Quarterly earnings reports seem like a permanent fixture of the business landscape. For investors and traders, "earnings season" comes four times a year and invariably proves to be a source of both great opportunity and great heartache. However, should earnings guidance be part of this process? Should investors demand that executives provide them with short-term earnings milestones that they are trying to meet? Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) CEO Warren Buffett (Trades, Portfolio) and JPMorgan (NYSE:JPM) CEO Jamie Dimon both believe quarterly earnings forecasts do more harm than good. In a 2018 interview with CNBC, they explained why.
Don't sacrifice next year for tomorrow
Buffett began by pointing out focusing too much on quarterly results can lead to poor long-term decision-making:
"When companies get to where they're living by 'making the numbers,' they do a lot of things that really are counter to the long-term interests of the business. I've never seen a company whose performance has been improved by having some forecast out there by the CEO that 'we're going to earn X' because it's not only sending the wrong message and delivering the wrong results to the company and the country, it's also teaching the people who work under him or her that quarterly performance is the end game. I tell our managers: just pretend that this is the only business that you and your family are going to own for the next 50 years and you can't sell it. Then you'll make the right decisions."
Buffett went on to say he knows managers, whom he personally likes, that resort to various shenanigans to meet their forecasts. The incentives in contemporary corporate governance pressure managers to go out of their way to meet and beat forecasts in order to cultivate a reputation as a person who "makes their numbers."
But business doesn't work that way. Down periods will happen now and again, and that's fine. What Buffett is saying is that forecasts are needlessly restrictive and not meeting them creates the implicit assumption that the manager in question has failed at their job.
Dimon agreed with Buffett, saying the incessant drive to meet short-term forecasts puts the long-term growth of a business at risk:
"It can often put a company in a position where management, from the CEO down, feels obligated to deliver earnings and, therefore, may do things that they wouldn't otherwise have done. So if you have a good board, and you say to them: 'I have a great investment opportunity, but it's going to cost me a couple hundred million dollars this quarter,' someone like Warren would say, 'Absolutely do it! That's future earnings.' Don't hurt your company because you're trying to meet a short-term thing."
In other words, long-term investment requires that some short-term gain is traded off. This isn't to say executives never make long-term decisions and are wholly beholden to the short term. But on the margin, they are more likely to take the short-term decision, and that alone is perhaps reason to curb the practice.
Disclosure: No positions.
Read more here:
- Introduction to Banks: How Do Banks Differ From Other Companies?
- Steve Eisman: Money Today Has Become Free
- An Introduction to Banks: The Balance Sheet
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
This article first appeared on GuruFocus.
- Warning! GuruFocus has detected 2 Warning Sign with BRK.A. Click here to check it out.
- BRK.A 15-Year Financial Data
- The intrinsic value of BRK.A
- Peter Lynch Chart of BRK.A