We’ve just come through what was, once again, a rather hectic month or so as the companies we follow within our members-only advisory services announced quarterly earnings.
Admittedly, coming up with something to say about these quarterly releases tends to be a challenge. Simply, not much happens in a three-month period that’s worth talking about when it comes to a company that you plan to be invested in for 3 to 5years, ideally more.
However, our mentality is not necessarily shared across the financial world.
At some point – and I’ve struggled to identify precisely when – quarterly earnings releases became an event. Something for the media to key on and, therefore, something that seemed “newsworthy” for the masses.
Think about the news blasts that we’ve all come across that the likes of Amazon (NASDAQ:AMZN) or Microsoft (NASDAQ:MSFT) or, here north of the border, the Big 5 Banks reported and all of the supposed implications contained within. When in reality, all they’ve done is describe what’s essentially water under the bridge.
After all, these reports are backward looking.
Now, can they provide some indication of what’s ahead? Sure. And they’re certainly better than nothing. But they don’t deserve near the attention the media would have you believe they deserve.
Perhaps this dynamic was best summarized by Mr. Amazon himself, Jeff Bezos:
"When somebody … congratulates Amazon on a good quarter … I say thank you. But what I'm thinking to myself is … those quarterly results were actually pretty much fully baked about three years ago. Today, I'm working on a quarter that is going to happen in 2020. Not next quarter. Next quarter for all practical purposes is done already and it has probably been done for a couple of years."
These reports matter to the media. They sure shouldn’t matter to the underlying companies though. And if they do, that’s not a company that we tend to want any part of.
They also matter to the market, though. At least in the short term.
Stock volatility around quarterly earnings releases can be significant. Which, in my opinion, is most of the reason why the financial media acts as it does. Thus creating somewhat of a vicious cycle.
The game
When it comes to quarterly reporting, there’s what the company says, which tends to be what it is. Year-over-year comparisons are made, maybe some balance sheet figures get mentioned, and the executives come up with some canned quotes and expressions to get them through a conference call with sell-side analysts.
There’s another side to the story, however.
Where this whole process gets wonky is that these company results are then compared with results that those same sell-side analysts had predicted. “Miss” the analyst predictions and there’s a chance your stock gets tagged. “Exceed” analyst expectations and your stock is probably in the green the next time it trades.
This little game is a big part of the media’s message.
In reality, however, companies don’t “meet” or “exceed” analyst predictions. Company results are what they are. It’s the analyst predictions that are wrong!
Nevertheless, it’s a big ol’ lazy lay-up for the media to “report” on this kind of stuff. So they do.
Where it gets really wonky though is that companies will frequently provide guidance to the sell-side analysts. This tends to help the analysts fill in their spreadsheets and come up with future predictions from which the company can either be deemed to have missed, met or exceeded expectations.
So then you end up with situations where, for instance, the past quarter “exceeded” expectations (good) but guidance is lower than expected (bad).
What’s a rationale person supposed to even do with that information?
Frankly, we’ve no idea.
And since none of this fits in with our long-term, business focused investing framework, we leave others to worry about it.
Two heavyweights say “no more”
Two others that tend to carry a touch more heft in the financial world than yours truly shared some similar thoughts in a Wall Street Journal article published earlier this week. Only, as one might suspect, they went far beyond the relatively narrow depiction on this matter that we’ve discussed to this point.
Warren Buffett, who I don’t think should require an introduction, and Jamie Dimon, CEO of JP Morgan, collaborated on a piece that I sure hope grows legs in the months ahead and serves as somewhat of a ground-zero for changing this whole game that we’ve described.
Their thoughts pertained to the guidance portion of the game.
Essentially, they want it to disappear.
Not because of the situation we’ve described. No, they went a little bigger than that.
Because it’s bad for the entire U.S. economy!
Some highlights:
The nation’s greatest achievements have always derived from long-term investments. In both national policy and business, effective long-term strategy drives economic growth and job creation.
In our experience, quarterly earnings guidance often leads to an unhealthy focus on short-term profits at the expense of long-term strategy, growth and sustainability.
Companies frequently hold back on technology spending, hiring, and research and development to meet quarterly earnings forecasts that may be affected by factors outside the company’s control, such as commodity-price fluctuations, stock-market volatility and even the weather.
The pressure to meet short-term earnings estimates has contributed to the decline in the number of public companies in America over the past two decades. Short-term-oriented capital markets have discouraged companies with a longer term view from going public at all, depriving the economy of innovation and opportunity.
On one hand, Buffett and Dimon’s message has already taken hold.
Companies that once upon a time would have happily listed in the public markets no longer are. No doubt, they’d rather focus on growing the business than getting caught up in some silly comparison game with sell-side predictions. And capital is plentiful enough outside of the public markets that they don’t have to play this game.
On the other hand, this dynamic is potentially robbing the public markets and all who participate (you, me, and millions and millions of others) of some of the most dynamic economic growth engines on the planet. Which is, thereby, impacting our potential net worth and ability to recycle that wealth back into the economy, which would ideally create a rising tide effect for all.
Foolish Bottom Line
The Buffett/Dimon piece goes on to make clear that this has nothing to do with transparency when it comes to financial and operating results. We certainly echo these sentiments. While quarterly reporting can be overwhelming, it does serve a purpose. I believe history would prove that out.
But nobody can predict the future. Stuff happens. To feel beholden to some figure that you fed the sell-side community at the expense of the long-term health and success of your business is hardly something that we, as business-first investors would think is a wise move. Regardless of the short-term impact.
Who knows where this might end up but we’re certainly keen to see in the reporting periods ahead if indeed companies that currently provide guidance stop doing so. The big picture though is to be aware of the short-termism that exists, as well as the misgivings that go along with the financial media. Be on guard as you navigate these waters and you’re sure to become a better (wealthier) long-term investor.
Iain Butler
CFA Chief Investment Advisor
Motley Fool Canada
John Mackey, CEO of Whole Foods Market (NASDAQ:WFM), an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten is an employee of LinkedIn (NYSE:LNKD) and is a member of The Motley Fool’s board of directors. LinkedIn is owned by Microsoft. David Gardner owns shares of Amazon. The Motley Fool owns shares of Amazon.