I guess it was bound to happen sooner or later: A reporter asked me to comment on a tweet from President Trump. Two weeks ago, the president addressed quarterly earnings. Here are his exact words:
“In speaking with some of the world’s top business leaders I asked what it is that would make business (jobs) even better in the U.S. ‘Stop quarterly reporting & go to a six-month system,’ said one. That would allow greater flexibility & save money. I have asked the SEC to study!”
I responded to the reporter with several thoughts, which I’ll expound on below to the extent that they concern investing. The aforementioned article can be seen on Bloomberg’s website.
U.S. exchange-listed companies are required to report their earnings on a quarterly basis, including filing Form 10-Q or the annual Form 10-K with the U.S. Securities and Exchange Commission (SEC). They are not legally required to give guidance or be concerned with analysts. There is pressure from investors and traders for companies to match or beat the forecasts that analysts make, however. This pressure leads to short-term thinking on the part of corporate executives that can have longer-term consequences.
An analysis of results from a 2003 survey of chief financial officers published in the Financial Analysts Journal found that 55.3% would be willing to “delay starting a new project to meet an earnings target, even if such a delay entailed a sacrifice in value.” Additionally, more than 48% of CFOs said they would postpone starting a profitable project if doing so meant that they would miss short-term earnings expectations by a smaller margin, even though they were certain to disappoint shareholders anyway.
Analysts, for their part, routinely underestimate what companies will earn, setting the stage for positive surprises. Between 1994 and the present day, nearly two-thirds (64%) of S&P 500 index companies reported better-than-expected earnings, according to Thomson Reuters. The beat rate for the past four quarters is even higher at 75%. As of last Friday, 79.8% of the 485 S&P 500 companies that have reported earnings bested their second-quarter consensus earnings estimates.
While analysts’ long-term soothsaying skills leave much to be desired, they are guilty of playing an active role in corporate executives’ short-term thinking and actions.
If President Trump’s intention is to steer companies away from quarterly targets, then it’s neither a new nor a bad idea. Berkshire Hathaway’s Warren Buffett and JPMorgan Chase & Co.’s Jamie Dimon have both called for an end to quarterly earnings guidance. The very big difference between President Trump’s tweet and the calls from Buffett and Dimon is that the latter two called for ending quarterly guidance, not the reporting of earnings. (This morning, on CNBC, Buffett said he wants to keep quarterly reporting, but reiterated his desire to end quarterly guidance.)
Because we don’t operate in a vacuum, the consequences of actually changing reporting requirements from quarterly to semiannual require a far lengthier discussion than what could be expressed in a tweet—even at the now-longer length of 280 characters. As I told Bloomberg, stock prices already react to quarterly beats and misses; the price swings could potentially be far larger if investors and traders only see the results once every six months.
Then there is nonpublic information. Data about how a company is performing between reports (e.g., how many shipments are being made, foot traffic into stores, etc.) would become even more valuable. A hedge fund or other large investors who had access to satellite imagery, industry experts and other nonpublic sources of information could gain an even greater advantage over those of us dependent on publicly available information, all else being equal. This especially would be the case if the subject company’s executives were staying silent and not giving any updates between earnings reports.
None of this even touches on public disclosure. As business owners, investors have a right to know how a company they own shares in is performing. Switching to semiannual reporting means we see less data. Such a switch would keep investors in the dark, and we know those with something to hide much prefer to provide as little transparency as possible.
- Using SEC Filings to Identify Risk Factors – These required filings can help you identify potential problems before they wreak havoc with your portfolio.
- Earnings Estimates – Though the profit forecasts made by analysts are partially to blame for short-term thinking, they are useful for individual investors.
- Actions to Take During the Five Years Prior to Retirement – These steps can leave you better prepared from a financial and lifestyle standpoint to transition into retirement.
- The Individual Investor’s Guide to Exchange-Traded Funds 2018 – This year’s guide has been expanded, covering 542 ETFs in print and over 2,000 funds online.
The U.S. financial markets will be closed on Monday in observance of Labor Day. Have a great holiday weekend!
Though October’s reputation is worse, September ranks last in terms of calendar-month returns. Since 1950, the Dow Jones industrial average and the S&P 500 have incurred average losses of 1.0% and 0.4%, respectively, in September, according to the Stock Trader’s Almanac. However, not every September has been down, and historically the fourth quarter has been favorable for stocks.
Just one member of the S&P 500 will report earnings, Broadcom Inc. (AVGO) on Thursday.
The week’s first economic reports will be the August Purchasing Managers’ Manufacturing Index (PMI) manufacturing index, the August Institute for Supply Management (ISM) manufacturing index and July construction spending, all of which will be released on Tuesday. Wednesday will feature August motor vehicle sales and July international trade. The August ADP employment report, revised second-quarter productivity, July factory orders and the August ISM non-manufacturing index will be released on Thursday. Friday will feature August jobs data, including the change in nonfarm payrolls and the unemployment rate.
Six Federal Reserve officials will make public appearances: Chicago president Charles Evans on Tuesday; New York president John Williams on Wednesday and Thursday; Minneapolis president Neel Kashkari and Atlanta president Raphael Bostic on Wednesday; and Boston president Eric Rosengren and Cleveland president Loretta Mester on Friday.
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Optimism among individual investors reached its highest level, while pessimism fell to its lowest level, since June in the latest AAII Sentiment Survey. This week’s results also show a decline in neutral sentiment.
Bullish sentiment, expectations that stock prices will rise over the next six months, rose 5.0 percentage points to 43.5%. Optimism was last higher on June 13, 2018 (44.8%). The historical average is 38.5%.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, pulled back by 2.4 percentage points to 32.1%. Neutral sentiment remains above its historical average of 31.0% for the 27th time in 28 weeks.
Bearish sentiment, expectations that stock prices will fall over the next six months, fell 2.7 percentage points to 24.4%. The historical average is 30.5%.
At current levels, all three indicators are well within their typical historical ranges.
The recent rebound in optimism is occurring as the major U.S. stock indexes are setting record highs. Nevertheless, tariffs and the possibility of an escalating trade war remain front and center on the minds of many individual investors. Also influencing sentiment are Washington politics (including President Trump), economic growth, interest rates (including monetary policy), valuations and corporate profits.
This week’s special question asked AAII members what influence second-quarter earnings have had on their outlook for stock prices. Nearly two out of five respondents (38%) describe corporate profits as either giving them a reason for optimism or keeping them bullish. About 25% of respondents say second-quarter profits did not alter or influence their outlook. Approximately 8% continue to view stocks as being overvalued. Trade issues are viewed as having a bigger influence than quarterly earnings for 4% of respondents.
Here is sampling of the responses:
- “Earnings were great, but they have not changed my opinion that P/E ratios are a little too high.”
- “Earnings remain positive and they evoke an optimistic outlook for future growth.”
- “Good earnings have not appeared to influence stock values very much.”
- “Limited. I’m more concerned with trade issues and deficit spending.”
Bullish: 43.5%, up 5.0 points
Neutral: 32.1%, down 2.4 points
Bearish: 24.4%, down 2.7 points
Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Local Chapter Meetings
August 23, 2018 What You Can Expect at the AAII Conference
August 16, 2018 Stock Buybacks Are Being Maligned
August 9, 2018 Selecting Stocks From a Screen
August 2, 2018 Seeking More Than One Factor Can Boost Returns
