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Strategic HR vs current share prices

IT might come as a shock why human resources (HR) pre-occupies itself with business phenomena such as share price.

Report by Brett Chulu

If you are still looking at HR with a condescending attitude, you are missing out on a phenomenon that is slowly gaining traction among forward-thinking Zimbabwean organisations, which are increasingly waking up to the unique contribution of strategic HR in driving earnings performance, and towards building and defending market value.

Strategic HR is concerned with building organisation-wide capabilities that deliver on the expectations of external customers, shareholders and other significant communities. Strategic HR understands the business and its external drivers just as deeply as any other business function. Strategic HR translates that deep understanding into talent, leadership and cultural practices.

Jack Welch, the former chief executive of General Electric (GE) who took GE’s market capitalisation from US$8 billion in 1981 to more than US$200 billion when he retired in 2001, took strategic HR seriously — he believed the head of HR “should be up there with the CFO (chief financial officer)”.

According to documented evidence, Welch, who oversaw a business empire with in excess of 200 000 employees across the globe, spent more than half of his time dealing with strategic HR issues and 15-20% interacting with external customers.

I believe that Jack’s investment in strategic HR is to a large extent responsible for the phenomenal growth of GE’s market capitalisation during his 20-year tenure. If Jack, for all his aura and gravitas derived from unparalleled business success, directed more than 50% of his focus on strategic HR investments, there is no reason why business leaders in Zimbabwe can fritter away an opportunity to leverage on strategic HR to differentiate their organisations from others in the product and financial markets.

Here in Zimbabwe, Joe Mutizwa, the former chief executive of the blue-chip Delta Corporation, drank into the philosophies of Welch, including the elevation of strategic HR to be at par with finance. Joe is now the chairperson of Starafrica Corporation. A former chief operations officer from Delta is now the CEO of Starafrica. It is no wonder Starafrica’s market capitalisation has more than doubled since the ex-Delta duo joined the once-ailing Starafrica.

Nearly each time a former GE employee joins another company, the company’s market capitalisation spikes. The same is now happening with Delta. That’s the potency of strategic HR.

If those tasked with the responsibility of directing HR at listed companies do not understand how their companies are being rewarded by financial markets, it is next to impossible to craft strategic HR practices that directly contribute to improving business performance on metrics such as market capitalisation (share price multiplied by outstanding shares).

The language of business is finance; and strategic HR must be sufficiently fluent in that language, not for the purpose of replacing the CFO, but to use that financial literacy to direct the talent, leadership and organisational culture agendas.

Earnings versus share price
In the spirit of linking strategic HR investments to our current business environment, we set out to investigate how financial markets in Zimbabwe are collectively deciding on allocating value to shares. We employed what is known as least squares regression; modelling to size the influence of earnings on share price. It is a well-known fact that share price is directly correlated with earnings performance.

The purpose of our analysis was to figure out the extent to which that relationship holds in the current operating environment. A sample of 18% of the firms listed on the Zimbabwe Stock Exchange (ZSE) was studied. Undiluted earnings per share (as calculated from published reports and verified with company-stated values) and closing share prices for the reporting period were used.

Our study established that indeed there is a very strong positive correlation between current earnings per share and share price. An R-squared value of 0.88 was obtained. This R-squared value, in simple terms, means that earnings per share accounted for 88% of share price. Put differently, a strong earnings performance in the current operating environment is highly likely to be rewarded with an increased share price.

Econet stock heavily undervalued
The statistical relationships we derived from the model, we extrapolated to a number of firms not sampled. Econet is a very notable anomaly.

From the parameters established from our model, Econet should be trading at around 676 US cents per share, based on last year’s earnings performance. At the current share price of 475 cents (at the time of writing), our model shows that Econet is at least 42% undervalued. What this means is that something else might be going on here. To suggest that Econet’s future earnings performance is under threat does not make sense, given the new products Econet is releasing onto the market.

An analysis of intangibles resident in Econet’s cultural practices interfacing key external stakeholders is difficult to fault. Here are a few cases. Econet is the biggest corporate contributor to the fiscus as officially noted in last year’s national budget statement and thus we do not expect any challenges with regards to taxation compliance now or into the future.

Econet’s corporate social responsibility culture is well-known. The company recently launched the green kiosks, a venture that ties business with corporate social responsibility. Econet’s innovation and pioneering culture is also consistent. All these positive intangibles the market seems to be discounting.

What it simply means is that the causal mechanism driving share prices as a result of current earnings performance is different.

Strategic HR interventions

Our research draws three lessons:
The first for those tasked with directing strategic HR is that in our current operating environment, a good earnings performance may not translate into anticipated market value as might be predicted by theory.

Equally important, the second lesson is that the existence of positive intangibles may not be rewarded commensurately by the market. With such an anomaly, it becomes incumbent upon business leaders to probe deeply into why their investments in talent, leadership and culture are being discounted by the market.

The findings of that probe then become the basis for adjusting investments in talent, leadership and culture.

With reference to strategic HR, knowing the specific causal mechanism, as established by qualitative research, helps to make informed strategic HR investments that impact positively on market perception. Strategic HR could check the pulse of the organisation by collaborating with other business leaders in designing, administering and interpreting qualitative research.

In that regard, perception surveys designed to draw both emotional and non-emotional data can be administered to investment communities, external customers and affected social communities, for instance. Forward-looking organisations can even undertake anthropological research to understand their external stakeholders in a deeper way than what quantitative research could ever reveal.

It must be borne in mind that when key senior employees give their all and their efforts are not rewarded by the financial markets, incentive schemes like share options and value-based share schemes such employee and share ownership schemes can sink underwater, possibly leading to employee-disengagement and the eventual loss of critical talent.

The third lesson is that more often than not, a good earnings performance is rewarded with commensurate market capitalisation. In that case, strategic HR must build the organisational capabilities that drive and defend earnings gains.

This, among other interventions, could mean building a strong performance management regime designed to entrench an organisation-wide innovation culture balanced by a strong efficiency culture.

In fact, innovation and efficiency need not be seen as conflicting. Innovative ways to drive efficiency can be encouraged and rewarded.
Business leaders cannot afford to treat HR as a backroom operation.
Chulu is a strategic HR consultant who has worked with listed and non-listed companies. E-mail: brettchulu@consultant.com

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