Anticipation is in the air, the nervous excitement is nearly palpable all across Wall St. It’s quarterly earnings season! You see, every three months publicly traded companies announce their earnings for the previous quarter to the public. It’s basically like elementary school report card day on steroids. It’s also one of the worst things to happen to the stock market and investing world in history.
Simply put, as a rational long-term investor quarterly earnings season is the bane of our existence.
Why Quarterly Earnings Season Is Bad For The Long-Term Investor
– Too much importance is placed on one quarter’s earnings: If a company beats Wall St’s earnings estimates its stock will skyrocket. If it falls short? Look out below! Investors (I use the term loosely) treat three months worth of financial data as if it’s a sign from God to buy or sell a certain stock. Of course, this skittish behavior is only perpetuated by the financial media. CNBC and the financial websites will treat an earnings report by Apple or Facebook as if it’s an event comparable to the U.S. invading Canada. Those of us living in reality realize that one quarter’s earnings is not that important in the big picture. If a stock I own misses earnings estimates by $0.01/share I’m not going to take it as a sign to sell off everything I own and start stocking up on canned goods!
– Executives have lost sight of the big picture – In the same way teachers are criticized for “teaching to the test”, corporate executives have started to manage to the next earnings call. Executives of a corporation are responsible for steering the ship and making sure the long-term outlook for the health of the country stays strong. Not to meet analysts estimates for Q4 at all costs.Some executives will forgo expensive investments in things like R&D because it’s not something that yields short-term benefits. In a way, you can’t blame them. With so much importance placed on earnings releases, executives job stability and reputations are more heavily weighted by short-term stock price movements. Not long-term stewardship of the company, as it should be.
– Managers take too many risks – Lehman Brothers, AIG, Enron, Worldcom, etc… With executive compensation so often linked to short-term performance goals managers often motivated to make too many risky moves just to meet those goals, often sacrificing the overall health of the company in the process. Employees at AIG were receiving HUGE bonus checks every quarter for meeting their quarterly goals. In their eyes, and their managers eyes they were doing a great job, meeting the goals that had been set for them. Meanwhile, because everyone in the company was obsessed with short-term results, they were unwittingly laying the foundation for the downfall of the entire company.
– Investors lose their long-term focus– In 1960 the average holding period for stocks was 8 years. In 2012 the average holding period is about 3 months. You can now call your self a “long-term” investor if you plan to keep a stock for just one year! That’s insane.While, it isn’t the only reason for this change quarterly earnings season and the hype that goes along with it has bred a generation of impatient investors. Investors that want results NOW or else they’re moving on to the next big thing. This is not the way to invest. Buying a stock just to sell it in a month or two (or less!) is gambling, regardless of what kinds of information or chart trends you may think you have. One of my favorite quotes on the stock market comes from Benjamin Graham (and is oft-repeated by Warren Buffett): “In the short-term the stock market acts like a voting machine, while in the long-term it acts as a weighing machine.” Meaning that in the short run, stock price is too heavily influenced by emotion and insignificant trends. While over the long-term the stock price will reflect the true value and performance of the company. When we invest we should invest in great companies we feel will perform over the long-term, not the latest stock we heard Jim Cramer shouting about on TV.
None of this is to say that quarterly earnings reports don’t have their place. It is important to keep tabs on how each of your investments is performing, and earnings reports can be a signal that it’s time to sell your shares. However, only take action if something in the report signals a fundamental problem with the company and its long-term prospects. For example: investors in Sprint (NYSE:S) which has missed earnings estimates for 19 straight quarters, or investors in Zynga (NASDAQ:ZNGA) which has been hemorrhaging money the past few quarters might want to take the latest earnings reports as a sign of a continuing negative trend.
As investors we should acquire and use as much information as we can in our decision-making. However we also need to filter out what information is truly important and what is just noise and hype. 99% of the time quarterly earnings reports are the latter, and should be treated accordingly.
Full Disclosure: I do not own, or plan to own any of the specific investments mentioned in the above.