Keeping it Simple

The Flesch score measures how easily a text can be read. Scores range from 0 – 100 with 0 meaning very difficult to understand to 100 meaning very easy to understand. Some generic examples of Flesch scores are:

Comics = 92

Wall Street Journal = 63

UK Income tax act = 26

Scientific Journals = 5

In the 1960s, the average Flesch score of scientific journals was 15. It has steadily declined as complexity and jargon increased. In any case, a scientific journal is expected to be more difficult to read than the Wall Street journal.

However, a company’s annual report should not be as difficult to read as the UK income tax act.

Brian Fugere, the author of the wildly interesting book ‘Why business people speak like idiots’ examined annual shareholder letters written by different CEOs. Using the Flesch he found that CEOs of admired companies with a history of good performance had easy to read shareholder letters (a high Flesch score).

Companies that were later shown to be fraudulent or have illegal insider trading by the CEO had difficult to read shareholder letters (a low Flesch score). The table below summarises the results.

CEO (Company, year)

Flesch Score

Cumulative return under CEO

Warren Buffett (Berkshire Hathaway, 2003)

44

2,404,748%

Jeff Bezos (Amazon, 2003)

43

104,740%

Larry Page (Google, 2004)

44

2390%

Jack Welch (General Electric, 2000)

44

4,000%

Dennis Kozlowski (Tyco, 2001)

29

Sam Waksal (ImClone, 2001)

22

-53%

Jeffrey Skilling (Enron, 2000)

18

-100%

Gary Winnick (Global Crossing, 2001)

17

-100%

The CEOs with easily readable shareholder letters have done fantastically well for their shareholders as can be seen in the table above.

CEO’s with something to hide often use complex and vague language because it creates the illusion of looking smarter than one really is. This was clear in Enron’s case – their final shareholder letter (before filing for bankruptcy) was incomprehensible. Their aim was to inflate profits and hide losses and shareholders were left holding an empty bag after the accounting acrobatics were uncovered.

This was the similar case in Tyco international which had fraudulent executives. Their shareholder letter, just like Enron’s, was incomprehensible and had a low Flesch score.

If you were to go long on the companies with high Flesch scores and short the low Flesch score companies, you would have made a lot of money. However, short selling can be very risky because of the asymmetric risk/reward profile since losses can exceed 100%. You always have a third option with companies you suspect to be fraudulent – stay away from them.

This of course doesn’t mean investing in companies with easy to read shareholder letters will always lead to good results. However, unnecessary complexity may be a sign to head for the door.

One thought on “Keeping it Simple

  1. […] A reader of this blog contacted me to suggest that when I look at financial text, instead of trying to analyse stories, I could instead test for “readability”. The idea being that the more readable a text, the clearer the strategy then the better the company might perform. Or indeed the more jargon, obfuscation and evasive language, the worse a company might perform. He’s done initial analysis showing that great performers like Berkshire Hathaway, Google and Amazon have much more readable communications than the likes of Enron, Tyco and Global Crossing, which all failed. It’s a good suggestion and encouraging to get feedback on ideas for writing about. There are some simple tests for “readability” such as a Flesch score. Like many good innovations (such as SatNav, message encryption and the early internet), readability scores were developed by the US military. The Flesch score is relatively simple = 207 – 1 x (total words / total sentences) minus 85 x (total syllables / total words). A high score means “easy to read.” “The cat sat on the mat.” scores 116. Whereas: “The Australian platypus is seemingly a hybrid of a mammal and reptilian creature.” scores 37.5 as it has 24 syllables and 13 words. […]

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