All posts by Paul Kearns

International Integrated Reporting Council recognises ground-breaking OMS work on Human Capital Reporting

IIRC Value of Human CapitalThe International Integrated Reporting Council responsible for developing a global <IR> framework has recognised MI approved, OMS LLP’s, work in its latest report on ‘The value of human capital reporting’ “Much human capital reporting currently focuses on inputs and activities, rather than on the outputs and outcomes. It is rare for companies to explicitly demonstrate how their human capital is contributing to value creation. However, some experimentation with reporting on outputs and outcomes is taking place.

For example, the OMS Human Capital Reporting Template © identifies “the critical questions that need answering” to reveal “underlying value and risk”7. The template “follows the principles of whole system thinking; recognizing that all organizational systems are inextricably bound up with human systems, which directly and indirectly influence performance, total value creation and operational risk”. The methodology  encompasses talent attraction, acquisition, development, performance management
and retention and how that integrates with the other financial and management systems.
OMS stresses that all human capital data and information must be ‘material’ in showing
“a direct, causal connection to value creation (or loss) and decreased (or increased)
organizational risk.”

Seeking True Alpha through Maturity Analysis

FTSE chartInvesting is an activity as old as money and although the data and technology has changed beyond all recognition since the ‘big bang’ in the City of London in 1986, fundamental statistical theory has not.  When it comes to assessing the performance of pension fund and investment managers, for example, we tend to see comparisons with standard indexes such as the FTSE 100 or S&P 500. That makes sense if competitive markets work efficiently and effectively with underperformers being forced to raise their game.  But what if all the companies in the index are underperforming relative to their potential?

At a recent responsible investment meeting, the head of responsible investment from a highly respected investment house, remarked that “most companies are mediocre”  performers in terms of management capability and quality. That is what conventional, bell curve analysis would suggest but it is not true when an outstanding company re-sets the benchmark for management quality (for a simple explanation of this please view our 3-minute video*).

The problem with investment strategies that concentrate on conventionally managed businesses is that the biggest opportunities lie elsewhere.  At OMS we have a clear focus on the potential returns that are achievable with human capital and effective Human Governance. Our research, rating and reports are designed to unearth companies where these opportunities lay and how they can be realized, for both the companies and their investors .

If you would like to know where your company or fund portfolio fits on our Global OMI, which companies are best placed for outperformance, or those where the greatest risks lie, please let us know.

*The original benchmark for the Maturity Institute’s scale was Toyota – currently with a market capitalization of nearly four times that of rival GM (Toyota $176.02bn/GM $45.95bn – http://finance.yahoo.com/ on 11th January 2016 @ 13:05 GMT)

 

How we use “Pinpricks of light” to illuminate Human Governance

Learning financial shoots 2What does the reporting of a seemingly innocuous measure like training hours tell us about a company’s management quality and material value generation from human capital?

Picking up on the theme of the recent post by my colleague, Stuart Woollard, about ‘pricing governance’ into company valuations and the general issue of what companies choose to include in their annual reports, I demonstrate below just how much insight can be gained from these so called “pinpricks of light” and how they affect the underlying value of an organization.

Let’s start with the the most obvious question: why do companies produce any reports for public consumption? We generally assume they do so either because they are required by company law or choose to report on matters that they believe presents the company in a favourable light. The pinpricks tend to be from areas they are least willing to reveal. If these assumptions hold true then anything a company chooses to tell us about its ‘human capital’ is probably something they are happy to publicise. So why is there so little mention of human capital data in the vast majority of annual reports from our OMI listed companies?

One pinprick regularly included is the number of training hours per employee.  In the case of the “Nestlé’ in Society Report” for 2014 we find that their “Average hours of training per year per employee per category” was 28.8. So what can we deduce or infer from this statistic?

First, it is worth asking how that particular figure was determined because measuring training hours is highly problematic and misleading. Nestlé’s note tells us that it “Covers approximately 85% of all employees through a combination of manual submission from the markets and the training system.” In reality, their training hours figure probably only refers to specific hours recorded for those who attend courses; either in a classroom or in front of a screen.  Also, its reference to a “training system” is likely to refer to a computerised booking system of who went on which courses.  This is where illumination really begins.

If Nestlé employs learning and development professionals, then it should use more precise language to explain what it is spending on ‘training’. For example, “teaching” and “training” are two entirely different processes. Teaching is primarily about imparting knowledge, while training is about giving people skills to do a job. ‘Training hours’ does not reveal anything about how well an employee has been taught, whether it has given them the capability to do their job better or what value it has added. Ironically, Nestlé’s voluntary reporting here turns out to be a negative indicator of human governance when put under an OMR analyst’s microscope.

So what could reassure shareholders’ about Nestlé’s governance and human capital management capability in this respect?

Rather than measuring input (training cost) and activity (hours) Nestlé should be measuring outcomes (what did employees do with what they learned?) and value (how much has Nestlé’s financial performance and market value likely to have increased as a result of its investment in learning?).  More importantly, does Nestlé know what a learning system is and how this drives value?  If they reported that they had recently created one, and it satisfied our standards, then this would immediately improve their OMR (currently BBB-).

One key element in that system would have to be a business appraisal of all investment in employee learning.  For example, OMS advises on how company employees can improve margins. A company can utilise a basic introduction to simple tools, which takes no longer than 2 hours, and has a very specific aim of ensuring every single employee learns how to work together to improve the company’s operating margin by 1% point.  If Nestlé dedicated just 2 hours, out of its average of 28.8, to this objective how much value would it add? Our view is already published in OMS’s a very recent Nestlé Research Note.  Here is just a short extract:

“Nestlé’s current operating margin is 11.80%[i]. Chart 1 below highlights operating margin among other comparator firms. Reckitt Benckiser currently receives our highest rating for this sector and produces the highest margin (Op Margin 25.39%; BBB+). Even companies on the same rating, such as Unilever, currently produce significantly more margin (Op Margin 16.38%; BBB-)[ii]. 

Nestlé’s big opportunity

From 2013 to 2014 Nestlé’s operating profit margins fell from 14.18% (CHF 13.068 billion) to 11.90% (CHF 10.905 billion). Research conducted by OMS LLP, in conjunction with the Maturity Institute[iii], shows that organizations below a BBB- level of maturity have huge gains awaiting them if the Executive team adopts a strategy to utilise mature HCM practices. In Nestlé’s case, we are confident that an extra 5-10 percentage points on operating margins are achievable within 2 to 3 years. Based on Nestlé’s 2014 figures, a 16.90-21.90% operating margin would equate to an additional operating profit of CHF 4.58 to 9.16 billion.”

It should be of great concern to all investment researchers and analysts, that the default rating for companies on OMS’s scale is a ‘B’; a lowly point 8 on a 22-point scale that mirrors standard credit ratings. When it comes to training practices, over 95% of companies adopt the same methods and still choose to measure training hours rather than anything meaningful in terms of company valuation. Any investment managers with holdings in Nestlé (or indeed for most other companies) might want to raise this point.

Of course, training hours is just one among a myriad of pinpricks that we analyse in this way. If you would like to know more then please contact us.

References:

[i] http://markets.ft.com/research/Markets/Tearsheets/Financials?s=NESN:VTX

[ii] Yahoo Finance at 3 November 2015

[iii] http://www.hrmaturity.com/the-evidence-is-plain-human-governance-is-material-to-corporate-performance/

Investors start to see the tangible value of human capital

human capital city investorsFriday 20 November 2015 may well be remembered as a seminal moment in corporate history. It was the day when the debate about human capital reporting ended and the professional practice of mature, human capital management was established.  One where the investment community showed clear recognition and concrete affirmation that Human Governance, and the human capital management practices that support it, are not just material to the value of companies, and the risk factor they carry, but a specific quantum is identifiable.  This was the day when the accountant’s long-held barrier for not being able to measure or manage value from human capital was overcome; a day when the term ‘intangibles’ became obsolete in corporate parlance.

The London Stock Exchange was the venue chosen by the Investment Association to for its launch event on Human Capital Reporting.  There could be no more appropriate a location to remind capitalists just how much people matter; and no better way to influence and convince than by using the City’s own hard measures of corporate performance.

This was the platform from which Stuart Woollard, Managing Partner, presented OMS’s organizational maturity rating (OMR) of BBB- and its Research Note for Nestlé to a number of senior figures from the investment community.  Research that was described as “excellent” by the Chair of the Panel, Ian McVeigh, Head of Governance at Jupiter Asset Management.  Stuart clearly and unequivocally advised that Nestlé has much to do from a Human Governance (HG) standpoint and declared that it could be worth 5-10 additional percentage points on current margins. On Nestlé’s 2014 figures this would equate to another CHF4.58-9.16bn (c. £2.9 – 5.9bn) of profit.

Another senior fund manager present on the panel, who had large holdings in Nestlé stock, had minor “quibbles” with OMS’s analysis and accepted the broad conclusion that Nestlé could significantly and sustainably enhance its value through better HG. This was recognition that conventional investment research and analysis had been short of the missing piece in company valuation for far too long and it now enables investors to ‘price in’ how effective a company is in Human Governance terms.

OMS’s ground-breaking work, under the auspices of the Maturity Institute, is rapidly finding acceptance with other investment professionals who are encouraged to make confident approaches to companies with the ‘key questions for investors’ that OMS’s Human Capital Reporting Template© provides. For example, rather than accept meaningless metrics such as staff training hours or employee engagement scores at face value, investment teams are wanting to find out what lies beneath the PR surface; asking about the extent to which a company creates value from learning and how engagement drives value creation in the long term. This is only one short, step away from requiring companies to provide much better evidence that they are making every effort to improve Human Governance in a way that will directly create higher, material value.

Before the Investment Association event last Friday, human capital reporting was still seen as a subject for debate; a hypothetical situation that might never exist. That particular debate is now consigned to history.  OMRs have made it a reality and disavowed investors, boards and executives of any notion that human capital is intangible or immaterial.  OMRs use the common language of credit rating and based on a universal rating scale (that mirrors S&P).  Ian McVeigh referred to the OMR scale, remarking that Nestlé’s BBB- was, in effect, only one point above ‘junk’ status.  Helena Morrissey, President of the Investment Association, said in her Welcome note for the event that it was time to ‘turn ideas into actions’; OMS already has and human capital analysis in investor research is here to stay.

OMS speaking at Investment Association on Human Capital Reporting

IA event HCR 20Nov15Stuart Woollard, Managing Partner at OMS LLP, will be speaking at the Human Capital Reporting event organized by the Investment Association in London on Friday 20th November, 2015. Programme details are available here. Stuart will be explaining OMS’s Human Capital Reporting Template and how it is used to produce OMRs (organizational maturity ratings) with a recent, specific example for Nestlé.

If you cannot attend but would like further information please contact Stuart