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I have come to the conclusion that quarterly reports, as they are presently practiced, undermine efforts to build a business in a sustainable way. Put bluntly, they promote short-term decision-making and strategic goals among directors and managers as well as for shareholders.
Senior managers feel tremendous pressure to "make their numbers" - to match or, preferably, outperform Wall Street expectations, and create the appearance of steadily improving results. Such a quarterly vision entices them to look for short cuts that will inflate earnings results at the expense of the long-term health of the enterprise.
It is critical for management to address future financial prospects, of course. The source of the problem is the time frame and the narrow vision it spawns. An earnings guidance every three months is the equivalent of the "tip sheet" for the race track junkie. All the emphasis is on, "did you meet it or beat it?"
Earnings guidance aims to convince investors and analysts that business is predictable. But in actual fact business is not predictable. When you see regular, predictable earnings, it is usually because management is smoothing the numbers out through some accounting gimmicks. There can be little doubt that companies manage their earnings forecasts like a Hollywood set. In a competitive environment as volatile as we have, can a company really predict - down to the penny - what its earnings per share will be four quarters from now? I think not. A spate of research demonstrates that there are ridiculously more companies that meet their earnings forecast to the cent, or beat it by a cent, than there are those that miss it.
In bull markets, companies are more likely to offer optimistic forecasts and join the bandwagon generated by stocks with fast-growing earnings-per-share. In bear markets, companies are apt to lower expectations so that they can beat their numbers and show strength in a tough season. It is the analyst's job to evaluate management expectations and judge if these expectations are too optimistic or too low. Unfortunately, analysts have not been exactly trustworthy when it comes to performing this task with objectivity.
I therefore applaud the decision that a small but growing number of companies are making to forego earnings guidance in their quarterly reports. More than one out of four U.S. companies are considering discontinuing the practice according to a 2003 survey conducted by the National Investor Relations Institute.
But doesn't this movement undercut investors' pleas for more disclosure in the post-Enron era? Not at all; quarterly estimates have proved to be a fairly shallow measurement of a company's actual health. It would be more helpful for a company to disclose to investors and analysts a long and short history of the firm's actual operating performance. Management also should be able to offer insight into what's happening for the company in the current quarter, and explain how it will run the business and manage expenses based on various revenue levels.
Above all, management has to decide what information to disclose and how often to disclose it. Then they should paint that picture consistently, in good times as well as bad.
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