Via ConvergEx's Nick Colas,
Tell me truthfully: do you actually get a lot of value from quarterly earnings reports? It’s not actually me asking; it is the Securities and Exchange Commission and the NIRI trade group, the most influential group of Investor Relations professionals in U.S. markets.
Last week the SEC published a concept release that seeks public input on a range of issues, perhaps most notably quarterly financial reporting for public companies.
Questions include: “Do investors, registrants, and the markets benefit from quarterly reporting?” and “Should we revise or eliminate our rules requiring quarterly reporting?”
In today’s note we consider what less frequent reporting might accomplish in terms of both the good (more long term thinking among both corporations and investors, for example) and the bad (potentially lower valuations and volatility). In the end, this is a good conversation to have regardless of where it goes. Even if nothing really changes, considering the intersection of 90-day reporting periods and investor behavior is a worthwhile discussion.
Let me take you back to the world of the Wall Street equity analyst on earnings days before the internet, email and even quarterly calls with management ever existed. For those of you with less than 20 years on the job, this would be the early 1990s:
You waited by the PR Newswire terminal with all the other analysts who had companies reporting that day. It was usually in the mailroom. Yes, companies faxed out their releases, but telephone line transmission rates were so slow you might not see the report for hours.
When your company’s earnings popped up on the screen, you printed out the release on a dot-matrix printer. It took 3-4 minutes to print a typical 6-10 page release.
You took the report back to your desk and plugged the financial results into your spreadsheet (we did have those, at least). No one had junior analysts back then – you did it all yourself.
While entering those numbers, you called the CFO at the company. His or her assistant would take a message. You never got through right away, and only the very largest companies had investor relations people.
Once the CFO returned your call, you had about 4 minutes to ask all the questions you wanted.
Things are a lot more civilized now, with the Internet and conference calls and transcripts and so forth, but financial results still come every 90 days whether you like it or not. That much is exactly the same.
A longtime friend and fellow auto analyst – someone who also remembers the pre-Internet days – pointed me to some recent developments, however, that might just change that. Her name is Susanne Oliver (http://www.oliver-ir.com/) and she has my thanks for bringing this topic to my attention. Three points to consider:
Starting in the middle of last year, some high profile asset managers and other Wall Streeters began to openly question the value of quarterly financial statements. No less a figure than Marty Lipton, founding partner of Wachtell Lipton, wrote that the SEC should ‘Pur(sue) disclosure reform initiatives and otherwise act to promote, rather than undermine, the ability of companies to pursue long term strategies.” You can read his whole note here, which is in support of several large active asset managers asking for various regulatory changes: http://www.wlrk.com/webdocs/wlrknew/AttorneyPubs/WLRK.24734.15.pdf. Also, a Slate article which mentions that Presidential candidate Hillary Clinton doesn’t like “Quarterly Capitalism”: http://www.slate.com/blogs/moneybox/2015/08/20/martin_lipton_wants_to_en...
In an SEC concept release last week, the Commission asked for public input on Regulation S-K reform. In case you aren’t up on your SEC Regs, this is the one that lays out reporting requirements for SEC filings used by public companies. It is a long document, but on page 285 the SEC explicitly asks for comment on questions as basic as “Do investors, registrants, and the market benefit from quarterly reporting?” Also on the docket: “Should we revise or eliminate our rules requiring quarterly reporting? Why or why not?” and “Should we consider reducing the level of disclosure required in the quarterly reports for the first and third quarters?” The whole release is here and it is important enough to actually scan the whole thing: https://www.sec.gov/rules/concept/2016/33-10064.pdf
This week, James Cudahy – the President and CEO of the National Investor Relations Institute (NIRI) – dedicated his weekly email to members and friends to this topic and offered up a NIRI poll asking what the SEC should do. This is significant, in that NIRI is to investor relations what the CFA Institute is to analysts: the keepers of the professional flame. As of 7pm Tuesday evening, votes were split: 50% of respondents thought the SEC should not change quarterly reporting requirements and 42% thought the Commission should make quarterly reporting voluntary. If you want to cast your own vote or see how opinion shifts, click here: https://www.niri.org/resources/publications/ir-weekly/ir-weekly-pulse-poll.
So how would moving to semi-annual financial releases change U.S. equity markets? While different equity markets around the world have had varying levels of financial disclosure requirements over time, it is hard to overlay those experiences with domestic equities. Different industrial concentrations, shareholder bases, and market dynamics all make it hard to calibrate how semi-annual reporting might change the U.S. equity market.
Here, however, are a few thoughts:
#1 - Changes in Single Stock Price Volatility
Positives of fewer earnings releases: Earnings reports are consistently a source of single stock equity price volatility. Not only does the company reporting earnings often see larger-than-normal price swings, but also those of competitors, suppliers, customers and substitutes. Reducing reporting cycles to 2/year from 4/year cuts this volatility cycle in half.
Negatives of fewer releases: By reducing the number of earnings releases, you may simply coil the volatility “spring” tighter for when companies do report. Leaving 180 days between peaks behind the financial curtail will almost certainly result in more surprises than an every-90-day look.
#2 – Impact on Single Stock Valuations
Positives of fewer releases: Over the long run (years), companies that report less frequently should have more time and capital to devote to their business. Instead of scrambling to close the books every 90 days, the finance staff could be helping operating managers more thoroughly plan new projects and products, just to pick one example. The higher returns on capital should improve valuations.
Negatives of fewer releases: Over the short term, cutting back on financial reporting frequency will almost certainly be difficult for investors to accept. A quarterly look at the financials provides some comfort (real or imagined) that the company in question is still on track. Absent that, investors may not be willing to pay the same valuation multiple for a company that reports semi-annually as one that releases detailed financials on a quarterly basis.
#3 - Industry effects
Positives for fewer releases: Some industries are so transparent and/or non-cyclical that investors are well-informed of the general state of affairs even without quarterly reporting. Consider consumer non-cyclical companies or well-capitalized energy concerns. In the former case, earnings rarely vary and, in the latter, commodity prices often drive profitability far more than internal corporate decisions. Less reporting may have little effect on investor confidence in such companies.
Negatives for fewer releases: Companies with a product story (like most of technology) may never willingly choose to report semi-annually as long as their story is working. Why miss a chance to ring the bell, after all? And, is so often the case, if these companies are making acquisitions for stock all the more reason to keep the good news flow coming. Now, when such a company decides to move to semi-annual reporting, it will be a powerful signal that the best days are over. How and when a company chooses between voluntary quarterly and required semi-annual reporting will be a useful signal to in investors.
In summary, this debate is clearly just starting, so it will pay to keep an open mind as it develops. We certainly agree that – in theory – anything that encourages longer term corporate decision making is likely a good idea. It will, over time, create more value for public companies and may even entice some private companies to take the IPO plunge since they won’t be beholden to the quarterly earnings slog. At the same time, the devil will be in the details and such a transition would be best done during the upswing of a business cycle (when things are improving) than going into a downturn.