A recent Wall Street Journal article by James Mackintosh suggests “short-termism” may be damaging the U.S. economy.
Large investors and academics believe companies are not investing enough into their businesses, due in part to the dysfunction caused by central bank policies. They also believe there is pressure on management to hit quarterly numbers, to the point where rational, long-term projects get delayed.
To address the problem of short-termism, the money-management firm BlackRock and four other companies founded the think tank FCLT Global, which stands for Focusing Capital on the Long Term. One of its first agenda items is to attack the long-established practice of companies providing investors with “earnings guidance.”
The term earnings guidance refers to the figures managements estimate their companies will earn over the next three months, and it is often expressed as a range. Sometimes, managers provide earnings guidance for the full year.
These short-term earnings projections are typically updated at each quarterly earnings release and discussed during the public quarterly conference calls held by management. Of course, the company’s stock price will usually react if managers make sizable adjustments to their future earnings guidance figures.
A vibrant industry exists based entirely on whether companies will meet or beat these short-term financial numbers. Financial data vendors provide investors with “consensus” earnings expected over the next few quarters to a year. So-called “whisper numbers” circulate among the brokerage research departments, which, as the name implies, are rumors that a company will report earnings that are better than their current guidance figures. Then on the date earnings are announced, you can practically feel the drumroll in the background as CNBC divulges the results. Usually, the cable station will display a chart of the company’s stock price that instantly displays the reaction by investors to the reported earnings. This focus on the short-term promotes volatility and detracts from the concept that real business value is created over the long term.
Clearly, managing short-term expectations can be a distraction for managers who are attempting to plan for the long term and make capital investments to grow the business and create long-term value. Worse, when manager compensation and other incentives become tied to short-term results, the long-term health of the enterprise becomes less certain.
Another area of effort to foster long-term investing is to encourage a dialogue of ideas between large investors and management. According to FCLT, institutional investors own 70 percent of the outstanding stock of the 1,000 largest U.S. public companies. Discussions between the board of directors and significant shareholders can empower long-term strategies for growth. Investors should also be willing to challenge managements whose strategies do not align with their long-term shareholder interests. Far too many institutions blindly vote their proxies in full agreement with management or outsource their voting obligations to consulting firms.
A move away from guidance will frustrate short-term traders and brokerage analysts. Shifting the focus toward long-term strategies will benefit businesses and long-term investors. Corporate boards, company managers and large investors will need to improve the communication of their long-term ideas to the markets.•
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 317-818-7827 or firstname.lastname@example.org.