2012 World's Most Respected Companies

This past weekend Barron's released its latest annual survey on the World's Most Respected Companies.

Barron's: The World's Most Respected Companies

Here are some notable stocks that have fallen out of the top twenty on Barron's list this year:

Berkshire Hathaway (BRKa): From 3rd to 15th
Pepsico (PEP): From 9th to 30th
JP Morgan (JPM): From 14th to 49th
Wal-Mart (WMT): From 18th to 51st

While it's at least debatable whether these business franchises have been somehow materially impaired long-term, clearly a hit to reputation of some kind has occurred. With this in mind, it's worth a look through the lens of the "halo effect".

Here's one example of the effect. It turns out stock price action can create a dynamic that spills over into the perception of other things (maybe the quality of the person in charge or the intrinsic worth of a business). This is what psychologists have called the "halo effect" and was first documented decades ago. It's important to remember that the "halo" can be both positive and negative. So it cuts both ways. It's also important to note that the above is just one example among many. More generally, the "halo effect" is about how any one powerful impression can influence our other judgments. This Wall Street Journal article by Jason Zweig does a nice job of explaining the effect.

The Halo Effect: How It Polishes Apple's and Buffett's Image

Now, I'm not suggesting that stock price performance is somehow behind the drop in reputation of the above four companies. Actually, Wal-Mart's recent equity performance has been rather good (though by coming into the 2000s way overvalued the business has spent ten years "catching up" to the stock price...that has probably created a considerable negative halo).

What's interesting is that the Zweig article uses Buffett's image as an example of a positive "halo". Well, it's less than a year since the article was written, and Berkshire Hathaway has fallen from number 3 on the Barron's list to number 15 in reputation.

The recently released Barron's article seems to indicate that at least part of the reason for Berkshire's fall is some of Buffett's politics. Well, whether one agrees with Buffett or not on politics, his views have little to do with Berkshire's intrinsic value and how the company will likely perform (create value) in coming decades. Still, at least based upon the survey it's hard to argue that there's been a temporary, even if so far modest, hit to Berkshire's reputation.

Allegations that Wal-Mart executives bribed officials in Mexico to make expansion easier obviously hasn't helped their reputation. As I mentioned, Wal-Mart's very recent stock performance has been pretty impressive. If Wal-Mart's stock were to outperform long enough to erase the decade of poor equity performance, would that halo favorably impact its overall reputation? You cannot oversimplify this stuff or make judgments too quickly but it will be worth watching over time.

In any case the halo effect can make an investor believe they are evaluating a stock's performance (or maybe a series of negative headlines) independent of a business's intrinsic qualities (or maybe the CEO's capabilities), but there's plenty of evidence to suggest that's not what generally happens. The reaction one has to stock performance or headlines can easily disproportionately spill over into the perception of the overall business itself.

It is easy to allow a positive or negative halo distort the perception one has of an individual or a business. A lagging stock price can weigh heavily on the perception of a company. A rising stock price can do the opposite, creating a favorable impression. Use of more objective factors is the best way to prevent price action or some other powerful impression from inadvertently influencing perceptions in a way that leads to expensive investing misjudgments. 

Adam

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