How to Invest Your Money » Stocks

The Ridiculous Obsession With Short-Term Earnings

Warren Buffett always says if you can’t see yourself holding a company for ten years, you shouldn’t hold it for ten minutes. As usual, the Oracle of Omaha speaks common sense platitudes that have made him a multi-billionaire while the rest of the investment world runs in circles trying to catch their own tail. Now I sympathize with all of these 24-hour investing networks and publications that need fodder for their talking heads to speak loudly about, but the obsession over quarterly earnings has gotten absolutely ridiculous. It is actually the main reason why I don’t believe the whole efficient market theory can ever be 100% correct (even though I’m a big passive investing advocate).

If you have been oblivious to what quarterly earnings statements are, please remain so and disregard the rest of this post. If you simply save your money, invest in basic diversified financial instruments, and use dollar-cost averaging to allow your portfolio to grow at a rate that towers over the vast majority of mutual funds – then congratulations, you are ahead of the curve. For the “beat-the-market” types out there that obsess over “meeting expectations” or not meeting them for a three month period, let me be the voice in the darkness – you are wasting your time!

How Much Are Predictions and Estimates Worth Again?

The whole idea that earnings estimates mean anything at all is ridiculous by itself. These huge corporations hire all kinds of PR people to either boost expectations (so they can sell off their shares at a premium) or hold expectations down, so that they can beat the artificially low estimates and then throw a big party as their stock goes higher based on almost no fundamental changes. If a company’s earnings are slightly under, meets, or is slightly over what someone thinks they should be, this simply should not change your fundamental view of the company. As long as their business plan is the same, management is the same, and the market is the same (or at least similar) then what does it really matter in the long run if, “Q3 underperformed earnings estimates by .10%.” A great example is the recent headlines this morning talking about how Apple missed expectations and how this is a major blow to the company. Look guys, Apple is notorious for holding down expectations each quarter, and they play the game really well. They probably didn’t do quite as good a job this time around. They are still an innovative giant that has dominant market share all over the world, and is creeping up on fresh model cycles. My guess (or “estimate” if you will) is that they will be just fine.
One other interesting part of this phenomenon is the fact that companies can play with their balance sheets so much these days that the numbers for the majority of big players are almost irrelevant anyway. The “insiders” call this “off the book” expenditures or investments. It’s basically what led to the recent boondoggle that just occurred at JP Morgan right under investment golden boy Jaime Dimon’s nose. If you really think that these guys don’t have the most “creative” accountants in the world working towards producing a balance sheet that will determine an irrational amount of investor behaviour then you are kidding yourself.

The Silver Lining

The only positive result of this earnings-season mania is that smart long-term value and/or dividend investors can probably benefit from the irrationality that it causes in market evaluations. I’m not a smart long-term value investor. Well, maybe I could be, but I have no faith in myself. I simply buy the index like clockwork and the end result is that I actually do “time the market” a little bit through simple dollar-cost averaging. Pretty sweet deal for a guy that doesn’t have to spend his lazy Sunday afternoons poring over spreadsheets and reactions to earnings that are so distorted they don’t matter anyway.

Why This Isn’t Just Annoying, but Also Extremely Harmful

The real consequences of the ridiculous level of media coverage of earnings season and the accompanying behaviour of investors is that it encourages all of the wrong incentives for the CEOs and Boards of major companies. Instead of taking creative risks, or making good long-term investments, there is substantial pressure to simply keep juicing the short term numbers in order to keep investors happy and keep huge bonuses flowing your way. If the company’s long-term value is really hurt, well guess what, that’ll be some other CEO’s problem. How many $50 million year-end bonuses does a guy really need anyway? This is exactly the sort of thinking that is killing the investment banking industry and for some reason the investment world continues to buy into these games instead of just buying solid companies and valuations that make sense. Don’t be one of the herd, think for yourself before panicking due to the fact that one of the companies in your portfolio had a relatively tough quarter for a reason they can easily explain and/or justify.

Comments

  1. Roger @ The Chicago Financial Planner

    Nice post, well-written!

  2. Kevin Mzansi

    Earnings season has always been a great time to pick up great companies when the talking heads are acting as doomsday prophets because of one-time earnings misses.

Leave a reply

Your email address will not be published. Required fields are marked*