Quick: Whose profile is on a US Quarter? That’s right – George Washington, the First President, the Father of Our Country. My daughter just turned 25 years old – a quarter of a century. She requested a cake that looked like a McDonald’s Quarter Pounder. We contacted a local bakery and they made a great cake for her. The “hamburger” part was chocolate cake, and the two “buns” were vanilla cake. They even added frosting lettuce, tomatoes, cheese and pickles! Here is a photo of it:
As I write this, it is quarterly earnings season and week. Many of the big companies – Alphabet/Google, Facebook, Amazon – report 2nd quarter earnings this week. GOOGL’s earnings were strong but maybe not what The Street was looking for. Facebook’s earnings exceeded The Street’s expectations. Amazon beat on Operating Cash Flow and Net Sales but still didn’t make a big profit. Same old story for Amazon, but that’s good – see below!
When I (or someone on CNBC for that matter) mention The Street, what do I mean? Mostly I mean analysts that cover the respective companies. Analysts are usually (but not always) employed by the big brokerage firms. Their job is to analyze corporate-provided financial data and to make projections of future sales, net income, and cash flow, as well as to label the company as a Buy, Hold or Sell, and to make a price target projection for the stock. Since corporate financial reporting is becoming more opaque, and because companies are more and more limited as to what they can directly disclose and when they can disclose it (see: Sarbanes-Oxeley), being a Wall Street stock analyst is a very difficult job. In addition to their own internal corporate accountability standards, analysts are graded each year by various financial publications including Barron’s.
Think of the Wall Street analyst brigade as the Mainstream Media of Wall Street. Collectively they are the filter between corporate raw reporting and its consumption by the investing public. Analysts report and then provide a “take” on the information companies dump out there. Above all else, analysts want consistency. They do not want to be surprised. The best companies at the reportage game foster strong relationships with the analysts that cover them. If the company/analyst relationship is adversarial, the company is sunk. Surprises include both to the downside and to the upside, although of course upside surprises are more quickly forgiven. Surprises mean the analyst looks bad. Company performs well and works collaboratively with the analysts, and analyst rewards company with positive recommendations and a Buy rating. That’s the way the game is played.
Too Much Emphasis?
In the past, there has been criticism by some in the financial media that there is too much emphasis on quarterly earnings in US markets. If they have to focus too much on quarterly results, the argument goes, companies will be less able to execute long term strategies for growth. Sometimes companies have to re-invest their earnings back into the company to the detriment of quarterly earnings. Capital Expenditures and/or Research and Development costs may or may not have to be expensed, which affects quarterly earnings. Japan, the criticism went, will win the day in the long term because their markets are more long-term focused and Japanese companies are therefore able to invest in products and technologies that will take a long time to develop but will own the future. How has that criticism worked out? Since The Bottom in March 2009, Nikkei (Japan) 225 Stock Index Future has risen from the high 7000’s (say 7800) its current value of 20040, which is an increase of about 157%. Not bad! The S&P 500 Index Future, at the same time, has risen from about 720 to 2471, which is an increase of 243%. Much better! At least since 2009, the US market, with its emphasis on quarterly earnings, has significantly outperformed. So, one could say the criticism doesn’t hold weight.
What about the criticism within the US itself that the emphasis on quarterly results prevents companies from investing in the future? I give you the example of Amazon, which just reported its quarterly earnings this week. Amazon has been around for 20 years as a public company, and to this day its emphasis is on Operating Cash Flow and Net Sales, and not on Earnings Per Share. Amazon now does turn a profit, but that is a recent development. Amazon has played the game correctly with its analysts. Amazon has co-opted its analysts on its strategy that it will re-invest its cash flow back into its business, in an effort to grow its business and to dominate in all of its businesses. Who would have guessed that the company that started out as mainly a book seller would become one of the world’s largest cloud computing providers through Amazon Web Services? Amazon has been able to accomplish this because it satisfied its analysts (and, of course, the investing public) and got them all to accept that they would grow but maybe not earn any actual accounting profits. A masterful job!
Markets enforce discipline on companies the way governments or other entities or institutions cannot. Markets can be brutal – perform, or you’re out! Quarterly earnings mean even more, closer discipline. Only the strongest of the strong companies make it through the gauntlet of quarterly earnings and the level of information sharing needed to co-opt the analysts and the investing public. No laggards allowed. That’s one reason why the US markets are the most efficient, and the US economy is the most successful in the world.