Mr. Fink, Don’t Blame Corporate Profit Guidance for Wall Street Short-termism

Wall Street Short-Termism – Companies and Their Guidance are
Not to Blame
 
While we applaud Larry Fink and other Wall Street leaders’
speaking out on the dangers of investment short-termism in Wall Street, we are
not convinced that the corporate profit guidance practices he critiques are the
cause of short-term thinking in Wall Street. We also find no small amount of
irony in Wall Street pointing the finger at companies. We do share his concern
about a dearth of longer-term thinking and capital allocation in Corporate
America, as that does seem largely missing from Wall Street yet critical to
long-term growth and success.
In theory stocks are valued based on the expected future
financial performance of the underlying company. Management guidance – profit
or otherwise – is an attempt to help investors understand where the company
thinks it is going, and who should know better than the company itself? Absent
corporate guidance on where the financial chips are expected to fall, Wall
Street picks up the slack and provides its own estimates to shape investor
expectations. Headlines and post-reporting trading activity tend to focus heavily
on results vs. the expectations codified in consensus estimates, and sales
calls go out encouraging investors to react to this short-term progress measure.
In this context, Mr. Fink’s suggestion to reduce or
eliminate company-provided data-points and perspective regarding where it is
going and the anticipated impact on its financial performance does not appear
to benefit to anyone. In fact, the less guidance companies provide, the more
likely Wall Street expectations can become off kilter. Such a divergence can
only reduce investor confidence in the visibility of future financial
performance, with a corresponding reduction in the company’s valuation – an
unfavorable feedback loop resulting from Mr. Fink’s suggestion.
In our view, the real problem is not profit guidance but the
Wall Street business model that makes active trading far more profitable than
buy-and-hold investing. The whip-sawing of capital in and out of various
investments generates commissions on each transaction, and in the case of funds
offered by Mr. Fink’s firm, their fees/loads are higher the more frequently assets
are moved from one fund to another.
So it seems to us that the structure of asset management and
performance fees, along with fund advertising/marketing that highlights
short-term performance to attract new investment (or defend existing
investments) is a principal driver of short term thinking, not corporate profit
guidance. We also believe that the genesis of activist investing is principally
rooted in the growing pressure to accelerate shorter-term investment returns.
Wall Street has set up the rules of the game of current
markets. It is this ecosystem that must take responsibility for the pressure to
deliver short-term performance – as well as the corporate response to dealing
with this very apparent set of rules.
The rapid growth of the volatility and short-term focus that
Mr. Fink seems to critique is not unrelated to the corresponding decline in
average Wall Street commissions. Increasing transaction activity has been
required to make up for lower commission rates, but this trend creates clear disincentives
for supporting long-term investment strategies.
So rather than blaming corporate guidance and disclosure
practices, perhaps Mr. Fink and his cohorts should ask whether they have done
all they can to create business and compensation models that support a longer
term investment view.
We would guess that there is much that BlackRock could do to
refine its methodologies, business model and communications to focus its teams
and customers on long-term results. That effort would help foster an
environment where companies could feel more comfortable to do the same with
their strategies and investments.
The securities industry and the financial media could go a
long way to helping in this endeavor as well, to wit – one of our clients
recently reported very impressive year over year improvements in its business –
and yet the Wall Street response was to ignore the 44% revenue improvement year
over year – and the $7M positive swing on the bottom line.
Instead, the media coverage and trading activity ignored the
impressive improvement and instead focused on the Company having “missed” the
revenue estimate and the bottom-line estimate of just one analyst covering the
stock. The company in question provides no profit guidance, is making long-term
investments in its business that Mr. Fink would applaud – but the market
reaction was the same. 
Given this orientation toward the precise predictions of
near term results – with or without a company’s help – is a company to blame
for trying to help shape Wall Street expectations with profit guidance? Who takes
the reputational hit when a company “misses” expectations set by Wall Street? From
our experience it is the Company, NOT Wall Street. We’ve never seen a headline that stated that analysts “missed” the
quarter.
For these reasons, we believe it is an investor relations
imperative that companies do all they reasonably can to inform investors on
their plans, outlook and financial expectations. This effort helps ensure that
third party expectations are as in-line with those of management as possible. Explicit
earnings guidance is one such means of achieving this goal, however there many
less granular ways of achieving the same thing.
Lest small or microcap companies take Mr. Fink’s advice to
heart – their plight is even more challenging as their limited visibility,
sponsorship and liquidity create even greater volatility in their share price
around financial results – and greater vulnerability to perception risk. These
factors provide a solid real-world rationale for working to shape investor
expectations around financial performance in the near term – the next few
quarters – as well as the long term.
While we completely agree that allocating capital and
resources toward long term strategies and goals makes the most sense, as long
as Wall Street gets to “vote” on our clients’ success in real time over 23,400
seconds of each trading day, 5 days per week and is not compensated based on a long
term performance, we find it hard to counsel our clients to buy into his
vision.
Instead, we believe companies should do an excellent job of
explaining their vision, their goals and plans for the long term, as well as
preparing investors for the consequences of those decisions in their near term
results. The more helpful detail they provide, the greater comfort and
confidence investors will have, and the more likely (not less likely) that
investors will be motivated to hang on for the long run too. Though we set out
to drive 2,000 miles to a distant city, does that mean that we must ignore the
guideposts and gauge readings along the way that help us understand how we are
doing in our journey and how well resourced we are to get there.
But kudos for at least raising the topic – as more and
better longer term thinking and capital allocation will lead to better long
term investment outcomes, which is good for all. But we are concerned his
prominence might unduly influence companies to follow his lead, particularly
those in the small or microcap realm – and find themselves in a worse position.
David C. Collins
Managing Director, Catalyst Global
New York City

February 9, 2016
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