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Judith Samuelson

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Putting an End to the Default Practice of Short-term Earnings Guidance

Posted: 10/19/2012 12:00 pm

It's earnings season. While the story behind Citibank CEO Vikram Pandit's resignation captures the headlines, CNBC and their competitors continue their breathless ritual of reporting the latest quarterly figures, comparing actual results with "expectations," and driving short bursts of buying and selling with predictable shifts in stock price.

Those of us in the business of influencing practice and protocol of public companies know better than to reach our friends in business this time of year. It's a lot like what I remember about cramming for midterms in college -- just let me get through this week, then I will have my life back.

To what end? Citi's stock is up a fraction; Goldman, which had a great quarter, is down, ostensibly because the company beat forecasts by something less than the bookies anticipated. The game is reset for the next quarter; the big winners, in addition to the business news channels, are sell-side analysts who are incentivized to produce trading volume. Both are looking for stories to sell every 90 days.

If you "google" earning reports, or earnings guidance (what the Street calls forecasts), you'll see how embedded EPS noise is in the psyche of the markets. NASDAQ, in its own analysis of the reporting season underway, strangely makes the story about the reporting and forecasting itself, rather than the underlying performance of the business sector. This makes sense -- the players glued to their screens -- TV and other sorts -- are traders and gamblers. One could hardly call them investors with real concern for the underlying drivers and risks. There are two games being played here, as Roger Martin always points out, and the one that CNBC is announcing has little to do with business fundamentals or long term trends.

Over the next few months, the Aspen Institute's Business and Society Program will convene a group of experts in New York and London who deal with both the sending and receiving of news. We will hit the pause button and consider what might constitute good practice in the realm of transparent and useful "guidance" and market communications. What is the experience of companies that have moved away from forecasting EPS, choosing instead to offer up metrics that say more about predictors of long term success? What is the role of both forwarding looking metrics, and backward looking results in promoting long-term orientation to the markets? What constitutes long term in the communications business and whom are we trying to reach? What can we learn from practices in specific industries?

In some cases, taking a fresh look at Wall Street communications might mean abandoning the tradition of providing earnings guidance, like Unilever and GE have done -- or learning from companies like Dow and Nestle, and upstart Google, that have never offered quarterly earnings forecasts.

In all cases, it means more useful information to those who hold your stock -- real investors -- and greater honesty about guiding market behavior. It means moving from earnings guidance as the default practice on Wall Street, and freeing up time and resources to develop and execute long term strategies that result in stable, consistent growth over time.

More research here would be a good thing, but there is ample evidence that managers who spend more time focused on meeting or exceeding the quarterly earnings spend less time on the decisions that are long term critical and reduce investments in R&D and LT capital expenditures. In other words, companies fixated on the quarter abandon, or give short shrift to, investments that ensure a publicly traded company's long term survival.

The main argument against companies providing guidance is that without such information, stock prices will be even more volatile, with analysts and investors left to their own devices, and besides, the more information provided to investors, the better.

There's no doubt that publicly traded companies have a fiduciary responsibility to provide investors with all the information that the SEC requires. But shareholders are not all the same, and other constituents also require attention: customers, employees and host communities. Surely these constituencies benefit from a company that's spending most of its time focused on producing high quality goods and services rather than maximizing profits, or the appearance thereof, to fulfill the short-term interests of traders and CNBC hosts.

 

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