As investment managers, we were wondering if Tiger Woods would do a good job running a publicly traded company. Certainly chief executive officers play a lot of golf, and some of them, including General Electric Co.'s Jack Welch and Sun Microsystems Inc.'s Scott McNealy, are both successful corporate managers and accomplished golfers. Could we develop an investment strategy based on golf competence?
A recent issue of Golf Digest contained an article on golfing CEOs, and we paid close attention to the table listing the golf handicaps for 200 CEOs of Fortune 500 companies. At first glance, it was obvious that, as expected, some CEOs of highly successful companies had very low handicaps. At the opposite end of the spectrum, some CEOs of struggling companies carried high handicaps. After years of searching through countless financial ratios, of dissecting every Alan Greenspan speech, of scrutinizing every wiggle in the economic statistics, had we stumbled across the stock market's unlikeliest of crystal balls? A golf ball?
We came up with the golf handicap/stock performance theory. Unfortunately, the exact formulation of the GHSP became difficult because of research team disagreements. Evelyn strongly believes the capabilities of top-notch golfers reflect their superior skill sets, which inevitably will lead to strong corporate performance.
On the other hand, there is Howard's time-on-the-golf-course-is-time-away-from-the-office school of thought. Along this line of thinking, low handicap CEOs probably are spending too much time on the golf course and not enough time in the office. It seems very plausible to him that high handicap CEOs are so focused on corporate success that they rarely get in a round, let alone practice.
Obviously the two theories contradict each other. And actually, there is a third theory: There is no relationship between golf skills and stock performance. This would be the worst possible outcome, because then IRC's accountant won't pay for our Golf Digest subscription.
Our analysis looked at the relationship between each company's CEO handicap and the average stock performance for the past five years ended Dec. 31. We found some low-handicap CEOs of companies with exemplary stock performance and high-handicap CEOs of companies with poor stock performance.
The analysis found support for Evelyn's transferable-skills hypothesis. Mr. McNealy has the lowest handicap of all of the CEOs. Sporting a minuscule handicap of 3.3, he led his company to the highest average annual return of 99.5%. (Yes, that's a five-year average annual return.) Charles A. Haggerty, on the other hand, has a handicap of almost 19. He had been the CEO of Western Digital Corp., which suffered through an average annual return of -16% over the past five years. A 19 handicap isn't dismal, but losing 58% of a firm's market value during a bull market tells us that something is lacking. Matthew Massengill became CEO in January.
But the analysis also found support for Howard's hypothesis. Paul B. Fireman has a nice 5.1 handicap, but his Reebok International Ltd.'s shareholders lost 75% of their investments over the past five years. His stock options are probably so far underwater he has a better chance of making money on the Senior Tour. Michael C. Ruettgers, with a handicap of 16.7, runs EMC Corp., which has produced spectacular returns nearing 72% annually for five years. He won't be getting criticized for playing too much golf.
While we have identified some examples supporting each of the competing theories, the distribution of the data looks fairly random. That does not prove there is no relationship between golf handicap and stock return. So let us press on to more rigorous analysis.
We turned our research effort to an investigation of handicaps and sector performance, in hopes that it would present a clearer picture. Grouping the companies by economic sectors, we computed sector returns and sector handicaps.
As expected, sector returns, weighted by market capitalization, vary widely, ranging from the lowest - transport, at 7.7% annually - to the highest - technology, at 53.6%. In contrast, sector handicaps are bunched quite closely. Consumer services, at 10.2, and technology, at 10.7, field the best golfers; industrials, at 15.7, and consumer cyclicals, at 16.0, are at the other end of the range. Transport has a relatively high handicap, 14.1, and the lowest of returns. Technology, in contrast, has a low handicap, 10.7, and the highest of returns. For all sectors, the average return was 33.9%, while the average handicap was 12.8. In fact, the correlation between sector returns and sector handicaps is -0.41 (low handicap, high returns, and high handicap, low returns). This is a big number and appears to give Evelyn bragging rights for the moment.
Howard was (not surprisingly) dissatisfied with these results, arguing that this simple correlation is likely to mask the importance of economic sector behavior on individual company returns. He proposed a regression test that would explain company returns based on both CEO handicaps and sector memberships. The results showed that while economic sector played a significant role in explaining company returns, unfortunately, CEO handicaps did not. This result supported neither our theories nor our claim to expense our Golf Digest subscription.
As our final test, we constructed a series of portfolios, picking from the stocks in the Russell 1000 index and using the CEO handicaps as our valuation factor. Companies with good golfers for CEOs got high marks, those led by poor golfers got negative ratings, and firms without CEO handicaps received market-return ratings. To ensure diversification, we limited all stock positions to 5% of the portfolio and optimized the portfolio to track within five percentage points of the Russell 1000 while favoring good golfers. The portfolios were rebalanced at the end of each quarter, although turnover was very modest since handicaps were assumed to be constant over the period.
Howard was pleased with the results. The pro-golf strategy underperformed its benchmark by 5.8 percentage points annually. With a realized annual volatility of 5%, the simulated results strongly supported the theory that low golf scores lead to low stock returns.
If there is a conclusion to be drawn here, it will have to be a split decision. Both hypotheses had their moments in the sun, yet neither could be supported with enough evidence to warrant investment action. However, we would encourage you to join us in the pursuit of stronger relationships between golf and investments. The next time your spouse finds you sprawled on the couch, watching people wearing advertising hats and using exotic metal wands to knock blobs of white plastic around expensive real estate, you can just yawn and say that you are working on a cutting edge investment strategy.
Howard Roth is senior vice president and Evelyn Orley is vice president of Investment Research Co. Asset Management, Rancho Santa Fe, Calif.
