Shareholder Letter Revelations: Can You Trust the Leadership?

    by Laura J. Rittenhouse

    When journalists learn that I search for meaning in CEO shareholder letters, they laugh, “They’re not worth the paper they’re written on.” Or worse, they call these letters a bunch of lies.

    When I tell individual investors how important it is to read shareholder letters, they groan. Many can’t even understand what the CEO is trying to say.

    This fact alone, however, provides an important insight into deciding how much to trust the company leadership. If you can’t understand the letter, how can you ever understand, or even trust, the financial statements?

    But don’t just take my word for it. Here’s what Warren Buffett, chairman and CEO of Berkshire Hathaway, told me about the importance of CEO letters in investment decisions:

    “It’s a significant factor, although not the only factor. First, I decide whether he or she wrote it or whether somebody in the PR department or an outside consultant wrote it. I can usually tell.

    “I grade them higher if I feel they wrote it. What I look for is someone that is talking to me frankly and honestly about the business, the way a partner would. If they’re talking to me as a partner would, that’s a significant plus. If they aren’t, it’s a significant minus.”

    Investors ought to sleep better knowing they own companies led by CEOs who choose candid disclosure over puffery. But how can you determine the difference? Basically, you just need to use your common sense and power to discern.

    Trust Your Instincts

    I recommend that investors first browse the annual report to see if they’re getting information or infomercial. There’s a good reason why most CEO letters seem unintelligible. Often, they are riddled with jargon and glossy prose that make sense only to insiders.

    For the past five years, I have analyzed Fortune 500 company letters. Only one-third of the letters I surveyed are clear, candid, informative and engaging. Most of the remainder read as if written by corporate committees or public relations firms without benefit of an objective editor.

    More often than not, people tell me they don’t read shareholder letters because they are too jargon-ridden. The following linguistic anesthesia comes from the 2000 Enron shareholder letter:

    “Our talented people, global presence, financial strength and massive market knowledge have created our sustainable and unique businesses. EnronOnline will accelerate their growth. We plan to leverage all of these competitive advantages to create significant value for our shareholders.”

    In a single paragraph, the letter introduces six of the most popular CEO letter clichés:

    • Talented people,
    • Global presence,
    • Market knowledge,
    • Financial strength,
    • Leverage competitive advantages, and
    • Create significant value for our shareholders.
    These are all important concepts. But so many generalities and so few specifics quickly become meaningless to any reader. Not only do such clichés fail to inspire trust, they should cause a prudent investor to wonder if the company has something to hide.

    When an annual report arrives in the mail, go directly to the CEO letter, take out a red pencil and circle clichés like “to create shareholder value,” and other words that don’t make sense or add to your understanding of the business. When you have finished, look at the page. If you see more red than black, consider yourself warned.

    Reading Between The Lines

    If a shareholder letter passes the circle test for fog, read it again. This time, read and underline what makes sense to you. Some shareholder letters are well-written and informative; they reveal a good deal about a company. Read in between the lines to determine how much effort the CEO is making to educate you about his or her business. Particularly look for insights about how the company balances its profits and principles. This one factor distinguishes the letters written by CEOs who score high in my survey from the poor performers.

    A CEO signals his or her profit focus by reporting on the company’s business opportunities and explaining how investors will benefit from them. Statements about strong credit ratings, focused market intelligence, and a keen understanding of its competitive advantage will reveal how well a company can execute its strategy. You will have gained valuable insights into the company’s goals and how well-equipped it is to meet them.

    Principles are equally important. A CEO builds trust when he or she reports on successes and failures; and how the latter will be addressed. Detailed statements about the values of the business and how these are practiced build trust. I also look for comments that reveal how the CEO articulates the needs of employees, customers, and investors. Does the CEO show how the company is meeting the needs of these corporate stakeholders?

    CEO Gordon Bethune, who has led a remarkable turnaround at Continental Airlines, writes a letter that combines both profits and principles. Here’s what he said in 2000 about the ethic of everyone winning together:

    “We only win when we all win together—employees, customers and stockholders.

    “That approach has been responsible for our record six straight years of profitability and success. We’ve put our trust and confidence in each other and it has paid us all huge dividends. We continue to grow the gap between ourselves and our competitors on key metrics for financial performance, customer satisfaction and employee relations.”

    His letter then went on and detailed those key metrics.

    Kicking The Tires

    This leads to the third step in the analysis of shareholder letters. If you’ve developed a positive opinion about a company after sorting out the fluff and reading for profits and principles, then it’s time to conduct due diligence. You should kick the ‘company’s tires’ to see if there is tangible evidence to support the promises it has made.

    For instance, Continental Airline’s Bethune knows the importance of keeping promises. Not long after the September 11 attacks, I flew Continental and asked the flight attendant how CEO Gordon Bethune was holding up in the resulting turmoil. She said, “I just sent him an E-mail to tell him how things were going. I think we’re going to be OK.” Surprised, I asked if he had responded. “Usually he gets back to any of us within 24 hours,” she replied. “I wanted him to know that he had my support.” I got similar responses from Continental’s ticket agents and pilots.

    On the other hand, when a company provides exemplary disclosure in the shareholder letter and doesn’t back up their talk with consistent actions, investors should proceed with caution.

    The Scorecard

    To more thoroughly analyze shareholder letters, I’ve developed the Shareholder Letter Scorecard. Just apply a letter grade to the following areas:

    1. CEO Voice: Personal and Authentic: When you finish reading the shareholder letter, do you feel like you had a meeting with the CEO? Do you feel as if the CEO is talking to you? Do you get a sense of the human face behind the CEO’s public persona? Does the CEO suggest he or she is looking for a long- or a short-term relationship?

      A CEO’s attitude toward shareholders can reveal how he or she runs the business—for long-term profits or short-term gain. I read between the lines of shareholder letters to try to figure out what kind of “relationship” a CEO is looking for. This helps me to see if I want to be a long- or a short-term investor in the business.

    2. Practicing the Financial Golden Rule: Is the CEO giving you information that he would expect to receive if he were the investor? Has the CEO addressed your general and specific questions and concerns about the company?

    3. Detailed and Jargon-Free Information: Is the CEO explaining complex topics in simple terms without “dumbing” down this information? Is the letter free of clichés and technical jargon? Are you getting relevant details that help you to make judgments about the profit and cash flow potential of the business and the company’s intrinsic value?

      The best letters provide business details in simple, but never simple-minded, language. And they explain how these investment opportunities will produce profits. The CEO should also talk about profit drivers that reveal useful information about how a business opportunity will generate profits, how much profit to expect, and how the profits will be used.

    4. Consistent and Realistic Information: Has the CEO provided historically consistent information, especially with regard to the company’s earnings? Is the CEO explaining the company’s goals and how the company intends to meet its goals? Does the CEO explain why the company’s targets and other performance measures are realistic?

      A CEO who wants to show that he or she is trying to be accountable to investors and other stakeholders is going to tell you about their corporate goals. Financial goals reveal the financial targets that CEOs want their companies to achieve; operating goals reveal the CEO’s aspirations to improve the way the work gets done. The highest score should be given to stated goals that: are not generic, but rather provide a specific performance measure; tell the reader the things a company must do to meet the goal; and candidly assess the chances of attaining the goal.

    5. A Proper Accounting of Earnings: Does the CEO letter reveal an understanding of the difference between the company’s cash and accounting earnings? Can you find statements of earnings in the shareholder letter and easily locate this same number on the firm’s income statement in the annual report?

      When companies responsibly report their earnings in their shareholder letters, investors gain greater confidence in the governance of the corporation. In fact, it is so important you would expect to find this information in every CEO letter. Not so. Forty-two percent of the CEO letters in our 2000 survey didn’t even mention company earnings. In other words, these CEOs neglected to tell you their “bottom line” grade for the year. Investors can only wonder if this omission was deliberate or an oversight.

      Even when CEOs do report company earnings, it’s often hard to figure out what they mean. You can blame part of this problem on accounting. Earnings can be reported at different “layers.” Many CEOs choose to report their earnings in shareholder letters several layers up, typically at a level that lets them show their company’s earnings in the best possible light. This is not illegal. But when companies offer these customized pro forma earnings, a careful investor will want to examine the underlying assumptions the company is using to calculate them. [For more on what the different earnings figures mean, see John Bajkowski’s article, “EBT, EBIT, EBITDA: Will the Real Earnings Figure Please Stand Up?,” in the August 2002 AAII Journal, available at]

      I recommend that investors look for two indicators in shareholder letters to judge management’s accounting integrity:

      • Clarity in reporting the nature of non-routine write-offs that affect company earnings; and
      • Consistency in the presentation of earnings over time.

    6. Balanced Strategic Sense: Does the CEO include a balanced picture of the execution of the company’s strategy and its results? Are you learning about the year’s business failures as well as the successes? How is the CEO addressing the company’s problems?

      The topic that is most frequently cited in a shareholder letter is “corporate strategy.” No surprise here—when we learn about a company’s plans to make money from tangible assets, like plants and equipment, and intangible assets, such as patents, brand recognition and new technology—we get to the heart and soul of financial analysis.

      Many companies describe the corporate strategy as a list of action steps they intend to take. But such a list only tells you what a CEO plans to do. They don’t show how these steps are being acted out in real-life situations. I give CEOs extra credit when they describe strategic stories, which give readers a feel for the CEO’s “strategic sense.”

    7. CEO Values: Is the CEO describing his or her values and are these related to specific events in the company? Do you gain more understanding about how the CEO and his or her company practice these values in relation to their corporate stakeholders: employees, customers, investors, suppliers and others?

    The Bottom Line: Trust

    Individual investors can never enjoy the same access to top company management afforded to institutional investors. Nor would this seem to be a good use of limited CEO time.

    For most individual investors, the annual shareholder letter—and the annual shareholder meeting—are the only ways you will ever get to visit with the CEO.

    So take the time to analyze the shareholder letter, and judge for yourself how much of your trust—and perhaps your investment dollars—you are willing to place with this CEO.

    Laura J. Rittenhouse is president of andBEYOND Communications, an investor relations advisory firm based in New York City. The firm each year compiles a benchmark for rating CEO shareholder letters based on reviews of the letters of 100 large-cap companies.

    This article is excerpted from Ms. Rittenhouse’s new book “Do Business With People You Can Tru$t,” $22.95, published by andBEYOND Communications. It is available from ( or through the publisher (639 West End Avenue, New York, NY 10025;

→ Laura J. Rittenhouse