The leaders of two of the world’s biggest companies weighed in on Thursday on the state of the investing environment in the U.S., specifically the focus on quarterly earnings and guidance and their effect on investor behavior.
In an Opinion piece published in the Wall Street Journal and a subsequent joint television appearance, Warren Buffett, Chairman of Berkshire Hathaway and Jamie Dimon, CEO of J.P. Morgan Chase (JPM - Free Report) , posited that investor focus on short term results caused companies to make inefficient decisions that allowed them to meet or exceed earnings estimates, but sometimes at the expense of long-term results.
They even went so far as to attribute a two-decades decline in the number of public companies to an unwillingness to operate in the glare of the public eye.
Berkshire and J.P.Morgan are America’s 8th and 9th largest companies with market capitalization of $478B and $382B, respectively. Share prices of both firms have risen steadily for decades.
Buffett and Dimon stressed that they are not opposed to financial reporting requirements, stating:
“Our views on quarterly earnings forecasts should not be misconstrued as opposition to quarterly and annual reporting. Transparency about financial and operating results is an essential part of U.S. markets, and we support being open with shareholders about actual financial and operational metrics. U.S. public companies will continue to provide annual and quarterly reporting that offers a retrospective look at actual performance so that the public, including shareholders and other stakeholders, can reliably assess real progress.”
The pair instead took aim at the practice of companies providing future revenue and/or earnings guidance to analysts, opining that the practice encourages managers from the CEO down to focus on “making the numbers” in the short term and to “do things that they otherwise wouldn’t have done.”
Dimon said the long view includes having the courage to make a decision - specifically to spend money - that might hurt short term results but that sets the company up for long-term success. He stressed the importance of an understanding board that allows a CEO to make such tough decisions. He also pointed out that it’s easy for a CEO to finesse any given reported number by cutting back on marketing, not opening new outlets or selling more product at a cheaper price – all of which could have negative long-term effects.
He even joked that in the extreme, a company could cut costs by reducing airplane maintenance, but it would obviously be a bad idea.
Buffett added “I tell our managers, just pretend this is the only position you or your family are going to own for the next 50 years and that you can’t sell it.”
The duo does not believe that forward-looking guidance should be disallowed, but rather that forward-looking management should probably simply decline to provide it.
What It Means to You
Hearing from Buffett and Dimon on these issues is the closet thing you can get to a free lunch. The message to individual investors is clear. Great companies are built over many years and individual quarters are barely blips on the radar. Pay attention to earnings, understand the history of a company's results and fully understand their vision for the future.
Do not sell a stock that you fundamentally believe in because they missed a quarterly estimate by 10 cents. If others are selling, consider it a favor - and an opportunity to pick up some shares on the cheap.
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