A common misconception is that “free market” proponents – and their most recognized advocate, Eugene Fama, Nobel Prize laureate – believe that stock markets are perfect. This is false. Markets are not perfect, but as Fama proclaims, they are relatively efficient. Acknowledging that markets are efficient is important: a relatively efficient market can provide information
that every firm can use to do strategic planning the right way.
Markets are especially adept at translating corporate growth expectations into changes in share price. Any piece of corporate, industry, or macroeconomic news has the potential to affect share prices. Think of what happened to a share price the last time a company provided forward guidance, the last time a CEO was replaced, or the last time new figures for the University of Michigan Consumer Sentiment Index were published.
Share prices fluctuate because investors assess the impact of any piece of news on a company’s future earnings. In some cases the impact is small and the share price barely moves. In others, it is perceived as material, and the share price can fluctuate significantly. In many cases, these changes start taking place immediately; in others, it may take longer as the market takes time to interpret the new development. Given the value of the firm, we can extract investors’ growth expectations, which we call the Future Growth Value (FGV®).
This FGV should be a starting point for a company’s strategic planning process. A firm’s goal should be to meet or exceed current expectations, and generate new expectations for the future. This process leads to an increase in share price and therefore, shareholder value.
After identifying the FGV component embedded in the company’s valuation, the firm should translate these expectations into internal targets. These targets should be set initially at the consolidated level and then at the business unit level and beyond. While targets will be set initially for the long-term, they should then be translated into annual targets.
The previous two steps constitute the target-setting part of the planning process. This is primarily top-down rather than negotiation-oriented. The next step is for the units to identify the initiatives that will allow them to reach or exceed first their multi-year and then their annual targets.
After each unit identifies all possible initiatives, it should prioritize them according to their capacity to create value. The projects with the highest NPV should come first.
After selecting the initiatives, the unit should execute them in the most efficient way possible. The goal should be to come in-line or under cost and capital expenditure projections, and over revenue expectations. The unit should track project performance on an annual basis to gauge whether it has met expectations. This will allow managers to identify areas where they have done well and others where they have come short so they make changes going forward.
Diagram 1 - The Strategic Planning Process
This might sound easy, but in reality it is far from it. This approach involves discipline and a solid backbone to stand up to the short-term minded analyst on Wall Street who asks for quarterly guidance and does not accept anything but quarter-on-quarter growth in EPS. Companies with strength and a long-term mindset will be rewarded as the lead steer investors that significantly affect the market with their decisions will stand by them.