Every three months there is a lot of anticipation and excitement before a company releases its earnings. A good earnings report can send a company’s shares up a few points. A bad earnings report can send a company’s shares tumbling down. While quarterly earnings were designed to give investors an update on the performance of a company, they have become a real important event to too many investors. Let’s take a look at why quarterly earnings releases are not such a great deal for long term investors.
Investors Become Too Short Sighted
The definition of long term stock investing has changed in recent years. A long term investor used to be someone who was in a stock for 10 years or more. Today, an individual will consider himself a long term investor if he invests in a company and holds its shares for a few months. Quarterly earnings have made investors impatient. They now expect every single stock that they own to produce instant results. This is no way to buy stocks.
Investors place too much of a premium on the results that a company produces over a three month time period. A company could have 10 great years of earnings but if it produces one quarterly clunker then investors will abandon ship. Investors have moved from seeking to invest in good long term growth stories to becoming momentum investors. They try to hop on companies once they report a good earnings number and are often disappointed.
Companies Lose Track Of Long Term Goals
Corporate executives and company management of American companies have a tendency to become too preoccupied with short term earnings results and lose sight of the long term strategic objectives that they should be focused upon. Companies will often forgo heavy investments in research & development and expansion in order to placate shareholders with a good earnings report.
It could be in the long term interest of a company to report lower than expected earnings for a quarter or two to make strategic moves that would position the company for the next decade or more. Most management teams however do not believe in this. That is because they fear the short term effects that a bad quarter would have on their company’s stock price. Their careers and reputations are often measured more by short term performance than their long term stewardship of a company.
Management Is Motivated To Take Too Much Risk
Executive compensation is often tied directly to earnings targets. Executives are motivated to only look at short term results because their bonuses are tied to the short term performance of the company. That is one of the reasons why so many financial companies leveraged themselves to the hill. Enron, HealthSouth, and WorldCom all had inflated earnings numbers that yielded big results for the owners and nothing at all for shareholders.
They took the maximum amount of risk that they could so that their companies would generate record earnings and record profitability. The companies that they guided were overextended and debt laden but the quarterly earnings looked good. Management didn’t really care if the company was positioned for long term success. They just wanted to get the maximum amount of cash out of the company while they could.
Too Much Emphasis Is Placed On Quarterly Earnings
Networks are as much to blame as anyone for hyping short term new events. Networks like CNBC dedicate an entire day’s worth of news coverage to highlighting the earnings performance of a company. They make investors feel as if they should make a buying or selling decision off of one quarterly earnings report. The networks do this because it helps to produce better ratings for their programs but it does not help investors at all. Quarterly earnings are nowhere near as important as the underlying fundamentals of a company.
I am not suggesting that companies do away with quarterly earnings altogether but I am in favor of companies placing less emphasis on them. A quarterly earnings report is useful for trend analysis but should hold very little weight when it comes to making an investing decision.