EDITORIAL: Sage advice on short-termism from Warren Buffett and Jamie Dimon
Two of the US’s figurehead businesspeople, Berkshire Hathaway chairman Warren Buffett and JPMorgan Chase CEO Jamie Dimon, last week wrote an op-ed in the Wall Street Journal encouraging companies to stop giving earnings guidance. It is counter to the trend of the past few decades towards greater transparency in business.
"In our experience, quarterly earnings guidance often leads to an unhealthy focus on short-term profits at the expense of long-term strategy, growth and sustainability," they wrote. Their call came not only from the duo individually but also from the organisation that Dimon chairs, the Business Roundtable, an organisation akin to Business Leadership SA in SA.
In some ways their call is not strictly relevant to SA since only a few companies provide quarterly earnings, mostly the gold companies since they have a large contingent of American investors, and none provide earnings guidance in the way that US companies do.
But in a broader sense their call reflects a trend away from short-termism, which is as relevant to SA’s markets as elsewhere — perhaps even more so.
Buffett explained that providing earnings guidance was having an unanticipated consequence because otherwise good businesspeople were increasingly running businesses to ensure they outperformed their guidance estimates.
Issuing earnings guidance — an indication of earnings per share for the successive quarter — became very common in the 1990s after the US Congress protected companies from liability for statements about projected performance. It’s now fairly commonplace in US markets; about a third of S&P 500 companies issued quarterly guidance in 2016, down from 36% in 2010. About 31% provide annual earnings per share guidance. The number discontinuing guidance is steadily increasing, and they include in the recent past Unilever, Facebook, GlaxoSmithKline and BP. Some have substituted providing multiyear guidance.
Buffett explained that providing earnings guidance was having an unanticipated consequence because otherwise good businesspeople were increasingly running businesses to ensure they outperformed their guidance estimates. Often marketing budgets would be slashed, research and development curtailed or products sold at steep discounts to reach the desired figure. Buffett and Dimon recognised that reducing or even eliminating quarterly earnings guidance won’t, by itself, eliminate all short-term performance pressures, "but it would be a step in the right direction".
There is, in fact, a counterargument, which is that short- termism is not driven by quarterly guidance; it is driven by a host of other pressures. These include competition between fund management companies frantic to win investment mandates, managers whose share options are dependent on share price performance, the fear of takeovers and, arguably, the nature of stock markets themselves.
As the Financial Times argues, even if companies don’t issue quarterly estimates, research analysts will construct their own models, as they do already all over the world.
If companies wanted to, they could pre-announce poor earnings for a certain amount of time to boost marketing, and the market could judge their decision. But in practice they don’t, and earnings calls typically show companies outperforming their own estimates, possibly massaged somewhat to engineer the impression of managerial brilliance.
Yet research seems to show issuing earnings does little to decrease volatility or even provide support for valuations. Buffett and Dimon’s argument does have merit and support from other professional investor organisations that are seeking to include society’s requirements into the mix.
The bottom line is that expansion often comes at the cost of profits, and good managers need a degree of insulation — not too much — to push their businesses forward, on condition that they take the time to disclose carefully and fully the key drivers of their business and their future plans. To that extent, it’s a positive step that business should support.