A reminder for sanity in earnings season

All,

In this earnings season of high volatility, a company beating (or missing) consensus estimates, even by pennies, can cause dramatic, champagne-popping (or heart-attack-inducing) spikes in share prices. But if/when management becomes slaves to the “expectations treadmill,” they can be tempted to trade long-term value creation for short-term consensus meeting.

Better to have management focused on long-term growth and return than resorting to whatever means necessary (accounting tricks, delaying investment in profitable projects, etc.) to meet a somewhat arbitrary number.

A good reminder for this time of year:
http://www.mckinsey.com/business-functions/strategy-and-corp…

Executives often go to some lengths to meet or beat consensus estimates—even acting in ways that could damage the longer-term health of the business.

A company’s performance relative to consensus-earnings estimates seems to matter only when it consistently misses them over several years.

Never resort to using cosmetic quick wins to meet estimates, such as creative accounting with accruals. Investors recognize these for what they are. Instead, focus on the company’s underlying fundamentals and on communicating those to investors. That’s what is most important for your share price.

Executives commonly believe that missing consensus-earnings forecasts will penalize their share price. We have found that is not the case, and executives should not take extreme measures to meet or beat estimates. Doing so may damage business health over the longer term. Rather, leaders should keep their focus on creating value, since that is the only reliable way to create durable shareholder returns.

Now, here’s to hoping all your companies create long-term value, whether they hit “consensus” or not!

They call me,
Mr TBS

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Thank you for that great reminder, Mr. TBS. The pressure to “meet the numbers” is a huge weight to bear, and some executives do not handle it well.

It reminds me of what happened to Delphi a few years ago. GM spun Delphi off in 1999, but it never really had a chance with the legacy costs it took with it. Executives played a few shell games in order to make the numbers and they eventually got caught: https://www.sec.gov/news/press/2006/2006-183.htm

The true nature of Delphi’s value came home to roost when they filed for bankruptcy in Oct. 2005.

Here’s to hoping the companies we invest in continue to focus on their long-term value and health, despite the wild swings in valuation that occur these days.

Cheers,
MJ

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Mr TBS

Great reminder that it is hard to over estimate the value of executives who have a track record of integrity. It is the only path to long-term value for our companies.

Thanks.

Jim

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