Friday, 28 June 2013

The Next 90 Days - Looking beyond the short-term tyranny of the quarterly earnings report

By John Buchanan

Every cautionary tale has its emblematic moment. In the case of quarterly earnings guidance, it was this: In early 2005, after eBay reported that it had missed its fourth-quarter 2004 consensus earnings estimate by just one cent, executives and shareholders watched in horror as the company's share price plummeted 22 percent—$17 billion in market cap lost in a single day.

True, missed estimates rarely result in investors inflicting such severe punishment. But the threat is always present, and regardless, no one wants to deliver uncomfortable news to the board, Wall Street, or Bloomberg. So no surprise that management does whatever it takes—within the law, if not reason or good judgment—to meet consensus estimates.

In order to accomplish that dubious and often difficult goal every ninety days, managers may deeply discount their products—thereby cannibalizing profit margins—or find other clever accounting tricks that, in effect, steal from the future to prop up the present. Sometimes managing expectations requires doing the opposite: For instance, within a few months of its (minor) setback, eBay regained momentum and saw revenues soar 37 percent in the third quarter of 2005—but this time management took pains to understate future expectations, and the company's roller-coaster stock ride smoothed out, to everyone's relief. Sure, everyone on the next analyst call understood that eBay was, just maybe, gaming the quarterly earnings system a little—but hey, the system is the system, right?

Except that it doesn't have to be. The majority of public companies strictly adhere to the practice, always looking ninety days ahead, but executives are increasingly grumbling and even balking. Many are openly asking to abolish—or at least seriously overhaul—the longstanding system, insisting that providing a quarterly report card does more harm than good.

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