On Short-Termism

Projecting quarterly earnings hurts the long term view

Published on:
August 10, 2019
Last Update:

Written by

Noam Ganel is the voice behind Pen & Paper, a value-oriented stock research publication. He  serves as  Vice President in Capital Markets at Silvergate Bank and holds the Chartered Analyst Credential (CFA).

My favorite tables shows the power of compounding. Taken from the Aquamarine 2017 annual report, the table has just three columns and four rows. The table shows what happens to an investment after 20, 40 and 60 years of operations assuming 7%, 12% and 18% rates of return.

How can we not marvel that a 12% rate of return will multiply the original investment by 10 times in 20 years?

Taken from Aquamarine 2017 annual report

Glancing at the table every once in a while, I am reminded that (1) stock investing is a long term game, (2) not losing money is more important than maximizing return and (3) a reasonable rate of return, say 7% to 10%, will result in a wonderful investment outcome over a long period of time.

Yet it is unbelievably difficult to focus on year 2039 and beyond. The anticipation of whether a company will report higher sales numbers or net earnings is just too exciting to pass on and it results in both wide mood swings and in swinging market prices.

It is a self-fulling prophecy: if investors expect stock prices to move as a result of quarterly projections then -whether the business fundamental changed what so ever - the stock price indeed moves.

According to Warren Buffett and Jamie Dimon, the quarterly projection of earnings per share is bad both to shareholders and to the economy as a whole. In an Op-Ed to the Wall Street Journal, they write:

Companies frequently hold back on technology spending, hiring and research and development to meet quarterly earnings forecasts that may be affected by factors outside of the company's control.

A few examples from my own portfolio: When Weight Watchers', which I bought in March, management reported to investors in April 2019 of expected softening in sales, the stock dropped to $17 from $27 in less than 24 hours. Yet when the same management reported last week of an expected uptick in sales, the stock immediately jumped to $30. Another example is Hyster-Yale which I bought a few months ago. Here too when management reported on an uptick in sales, the stock climbed to $63 from $55. In short, when management projects earnings, capital markets do what they do best - they react.

Yet between stimulus and response there is space[1]. And I argue that the price movement after a quarterly announcement is the wrong response. Can we reasonably expect a company such as Mednax for example, which I wrote about last week, with over 16,000 employees and a fresh senior executive leadership[2], to make meaning changes in 90 days?

Today's reporting standards

Wall Street certainly expects more reporting today. In The Art of Speculation, written in 1930 ,the legendary investor Phillip Carrett, writes that "many companies publish annual statements that confine themselves to balance sheets and even those publishing income statements omit many details."

More remarkable than the little amount of information companies reported back then is that investors were drawn to the stock market just as much as they are today.

But today's companies report much more. Consider Hawaiian Airline’s management, which provides guidance on expected gallons of jet fuel consumed (expected to be 1.0 to 2.0% less); that available seat miles will be up between 1.5% and 2.5%. It further breaks down the quarterly earnings report by available operating revenue per ASM of 13.81 cents, compared to 14.25 cents a year ago.

This level of reporting takes much energy. I can only imagine how much time senior management spends in preparing for analysts’ questions and how both legal counsel and public relations people advise them. Legal counsel may ask them to use words such as "we believe" or "it is likely that" while public relations people will tell them to emphasize words such as "we exceeded" and "we are positive" and "we see growth."

***

Research[3] shows that daily meditation or religious practice assists in developing more tolerant, kind behavior. People who have such daily practices are less prone to get upset while driving and are more kind to random strangers.

And just as spiritual meditation on why we are here, how did we get here and how we should live our lives is helpful, I believe that a quarterly- let alone daily - outlook on stock movements is harmful.

To that I suggest three remedies: First, to develop meta-rules, such as "will not sell a stock for at least two years." This will reinforce the attitude that a quarter is just one piece of the puzzle.

Second, to garden. There is no better reminder that change takes time than nature. That There are simply no shortcuts.

My friend's Tomer vegetable garden

Third, cut, paste, print and regularly view and meditate on the Aquamarine table.

FOOTNOTES
[1] Viktor Frankl writes that space is our power to choose our response. In our response lie our growth and our freedom. This is taken from his seminal book, Man's Search for Meaning.
[2] The 25-year president of the company recently retired
[3] Read American Grace: How Religion Divides and Unites Us by Robert Putnam for more on this topic. The book is about two of the most comprehensive surveys ever conducted on religion in public life in America.