenure of then-CEO James Burke. Burke and his team set the gold standard in corporate crisis response that endures to this day.

Quality shareholders are attracted by cultures of the sort described in Berkshire’s owners’ manual and the J&J credo, but also insisting on walking the talk, since words are cheap. After all, Enron famously articulated a mission statement of the highest values, while engaging in elaborate frauds, much of it delineated in convoluted fog in its annual 10Ks whose opacity repelled many quality shareholders.

Many have plagiarized the J&J credo  without necessarily breathing it , so those words alone cannot be taken at face value either. Whatever their written mottos, when delving behind the curtain, it is best to see if action and words match. 

Quality shareholders avoid companies that deny addictive dangers of their products despite the evidence, who hide manufacturing or component defects that risk lives, that tamper with data to disguise the truth, or that elevate financial cosmetics over economic substance. Corporate cultures that produce such behavior are impoverished, both morally and economically, and one big misstep can be ruinous for all stakeholders.

Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of The Essays of Warren Buffett: Lessons for Corporate America. <EMPHASIS>Cunningham owns shares of Berkshire Hathaway</EMPHASIS> For updates on his research about quality shareholders, sign up here.  

More: 10 companies that know how to spend money so you have a chance to make some

Plus: Here’s the one time when it’s OK for you to fall in love with a stock

/zigman2/quotes/208872451/composite
US : U.S.: NYSE
$ 418,599
+208.84 +0.05%
Volume: 344.00
Sept. 24, 2021 11:05a
P/E Ratio
6.13
Dividend Yield
N/A
Market Cap
$629.46 billion
Rev. per Employee
$681,972
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/zigman2/quotes/200060694/composite
US : U.S.: NYSE
$ 277.99
-0.13 -0.05%
Volume: 755,842
Sept. 24, 2021 11:07a
P/E Ratio
6.11
Dividend Yield
N/A
Market Cap
$629.46 billion
Rev. per Employee
$681,972
loading...
/zigman2/quotes/201724570/composite
US : U.S.: NYSE
$ 164.87
+0.01 +0.0061%
Volume: 1.11M
Sept. 24, 2021 11:07a
P/E Ratio
24.79
Dividend Yield
2.57%
Market Cap
$433.99 billion
Rev. per Employee
$613,918
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