The Business of Annual Letters

Why Do Some Companies Write Them? What Makes a Good One?

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A big part of any CEO or asset manager's job is to communicate with their investors. There's a cynical reason to do this: disgruntled investors can amass enough stock in a company to pick a new CEO, or pull money out of a fund. And there's also an idealistic corporate governance reason: the separation of management and ownership means that investors' money has been entrusted to someone who has a moral duty to manage that money well on investors' behalf.

But there's also a practical argument. Managing a company or portfolio is a busy job. In general, those that are in charge would be able to fill more than 24 hours a day with useful work—and that’s saying a lot, because a big part of what they do is either saying no to things or delegating them. And the more successful a company or fund is, the bigger its surface area, and more immediate decisions end up reaching the manager's desk. So, assuming the company is growing, the person in charge is always busy and always getting busier. That makes carving out some time to step back, review their company's model, think about what it's trying to accomplish, and how it will do so very difficult—but even more valuable.1

While that dedicated reflective time is useful regardless of its output, a lot of that thinking ends up informing investors. And investor relations generally is about some mix of at least four things:

  1. Trying to maximize the amount of money flowing into a company, or the valuation accorded to it. From a company's perspective, investor relations cultivates a relationship that leads to more assets or a higher stock price.

  2. Making sure the investor population understands what the strategy is and has appropriate expectations. This is more of an ongoing issue with asset managers than with companies, because asset managers can shift strategies very quickly.2

  3. Feedback and idea generation. One benefit of outside investors is that they increase an organization's surface area. There are second-degree connections to companies that are good potential investments or acquisitions, and that are potential threats worth monitoring and mitigating. Investors can be a source of talent, too (though that gives the source investor some operating leverage: it's hard to undo a mistake that came through a referral!).

  4. Investor communications naturally get reviewed by third parties. This can create an incentive to exaggerate competitive advantages in order to scare off competitors, but to understate margins and growth in some sub-businesses by burying them. Google and Amazon probably created tens of billions of dollars of shareholder value by refusing to disclose much about YouTube and AWS early on, so competitors didn't try to copy them more aggressively. Investor communications can be an effective way to keep people out of a market, or to get other investors in an industry not to add capacity. (Ryanair is particularly fond of repeatedly claiming that the summer travel season is off to a slow start, and that only an airline with a cost structure as low as theirs should be ordering new planes. Somehow, summer usually turns out to be okay for them.)

Writing a lucid annual letter is a very good way to accomplish all of this. The longform format means that it's a good way to lay out a complex argument in a controlled fashion, and the fact that these show up in annual reports means that they're likely to get read because they might contain new quantitative information.

And yet, the vast majority of annual letters are not worth reading, and many companies don't bother. It has gotten popular to include a letter-to-shareholders in a company's prospectus, a trend that seems to have gotten big after Google did it (Amazon did a similar letter in their first annual report, which they reprint in every other annual report). But there's a short list of companies with shareholder letters that are worth reading even if the reader isn't planning an investment:

  • Berkshire Hathaway is the leader here, and their letters have even been collected into multiple books. But the alpha here has been heavily mined.

  • JP Morgan provides a very good look at a large chunk of the economy, and Jamie Dimon is not afraid to make claims about macro risks or the policies that might avert them.

  • Square does a good job of explaining the state of small business in their quarterly reports.

  • Stripe's annual letter is basically The State of High-Growth Companies.

  • Netflix's quarterly reports are a good look at how people spend time, rather than money. In particular, any changes in Netflix's competitive dynamics imply some new time-use category that's becoming extraordinarily important.

Beyond that, how many great letters are there? Among investment firms, there are some that have excellent blogs, newsletters, and podcasts, but those are often not quite in the spirit of an annual letter—A16Z has good reports on emerging industries, for example, but isn't really writing about their firm itself and how they think. Many investment letters from companies involved in public markets get read by analysts doing equity research, but because the people writing those letters understand this, their disclosures are partly a function of whether or not they're done putting on the trade.3

One possibility is that many companies don't use writing as their main medium for thinking about and making internal decisions. Or, if they do, they may still bias promotions towards people who are charismatic in person rather than in pixels. (You might reach out to someone about a job purely based on what they write—this has happened to me many times, in fact!—but it's hard to imagine someone getting selected as CEO by a board they'd never interacted with in person, entirely based on good memos.4 ) As companies slowly shift to making more decisions over email and text message, and recording results in internally-accessible wikis, we could end up with better selection for better annual-letter-writers.

But a good writer, of which there aren't many, leads to another problem. Now, succession means either a) weighting writing skills very highly, b) accepting that the company's annual letter will get much worse when the current leader steps down, or c) omitting it entirely under the new management. All of these are hard. But they're also just one instance of the general CEO succession issue: if a CEO does a good enough job, they solve a lot of problems for the company, but new problems inevitably crop up. That requires a different kind of CEO; sometimes it's best for a company's founding CEO to be good at product, or engineering, but to eventually be replaced by someone who focuses more on margins, efficiency, and return on investment. Certainly, Apple shareholders feel this way, though fans of their products may disagree.

That model implies that good annual letters have a lot in common with other literary careers: they're partly a function of talent, partly the result of experience, and partly a function of media distribution—the economic success of Playboy in the mid-twentieth century subsidized a lot of good short fiction, and short fiction as a genre has gotten rarer since then. The distribution problem, in this case, is that a company has a story to tell that's best told in the form of a serialized short-term company history with near-future speculative fiction elements. But all of those stories come to an end sooner or later.

Disclosure: Long Amazon, Microsoft

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Read More in The Diff

The Diff has written about some of the investor and company letters mentioned above, including:

1. This is true even if nothing gets published. When Bill Gates ran Microsoft, the company's annual reports weren't especially noted for their insights—at least, it's rare to hear Gates quotes from them rather than from speeches, internal memos that were made public during trials, etc. But Gates did take time off every year for a "think week," which was partly about spending some time on non-Microsoft intellectual exercises and partly about thinking further ahead than what day-to-day work allowed.

2. Unless you're running a very large fund, you could, between investor updates, theoretically switch from being pure large-cap growth to pure global macro; it's easy to sell shares of liquid megacap stocks and easy to buy futures and other derivatives referencing currencies, rates, and commodities. Some investors do make stylistic swings, which sometimes work out quite well (many value investors evolve towards quality growth over the course of their careers) and some of which can be a long-term drag on returns ("macro tourism" usually doesn't work out, though John Paulson has one of the best records of all time because he switched from merger arb to macro tourism at an opportunistic moment).

3. This is a case, though, where the annual letter is a good way to set expectations. If a generalist fund ends up finding lots of bargains in oil stocks, banks, or biotech, they'll call this out partly so they can explain it in advance if those stocks in particular have a bad quarter.

4. If you know of cases where this, or something like it, happened, then please let me know! In cases where it's not publicly known, it's off-the-record by default.

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