The Problem With Quarterly Reports

The Problem With Quarterly Reports

Greetings investors!

As I find myself knee-deep in yet another busy earnings week, I decided to take some time to reflect on an argument that’s older than time itself, immortalized by the great William Shakespeare in Hamlet:

“To report or not to report?” (don’t quote me on this)

What this means of course — other than that I have a knack for mishearing famous quotes — is whether companies should be providing quarterly earnings or not. Personally, I believe that the concept should be scrapped and not just because it would make my job a lot easier every 3 months.

Here’s why:

1. Quarterly earnings promote a short-term outlook

Back in 2018, President Trump asked the SEC to consider allowing companies to publish earnings reports every 6 months instead of the current quarterly mode. In Europe and other markets, companies usually only report on a bi-yearly basis, while investing moguls such as Warren Buffett and JPMorgan CEO Jamie Dimon have also backed this sentiment.

According to a 2017 McKinsey study, firms with a long-term outlook exhibit stronger fundamentals, deliver superior financial performance and add more to economic output and growth. McKinsey also found that giving short-term guidance makes no difference to corporate returns. So why do the larger U.S. exchanges refuse to change their ways, despite the added legal, accounting, and promotional costs involved?

There is an argument that switching from quarterly reports to annual or bi-yearly will promote businesses to cover up missteps as well as increase the risk of insider trading. However, during this age of surveillance and communication in which we currently reside, this is an old fashioned concern.

This short-term thinking is outdated, and investors should be focused on important figures such as the company’s balance sheet, its year-on-year revenue growth, and debt vs cash ratio, etc. These figures will give you an idea into its long-term potential, and whether it's going in the right direction, rather than worrying about how the firm will do over the next 3 months. Remember, wealth is built over time, not quarters.

2. It restricts a CEO's ability to do what’s best

Then there is the problem of talented CEOs who are pulled back by the leash of being forced to provide updates every 12 weeks, in which very little long-term success can come to fruition.

Take former Pepsi CEO Indra Nooyi, who helmed the beverage giant from 2006-2018. When asked about leaving the company, she lamented that the treadmill of quarterly reporting made her ‘pay undue attention to short-term results’.

It is even worse for new and innovative industries that require time to grow but must focus on short-term numbers in order to keep shareholders happy. Telsa, for example, is a company that regularly misses quarterly targets set by both analysts and CEO Elon Musk — Musk has even referred to analysts as ‘boneheads’ in the past and vetoed ‘boring’ questions. His frustration is understandable as Tesla’s long-term outlook is very strong, with a huge runway for growth. Quarterly earnings can distract from the company’s long-term vision of dominating the EV market, which is estimated to make up 30% of the overall automobile sales by 2030.

When investing, you should be asking yourself: “Where will this company be in 10 years?” and not “How will this company perform next quarter?”.

3. It can discourage innovation and growth

Company growth requires investment. Without the input of shareholders, CEOs will often participate in stock buybacks, which drives up EPS, and in turn, helps drive up the stock price. This can be good in the short-term for investors to the extent that, when stock is repurchased, it reduces the number of outstanding shares on the market and increases the value of the shares they currently hold. However, in the long-term, it could also siphon funds away from innovation and growth.

Then there are companies that sit on piles of cash like some selfish dragon guarding its treasure in a bid to conserve their balance sheets. If a company is unwilling to grow, then your investment will not grow either, so it’s better to understand long-term potential rather than taking it quarter-by-quarter.

The most important thing for investors to know about these short-term reports is that they should not at all affect your decision to either buy or sell shares. To shed some light on the insignificance of quarterly guidance to a long-term investor, I’ll quote my colleague Rory from a recent edition of the Stock Club podcast:

“One quarter only represents one-fortieth of the time you're holding onto a stock if you are investing in it for 10 years.”

Here at MyWallSt, we are long-term investors who believe that one of the most important tools for accumulating wealth is ‘patience’. Quarterly reports promote the exact opposite of this with a short-term, “now now now” mindset,

Investors should do enough of their own research to understand a company’s long-term potential, not just its quarter-by-quarter performance. By doing this, speculative short-term analysis should never be a hindrance to growth.

JamieJamie

Sign up for free to continue reading.