Bottom-Line Quality

May 5, 2003
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Holy corporate accounting scandal!

For the good of American capitalism, let's hope that dastardly deeds of the kind uncovered recently at companies such as Enron and Worldcom are much more the exception than the rule. But while large-scale accounting fraud may be relatively rare, the fact is that top management at many publicly held companies routinely fudge their earnings numbers. Maybe even at your company.

Why do they do it? They've got to hit the consensus quarterly earnings estimates set by financial analysts. Companies whose profits fall short of the numbers often see their stock prices plummet, sometimes by double-digit percentages. And because many top executives receive part of their annual compensation based on their company's stock price, many "manage" their earnings a bit each quarter to be sure of beating analysts' earnings-per-share estimates, if only by a penny or two. It's a reality, like it or not, and a practice that Wall Street has long been aware of.

What's this got to do with quality? One of the most commonly heard complaints from quality professionals is a lack of top management commitment to quality. And the solution to that problem, many experts recommend, is to explain quality to the top brass in terms they can understand -- namely, dollars and cents. If you can show your CEO that sound quality management practices will have a positive impact on earnings, as well as the company's stock price, you'll have a much better chance of getting his or her attention.

Unfortunately, that's easier said than done. When it comes to the short-term, quarterly numbers, quality management has minimal impact, market watchers agree. But over the long haul, quality does make a bottom-line difference that can translate to better stock price performance.

"Once you're using advanced management techniques, including things like Six Sigma, ISO and Baldrige, you start to gain efficiencies that your competitors don't have" says Craig Robinson, president of Robinson Capital Management, a Minneapolis investment firm. Those efficiencies can pay off in improved profitability and other benefits that the stock market will reward, he says.

As a tool for investing, Robinson's firm about three years ago developed the Q-100, an index of companies selected for their leading quality management methods. The Q-100 numbers tell the story. Since the inception of the index in September 1998 through the end of 2001, Q-100 companies returned 26.97%, compared to 17.59% for the Standard & Poor's 500 stock index during the same period.

Other quality indicators have produced similar results. The Baldrige Index, for example -- made up of Malcolm Baldrige National Quality Award winning companies -- has consistently outperformed the S&P 500 for the past eight years, says the National Institute of Standards and Technology.

So even if you can't show the boss how quality can help your company hit the analysts' quarterly estimates, you can provide evidence of quality's long term, positive impact on earnings and stock price performance.

Oh, and one other thing. According to Robinson, quality companies in the Q-100 provide more "upside surprises" than competitors, meaning that earnings in any quarter might unexpectedly beat analyst expectations. With surprises like that, there's no need to fudge.

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