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Why Trump is right about wanting to end quarterly earnings reports

Julia La Roche

President Donald Trump tweeted on Friday that he’s asked the Securities and Exchange Commission to look at moving quarterly reporting for publicly-traded companies to a six-month schedule.

Trump later told reporters that the idea was raised by Pepsico’s (PEP) outgoing CEO Indra Nooyi during a dinner held earlier this month with business leaders at his private golf club in Bedminster, New Jersey.

This is not a new idea, nor a far out one at that. And there is plenty of nuance. While many investors are quick to push back on the reduced transparency, many experts still see the value in regularly providing industry-specific performance indicators. It’s largely the practice of specifically reporting earnings on a short-term basis that seems to be most unproductive.

Quarterly earnings announcements are losing relevance

Baruch Lev, a professor of accounting and finance at the Stern School of Business at NYU, has also proposed moving from a three-month reporting schedule to every six months.

“This is not new to me. I’m for it,” Lev, who recently co-authored a book, The End Of Accounting, that explores this exact idea told Yahoo Finance in a phone interview.

Professor Lev’s premise for moving from three months to six months is that earnings have lost most of their relevance to investors.

Lev demonstrated this in a recent paper he co-authored with Feng Gu, an accounting professor at SUNY Buffalo. In the paper published by the CFA Institute, they show that the gains from perfectly predicting the consensus beats and misses for each quarterly report have diminished over the last thirty years. As of 2017, the gains for perfect predictions are 1.7%.

Investors who accurately predict consensus estimates for quarterly earnings have seen returns from their perfect predictions decline.

“[A] devil’s advocate might argue that although the perfect earnings prediction gains have declined sharply over the past 30 years, the current 2% three-month return is not exactly chump change. True. But to obtain such gains, you do not need any intricate machinery to perfectly predict consensus beats and misses,” the pair write. “A ‘dumb’ momentum investment, which invests only in the 10% of stocks with the highest return over the past 12 months and shorts the lowest 10%, yields a similar return. Recall that the 1.6% to 2.0% gains from predicting consensus beats and misses are derived from a perfect prediction. Because that is impossible, the actual gains from your elaborate spreadsheets and earnings prediction models are substantially smaller.”

Quarterly reporting is distracting for management

Another reason to move to the six-month system is to avoid the “craziness” and “hoopla” surrounding quarterly earnings reports.

“I’ve heard from a CFO who can’t sleep the night before [earnings],” Lev said.

Indeed, it’s not unusual to hear about executives who say regrettable things on earnings calls only to apologize for those comments later.

There’s also a huge time expenditure around those quarterly conference calls, he added.

“I was told by one CEO, I couldn’t believe it, but he told me he prepares for four days for the conference call with all kinds of focus group with PR and others. I was convinced you mean ‘four hours?’ He said, ‘No, Baruch. Four days.”

Some executives, like Warren Buffett, forego analyst conference calls altogether.

Short-termism encourages ‘the earnings game’

For many years now, the idea has been floated that if you require companies to report quarterly they will be focused primarily on meeting market expectations and sometimes they’ll take gimmicky actions such as cutting R&D to help meet or beat the forecasts. One study showed that when European companies moved from six months to three months, there was a substantial increase in short-termism by managers.

“The great benefit of moving to six months: you cut in half this craziness, which people call ‘the earnings game’ in which managers try to game analyst forecasts,” Lev said. “It’s a whole game with lots of effort [and] money lost by investors who react to changes in analyst forecasts for no purpose at all.”

These earnings estimates that companies are benchmarked against when they report each quarter stem from Wall Street analysts who spend a great deal of time forecasting. In addition to relying on the financial information that the companies report on a quarterly basis, analysts also use guidance that managers provide to build their forecasts. Analysts then use that information to form buy and sell recommendations for their clients. Collectively, the analysts’ forecasts make up the “consensus” estimates that the company’s quarterly earnings results are ultimately benchmarked against.

There’s no need to report the whole balance sheet

While there is some valuable information that investors may be able to glean from earnings and earnings per share, investors would be better off getting their information needs elsewhere, Lev argues.

Across different industries, there are factors that matter much more than a company beating, meeting, or missing the earnings consensus. For instance, information such as policy renewals for insurance companies, same-store sales for retailers, the percentage of seats filled for airlines, or capacity of cargo for transports, or the size of nonperforming bank loans, are examples of information that’s more useful than just the bottom line.

According to Lev, there’s no need to report the whole balance sheet every quarter. Instead, the SEC can mandate for each industry what measures reflect the business and if they should distribute that quarterly or monthly.

“The thing is going away from quarterly reporting is not necessarily a good thing,” Suresh Nallareddy, an assistant professor of accounting at Duke’s Fuqua School of Business, explained. “Capital markets want to know what is happening to the firm.”

Similar to Lev, Nallareddy’s idea is to move to a system where companies provide the financial information every six months, while only providing more qualitative data on the three and nine-month marks.

“Many market participants, as well as the Business Roundtable which we are a part of, have been discussing how to better orient corporations to have a more long-term view,” Nooyi said in an emailed statement. “Most agree that a short-term only view can inhibit long-term strategy, and thus long-term investment and value creation. My comments were made in that broader context, and included a suggestion to explore the harmonization of the European system and the U.S. system of financial reporting. In the end, all companies have to balance short-term and long-term performance.”

Julia La Roche is a finance reporter at Yahoo FinanceFollow her on Twitter.