inside the buy-side® 2q14

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www.corbinperception.com

INSIDE THE BUY-SIDE®

SECOND QUARTER | ISSUE DATE: APRIL 11, 2014

Perhaps pausing for a breath following 2013’s

sharp run up, equity markets posted a mixed

performance in the first quarter, as the Dow fell

0.7% while the S&P 500 and NASDAQ posted

modest gains of 1.3% and 0.5%, respectively.

Still, despite the smallest quarterly advance for the

S&P 500 and the NASDAQ since the fourth

quarter of 2012, it was also the fifth straight

quarterly rise for both. As well, the Dow and the

S&P 500 posted gains for February and March.

In our ongoing effort to track investor sentiment

and expectations, we surveyed 50 financial

professionals globally and across multiple industry

segments and investment styles.1 In total,

participating institutions manage upwards of $729

billion in equity assets.

News out of Washington was front and center in

the quarter. Fed Chairwoman Janet Yellen’s first

press conference in mid-March briefly sent

markets tumbling. After announcing that the QE

program would end this fall if the Fed continues to

taper purchases in measured steps, Yellen said the

first rate increase following the end of stimulus

could be in “six months or that type of thing”. Fed

officials also predicted their target interest rate

would be 1.0% at the end of 2015 and 2.25% a

year later, above previous forecasts and based on

upgraded projections for the labor market. Yellen

later eased investor concerns, saying the economy

will need Fed stimulus for “some time”.

Meanwhile, in February the House approved a

one-year extension of federal borrowing authority,

allowing a debt limit increase without any

conditions. The vote, largely along party lines,

was a shift away from the confrontational tactics

House Republicans employed the past three years,

culminating in last October’s 16-day government shutdown.

1 Timeframe: March 20 – 25, 2014

Investment Style

Core Value | 36%

Core Growth | 28%

GARP | 20%

Growth |12%

VC/Private Equity | 2%

Yield | 2%

Sector

Generalist | 42%

Industrials | 30%

Multi | 22%

Technology | 4%

Consumer Discretionary | 2%

Geography

North America | 66%

Europe | 30%

Asia| 4%

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Key Trends

As earnings season gets underway, 77% of those surveyed expect 1Q14 results to be in line

with or below consensus expectations

While the majority forecasts organic growth, EPS growth and FCF to improve this quarter, it

is a notably smaller number while the percentage of respondents expecting these metrics to

worsen has risen significantly from the previous quarter

60% of participants describe executives’ tone as more cautious quarter-over-quarter

39% of those surveyed characterize their current market sentiment as “cautiously optimistic”,

down significantly from the 75% who held this view last quarter

Investment professionals report favoring the IT, Healthcare and Financial sectors and express

bearish sentiment toward Utilities, Energy and Consumer Staples

Dividends reemerge as the top choice for use of excess free cash followed by reinvestment

and “smart” M&A

The Fed, economic growth and a lack of viable investment alternatives are the primary

drivers of the equity rally, say those surveyed

– 35% assert market valuations are not sustainable at current levels

Regarding the global macro outlook, concerns about China’s growth and credit are the top

issues weighing on investor sentiment, followed by a stagnating U.S. economy and emerging

geopolitical risks

While innovation is largely difficult to quantify, 61% of surveyed investors report that it is an

important factor in their investment thesis

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Equity Markets Fluctuate with Global Macro Events

U.S. stocks ended 1Q14 with minimal changes, as an early sell-off gave way to a recovery that

offset the losses. The decline was relatively brief and confined to a two-week stretch in late

January through early February.

Utilities emerged as the top

performing S&P 500 sector during the

quarter, up 9.0%, with Healthcare also

outpacing the market, finishing higher

by 5.4%. Consumer Discretionary

stocks, the best performer for 2013

overall, struggled in 1Q14, finishing

lower by 3.2%.

The majority of participants attribute

the market’s performance to the Fed’s

highly accommodative monetary

policy last quarter

“Stocks are a little too expensive but sustainable as long as the Fed remains behind

the market.” Core Growth, Multi

“Valuations are sustainable because there is still a large amount of money on the

sidelines.” Core Growth, Multi

“Multiples at these levels are typical in the current interest rate environment.” Core

Growth, Generalist

56%

47%

47%

32%

24%

6%

The Fed

Economic Growth

Lack of Alternatives

Inflows (Fixed Income)

Operational Improvements

Shareholder Activism

Rally Drivers

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1Q14 Market Performance

DJIA -0.7% NASDAQ +0.5% S&P 500 +1.3%

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What Was Your Opinion of 4Q13 Earnings Results?

Better Than | 50%

In Line | 40%

Worse Than |10%

What Are Your Expectations for 1Q14 Earnings Results Relative to Consensus?

Better Than | 23%

In Line | 32%

Below | 45%

Expectations in Retreat

Looking back at results for 4Q13, half of those surveyed, or 50%, indicated results were better

than expected while 40% considered them to be in line. The good news came from cost

containment and bottom-line growth, while revenue growth remained flat.

Meanwhile, expectations for 1Q14 are significantly lower than they were for the previous

quarter. The majority of respondents expect results to be in line with or worse than consensus

estimates, as a “weather drag” from the worst winter in decades negatively affected businesses in

the Midwest and on the East Coast, especially in the retail sector and related industries. As well,

participants also see troubling signs from “adverse currency movements” and a weakening

Chinese economy.

“As usual, as 2013 progressed, earlier earnings estimates moved lower and then

results seemed in line or beat by a small bit. Revenues were flat in most cases as

expected.” Core Growth, Multi

“I expect results to come in worse than expectations. The market is near a top,

China is in trouble and stimulus does not work.” Core Value, Generalist

“I expect stronger demand with a pick-up in the economy but there are cost

pressures and adverse currency movements to take into consideration.” Core Value,

Generalist

“Companies have lowered the bar citing weather and are likely poised to surprise on

the upside.” Core Value, Generalist

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Management Tone -- Current Quarter

Unchanged (Bullish) | 17%

Unchanged (Cautious) | 60%

Less Negative | 13%

More Negative | 11%

Management Tone -- Prior Quarter

Unchanged (Cautious) | 48%

Less Negative | 46%

More Negative | 6%

Management Tone Notably More Cautious

Surveyed investors report that executives with whom they interact are far more cautious than in

the previous quarter. The number of respondents reporting an unchanged but “cautious” tone

rose to 60% from 48% last quarter while those who report a “less negative” tone fell to 13%

from 46%. Investors attribute their increased caution to a variety of factors, including the

weather and skepticism regarding the potential to expand margins and grow the top-line.

“There is a choppy demand environment with a lack of top-line growth and you see

many companies blaming the weather for weak results.” GARP, Multi

“They are worried but, as always, optimistic that the year will unfold in a

constructive manner. Weather is obscuring visibility.” Core Value, Industrials

“It depends on sectors but it seems there is a general pick-up in business activity and

CapEx, which are leading to more bullish views.” Core Value, Generalist

“Broadly, managements have been cautious on margin expansion. They are focused

on returning cash to shareholders via repurchases and/or dividends.” Core Growth,

Multi

Market Sentiment Fades…

As equity markets lost some of their mojo in 1Q14, investor sentiment turned more sober, with

39% of surveyed respondents describing themselves as “cautiously optimistic” compared to 75%

last quarter. Further, the percentage of contributors describing their outlook as neutral or neutral

to bearish is significantly higher while those reporting an outright bearish view rose to 6% from

0%.

Participants cite “slightly overvalued” stocks relative to earnings and a dearth of real economic

growth, the tapering of the Fed’s QE policy, slowing growth in China and general global macro

uncertainty for their relative pessimism toward equity markets.

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Investor Sentiment -- Current Quarter

Bullish | 10%

Cautiously Optimistic | 39%

Neutral | 24%

Neutral to Bearish | 20%

Bearish| 6%

Investor Sentiment -- Prior Quarter

Bullish | 10%

Cautiously Optimistic | 75%

Neutral | 8%

Neutral to Bearish | 8%

Are Markets Sustainable at Current Levels?

No | 35%

Yes | 18%

Yes with Caveats | 35%

Depends | 12%

“I am cautiously optimistic. I feel that the current markets are slightly overvalued

based on trailing 12 months EPS and even on forward EPS based on historical

valuations, so a correction or sideways consolidation in the next few months seems

likely. I expect that the second half of the year will be positive and the market will

close positive for the year.” Core Growth, Multi

“I am neutral. The market is still likely to consolidate near-term before gaining

strength in the second half. The geopolitical situation provides an opportunity to

move to the sidelines after a strong 2013. Better growth in the U.S. and Europe will

drive second half strength.” Core Value, Generalist

“Looking into the future, I don’t see drivers for employment, which is the ultimate

driver of an improving economy.” Core Value, Multi

“I am neutral to bearish because of inflation, a weak consumer, potential for

reduced QE and a slow housing recovery. Meanwhile, valuations are elevated.”

GARP, Multi

…And Valuations are Questionable

In regard to the sustainability of current

market valuations, contributor opinion is

mixed.

More than one-third, or 35%, contend

valuations cannot hold up, believing prices

are already “too extended” and that interest

rates will rise while also pointing to the

lack of corporate growth. The same

number of respondents maintains

valuations are sustainable “for another year

or so” provided the Fed refrains from “aggressive monetary tightening”. Meanwhile, just 18%

say unequivocally that market prices are sustainable, as valuations are rebounding from “very

depressed values” and current multiples are “typical” for the current interest rate environment.

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“The market is fully valued or slightly overvalued at this point. I expect future EPS

growth as well as top-line growth to drive the market higher in the second half.” Core Growth, Multi

“Profit margins are at all-time highs and multiples are elevated. Meanwhile, top-

line organic growth is non-existent. As the Fed reduces liquidity, assets will be re-

priced and stocks will likely fall.” GARP, Multi

“Valuations are sustainable as long as interest rates remain low. As such, equity

valuations can remain here or go higher.” Core Growth, Technology

Investment Themes and Sector Trends

Surveyed investment professionals indicate that

secular growth, mid-cap, and dividend-paying

stocks are the most attractive investment themes

while IT, Healthcare and Financials are the sectors

earning the most bullish sentiment given their

favorable valuations and growth prospects.

Conversely, participants maintain they are avoiding

low quality/high beta, early cycle and defensive

themes, similar to last quarter, and are bearish on

Utilities, Energy, Consumer Staples and Telecom.

The energy space is perceived as a potential

underperformer, particularly if the Chinese

slowdown persists leading to a decline in global

demand. Further, despite attractive dividend

payouts, utilities are perceived to be fully valued

and thus less attractive in a period of rising real

interest rates, while regulatory policy remains a

concern in the space.

“We have had a bias over the last few years

toward stocks that pay a decent yield. That is

something that we look for.” Core Value, Multi

“We are avoiding interest rate sensitive stocks with above historical valuations.” Core Value, Generalist

35%31% 29%

SecularGrowth

Mid-cap DividendYield

Investment Themes -- Most Attractive

55%

25% 23%

Low Quality/High Beta

EarlyCycle

Defensive

Investment Themes -- Least Attractive

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“We are bullish on IT because of the valuations.” Growth, Generalist

“Financials will continue to recover as rates rise. Valuations are also less

expensive in financial stocks and banks in particular.” GARP, Multi

“Utility valuations are too high given anemic growth rates. Their dividend yields

are higher than the market but 3% yields elsewhere could provide comfort if we get a

10%+ correction in prices.” Core Growth, Technology

When evaluating companies, surveyed investors confirm that the most important financial

characteristics considered are:

91% | Organic Growth

87% | Consistent Cash Flow Generation

85% | EPS Growth Potential

85% | Top-line Growth

85% | Balance Sheet Strength

83% | ROIC

80% | Margin Expansion

“The best stocks over the long-term are the compounders, which generate lots of free

cash flow, have ROIC well in excess of WACC and can grow organically.” Core

Value, Industrials

“Evidence of pricing power and sustainable growth are key.” Core Value, Generalist

68%

50% 50%

37% 32%21%

15%9% 9%

3%

6%

15% 15%

15% 21%36%

30%33% 33%

58%

Sector Snapshot

Bullish Bearish

IT Financials Healthcare Industrials Consumer Discretionary

Energy Materials Telecom Consumer Staples

Utilities

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Improving Staying the Same Worsening

“I believe sustainable earnings growth will drive stock performance and it does not

need to be organic.” Core Value, Generalist

Performance Metrics Channel Check

In our quarterly channel check on performance metrics, the majority of contributors are less

optimistic about companies’ ability to deliver continued upside in Organic Growth, EPS and FCF

than they were last quarter. While slightly more investors expect an improvement in Organic

Growth and FCF, it is a much smaller percentage this quarter than last. Moreover, views that

these three measures will worsen is significantly higher quarter-over-quarter.

Dividends Take Center Stage After Two Quarters of Playing Second Fiddle

Surveyed investors rank dividends as their preferred use of excess free cash, up from the prior

quarter, while the desire for reinvestment has waned after two straight quarters of holding the top

spot.

For the second consecutive quarter, share buybacks ranked lowest in terms of top priority cash-

deployment preferences as valuations continue to look rich. Despite fading popularity amongst

the buy side, buybacks by S&P 500 companies in 4Q13 reached $129 billion, exceeding the

3Q13 total of $128 billion, according to preliminary estimates by S&P Dow Jones Indices.

0%

10%

20%

30%

40%

50%

60%

70%

3Q13 4Q13 1Q14

Organic Growth

0%

10%

20%

30%

40%

50%

60%

70%

3Q13 4Q13 1Q14

EPS Growth

0%

10%

20%

30%

40%

50%

60%

70%

3Q13 4Q13 1Q14

FCF Growth

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1st Choice 2nd Choice Low Priority

Preferred Uses of Cash

You Asked, We Polled: Repatriation

Nearly half of all respondents, or 49%, favor repatriation of foreign cash while 47% also agree

but concede that support for the policy depends on the tax rate imposed. Further, of participants

in favor of repatriation, 54% state that a tax rate of 10% to 20% would lead them to change their

opinion. Additionally, 18% said their opinions would change at a tax rate of 30%, while 14% of

investors had no opinion. Only 9% favor repatriation regardless of the rate.

“If they have NPV positive investment opportunities abroad, then no need to

repatriate.” Core Growth, Generalist

“It depends on the situation but in general, I don’t like excess cash holdings, no

matter where they are domiciled.” Core Growth, Technology

“It depends. If there is an important need for it domestically and/or leverage is a

concern, then companies should.” Core Value, Industrial

China, Status of U.S. Recovery and Geopolitical Risks Top Concerns

Investors were hit with an onslaught of disturbing economic and geopolitical news from abroad

with China emerging as a leading concern this quarter. Sparking credit fears, China experienced

its first-ever domestic bond default, raising questions about the potential for “contagion” in the

region and around the globe and prompting concerns about the health of the nation’s shadow-

banking sector. The combination of government credit risk and an economic slowdown resulted

in the Yuan falling by roughly 2.6% against the U.S. Dollar during 1Q14 as investors continue to

pay close attention to the world’s soon-to-be largest economy.

While the weather received the lion’s share of the blame for weaker-than-expected non-farm

payroll numbers out of the U.S., investors remain skeptical of the health of the domestic

49%32% 32% 30% 24%

34%49%

34% 41% 48%

17% 19%34% 30% 29%

Current Quarter

60%

33% 33%20% 22%

31%

48% 43%45%

22%

9% 19% 24%35%

56%

Prior Quarter

Reinvestment Dividend Growth

M&A Share Repurchase

Debt Reduction

Dividend Growth

Reinvestment

M&A Debt

Reduction Share

Repurchase

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economy. Thus, concerns related to labor force participation, as well as rising debts and deficits

remain top of mind.

Continuing, as the Federal Reserve continued to taper its QE program by $10 billion a month,

questions remain regarding how policy will be carried out and the pace at which rates will rise.

Although the markets have generally responded positively to the Fed’s actions, investors warn

that rates rising too quickly have the potential to derail the ongoing recovery.

Russia’s invasion of Crimea caught global markets off guard, resulting in heightened volatility

and broad based uncertainty surrounding the economic impact of potential sanctions levied by

the West. While rhetoric has dissipated somewhat from the initial infiltration of Ukraine,

investors will undoubtedly remain attentive to the Russian situation.

European Central Bank chairman Mario Draghi and IMF head Christine Lagarde remain

steadfast in their commitment to prevent the E.U. from falling into a deflationary spiral. Despite

the fact that Euro-zone inflation in March hit its lowest level since November 2009, Draghi has

avoided lowering the central bank’s benchmark interest rate from 0.25%.

“Organic growth in the U.S. and China will be lower than expected. China’s credit

situation is very dangerous and valuations in the U.S. are very overvalued in

normalized terms.” GARP, Industrials

“Labor force participation rate is too low, a divisive climate of blaming others

promoted by the Administration and excessive debt levels in all areas of government

are highly troublesome.” Core Growth, Generalist

“Top concerns include the Fed falling behind the curve, Europe lapsing into

recession and emerging markets pulling the developed world into slowdown.” Core

Growth, Generalist

“I am concerned about U.S. political posturing domestically. International concerns

include geopolitical risk and Japanese slowdown.” Core Value, Industrials

Top Investor Concerns

IR Best Practice: The Importance of

Prior Quarter

Health of LatAm Economies

Lack of China Recovery

European Stagnation (e.g., deflation risks)

U.S. Gov’t (e.g., leadership, regulation, policy)

Rising Interest Rates/Inflation

Current Quarter

China Slowdown, Credit Crunch

Status of U.S. Recovery

Geopolitical Risk

Fed Uncertainty (e.g., QE, rising rates, inflation)

E.U. Growth, Fiscal Concerns

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How Important is a Company’s Ability to Innovate to Your Investment Thesis?

Very Important| 21%

Important| 40%

Somewhat Important| 35%

Not Important| 4%

IR Best Practice: Positioning Innovation as a Competitive Differentiator

According to the majority of surveyed buy

side investors, or 61%, innovation is

Important to Very Important to their

investment thesis, yet they note it is often

“difficult to judge”.

Corbin Perception delved deeper and asked

what measures are most important when

assessing innovation and, not surprisingly,

found that investors are most focused on

evidence of market share wins and resultant

growth.

In messaging, corporations should seek to tell and reinforce their innovation story by tying

technology, products, engineering and R&D spend to organic growth. As organic growth rises

investors will likely increasingly recognize innovation as a driver and investment differentiator.

As well, companies should develop metrics that measure success and progress.

“Innovation equates to value creation that delivers economic profits.” Core Growth,

Multi

“Innovation with new and improved products is what ultimately drives revenues.” Core Value, Multi

76%

78%

78%

79%

79%

83%

85%

89%

89%

92%

92%

95%

97%

100%

100%

# of New Products

IP Protection

R&D as a % of Sales

Technology (leading edge)

Investment in R&D

"Disruptive"

Ability to Lower Costs

Engineering Capabilities

Products (quality, value-add)

Pipeline

Technology (proprietary)

% of New Product Sales

Organic Growth

Ability to Raise Prices

Ability to Take Market Share

Innovation Measurements

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knowledge of investor engagement best practices to achieve results.

We are passionate about what we do and develop relationships that are collaborative and long

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Our client proposition is based on: 1) insightful, research-driven counsel; 2) a talented and

experienced team; 3) an in-depth understanding of best practices and the ability to apply that

knowledge to unlock value; and 4) an unparalleled commitment to client service and satisfaction.

Visit our website or contact us to learn more:


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