Shareholder Expectations, Low and Otherwise

Shareholder Expectations, Low and Otherwise

We’ve talked a lot about capital allocation and how it relates to the intrinsic value of the company. But not all management teams allocate their capital very well. Nor do they invest for the long term good of their firm. Some in fact do just the opposite and over time destroy shareholder value by putting more emphasis on meeting their earning projections for the upcoming quarter.

The financial industry is obsessed with short term performance. Fund managers are expected, at the very least, to match the performance of their peers (index hugging). In other words the industry mantra has become, “we can all go down together but I can’t let them go up without me”. This in turn has put a lot of pressure on the manage teams of individual companies to make their quarterly numbers. If they don't the stock of their company gets hammered. This has produced a lemming like response in the industry where investors (traders?) flock from one stock to another in the hope of superior price performance. 

A management team might cut funding for research and development so they can be assured of hitting their earning targets for the next quarter. The senior management team of another company may insist on not cutting funding for these same initiatives and see the stock of their company punished and sold off when they miss their quarterly numbers. 

The result of all of all of this can feed on itself where the expectations of companies who constantly meet and beat their quarterly earning numbers are expected to keep performing the same way. This in turn puts a lot of pressure on management to make further cuts in their discretionary investing and even to misreport their numbers. Investor expectations can get raised to the point where when the company finally fails to meet it's numbers, it's stock can crash. Meanwhile at the firm where management misses their numbers but continue to invest for the long term, they can often surprise to the upside and smash their expected low numbers when their long term initiatives finally bear fruit.

The moral of the story is invest in companies who invest in themselves. Invest for the long term and invest in companies who invest for the long term. When you invest for the long term you will make fewer investment decisions and that can only be a good thing.