From time to time – last month and last October being two examples – the Lex column in the Financial Times will train its intellectual artillery on quarterly projections and other aspects of corporate reporting. Reading these pieces, one senses Lex may be at a loss as to just who might profit from what it describes, among other things, as “guidance rituals” and “a dangerous waste of time”.
Before suggesting a potential beneficiary that may not have occurred to Lex, we should state upfront that, here on The Value Perspective, we would disagree with few, if any, of the columns’ points. “Take out two full-blown quarterly reports,” one argues, for example, “and you create two additional CEO and CFO work weeks every year, and lots more time at mid-management level.”
Nor can the costs only be measured in management time, with Lex also noting: “Pressure to hit targets may make management myopic, hurting long-term profits.” Other damning comments include “The guidance ritual looks like a matter of minor changes to when investors find out what” and “Skip the projections, rational or otherwise. Tell us more about the present, instead.”
Well, amen to all that – though, if we had to pick out the most damning line of all, it would be where Lex quotes a Japanese company that solemnly pronounced, as if it had just discovered the meaning of life: “Currently it is difficult to provide forecasts … due to a large number of uncertain factors.” And how exactly does that differ from trying to predict the future at any other point in time?
So who then might benefit from the modern-day insistence that, every three months, companies should manage expectations about their current circumstances and – the dictionary definition of hope over experience – make forecasts about what might happen next? Lex again offers a clue, noting: “It is a basic tenet of modern finance theory that investors are willing to pay more for less volatile earnings.
“To generalise: investors do not like surprises. So companies that set and hit public targets should be worth more.” Elsewhere, Lex observes: “Value, over the long run, is a function of business fundamentals and these cannot always be planned a quarter or a year in advance.” There is a tension here and it is of course something from which value investors can profit.
Corporate forecasts and reporting may be intended to reduce surprises and in turn volatility but, in reality, the practice can over the short term achieve precisely the opposite effect. Relatively small misses by companies of their projected numbers can cause disproportionate moves in their share price as the wider markets react too negatively – or indeed too positively to unexpectedly good news.
If nothing else, this panic or overexcitement can create liquidity in the market. Often, however, it will lead to profitable opportunities for those investors who have worked hard to build up their own idea of the intrinsic value of a business and know that is highly unlikely to change on the basis of the last three months or the three to come.