Investing 101: Why Corporate Governance Matters

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(List compiled by Alexander Crawford and Danny Guttridge. Net margin and price data sourced from Screener.co, RiskMetrics ratings sourced from Yahoo! Finance, all other data sourced from Finviz.)

Companies cannot succeed in the long term unless they follow and maintain a solid set of corporate governance policies. These policies dictate how a company is run, and they are meant to mitigate conflicts of interests between company owners (i.e. shareholders for publicly traded firms), the board of directors, and company management.


In theory, company owners want to maximize the wealth of their company, while management wants to maximize their personal wealth (a clear conflict of interest). The board is an intermediary, who serves to mitigate this conflict by watching over management and auditing the firm’s performance. In order to keep conflicts at a minimum, corporate governance policies are followed.


These policies can vary from decisions related to executive compensation to board composition to whether the CEO is also the Chairman of the board. The company RiskMetrics has broken corporate governance policies into four main categories, on which they rate relative risk: the board, the audit committee, the compensation committee, and shareholder rights.


When corporate governance issues arise, such as when a company receives a bad audit report, those issues will almost always be reflected in the company’s stock price and long-term performance. Therefore it pays to evaluate a company’s corporate governance reputation.


Here we ran a screen on companies with growing profitability (comparing trailing-twelve-month net margin to the five-year average) that are undervalued to target price. We screened these companies for those that are rated by RiskMetrics as “low risk” for all four corporate governance categories. The 2 stocks in the list are below.

A closer look at the terms used above:

Trailing twelve months (TTM):  An indication that the calculated data has come from the last twelve months.

Analyst target prices  can be very useful guides for investors. The target price is a price level set by analysts that, based on their data and estimates, represents their predictions for that company in the upcoming year. Because analysts often have different opinions, we use the average analyst target price. When a company's current market price is deeply lagging to the target price, it may signal that the company has more value to price in (meaning, the stock price may rise).

Net profit margin  describes how much profit a company keeps for every $1 it generates in revenues. It is calculated as net profits divided by sales and is reported as a percentage. Increased net profit margin is a good thing because it means the company is retaining more earnings and implies that it is in better control of its costs. This metric is best used for comparing companies in similar industries.

Do you think these stocks are being undervalued? Use this list as a starting-off point for your own analysis.

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1. HEALTHSOUTH Corp. (HLS): Specialized Health Services Industry. Market cap of $2.07B. TTM net margin at 0.46 vs. 5-year average at 0.11. Target price at $30.34 vs. current price at $21.79 (implies a potential upside of 39.24%). According to RiskMetrics, the company has "low risk" in all four corporate governance categories. The stock is a short squeeze candidate, with a short float at 8.74% (equivalent to 8.56 days of average volume). The stock is currently stuck in a downtrend, trading 15.59% below its SMA20, 18.36% below its SMA50, and 9.78% below its SMA200. It's been a rough couple of days for the stock, losing 12.56% over the last week.

2. KKR Financial Holdings LLC (KFN): Asset Management Industry. Market cap of $1.72B. TTM net margin at 0.68 vs. 5-year average at -0.08. Target price at $12.46 vs. current price at $9.64 (implies a potential upside of 29.25%). According to RiskMetrics, the company has "low risk" in all four corporate governance categories. This is a risky stock that is significantly more volatile than the overall market (beta = 2.69). The stock has gained 26.34% over the last year.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks: HLS , KFN

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