Customers´ arguments are powerful: unless a fund manager consistently beats a standard benchmark such as the S&P 500 index consistently, he or she is a value destroyer on relative basis.

And THAT´S the only basis that matters. Even today´s chronically underperforming CEO in entertainment and telecoms clinging desperately to their jobs for as long as they can generated some nominal ‘value creation´ numbers at some point in their career. But running a 100 yard dash in 12 seconds is no accomplishment at all when everyone else breaks 10.

For today, investing in the S&P 500 is a no-brainer, the 21st century equivalent to sticking money in a low yield passbook savings account and then just forgetting about it.

Corporate senior management hope that similar tough-minded performance criteria are not applied to them, as well. Oops, they are.

Today, the CEO and entourage of a company that fails to beat the S&P 500 as well as that industry´s index on a Total Shareholder Return basis (that is, share appreciation plus cash dividends) faces an even shorter period in office than today´s three year CEO average (From Chapter 4, VBM Consulting´s THE VALUE MANDATE by Clark & Neill).

Relative TSR or RTSR as we refer to it (Company TSR compared to the S&P 500 or other, widely accepted suitable index) is best calculated on a 1, 3 and 5 year basis, simultaneously.

Such an approach helps prevent some of the worst valuation errors, such as the Dot-Com bubble of 96-00 or the false valuation tout-distortion for late 90s telecommunications companies despite the absence of any credible value-business plans.

Use of RTSR in this manner also cancels the ‘rising tide´ distortion. That´s when company valuation rises and falls because of overall market conditions, having little or nothing to do with top management value-competence and performance.

Some CEOs love to claim unearned credit for ‘value creation´ when a rising overall market increases the valuations of ALL companies, good or poor. Those same chief executives are far less enthusiastic about being personally blamed for value destruction when the overall market tide goes down. The best idea is to eliminate market tidal distortions on both the upside and downside —which is exactly what use of 1/3/5 year RTSR achieves.

It is by comparing the pattern of 1, 3 and 5 year company RTSRs that management´s true ability (or inability) to create value is revealed.

A single year RTSR measure (e.g., beating the S&P 500 over one trailing year) might be a fluke or a fad or both-- manipulated by some touts headed for self-destruction just a few quarters later. But a positive one year RTSR by a new top management team following negative 3 and 5 year RTSRs provides some reason for hope.

Maybe, just maybe, the corporation´s newest leaders have stopped the value destruction of their predecessors and discovered some new value sources of their own.

A deteriorating situation—as revealed by progressively lower RTSRs for 5, 3 and one year—indicates real problems.

Management has lost the plot and no longer knows how to create value. If the deteriorating performance is accompanied by complaints about “unavoidable external conditions”, this concern is doubled. Not only are management incompetent, in value terms, but they´re wasting time generating excuses, not remedies.

While there is no single ‘right´ RTSR measure for the reasons described above, the three year measure is the closest thing, mostly because that time period so closely corresponds to corporate top management´s maximum expected term in office.
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