Trump Wants The Earnings Reports News Cycle To Shift From Quarterly To Semi-Annual; Is It A Good Idea?
Ah, it’s the season of quarterly earnings reports. Elon Musk pulls an earnings surprise out of a hat and Tesla (TSLA) stock soars 9% the next day. Amazon.com (AMZN) reports strong earnings but revenue that’s below analyst forecasts. After the markets close, its stock tumbles 7%.
For decades, Wall Street pros and individual investors have braced for this stock market ritual, quarter after quarter. They hope positive earnings news will light up their stocks. They lament the shortfalls that take the floor out from under them. Some corporate executives, meantime, seem to abhor the whole process. Critics say quarterly earnings reports force them to focus on short-term targets, not long-term success.
Same old, same old? So it was, until a group of CEOs got President Donald Trump’s ear. After an August meeting with business leaders, Trump asked the Securities and Exchange Commission to study the idea of ending quarterly earnings reports. Instead, publicly traded companies would report financial results to investors just twice a year. The aim: reduce business costs and foster long-term thinking.
Trump reportedly got the idea from Indra Nooyi, then CEO at PepsiCo (PEP) and current chairwoman, after a dinner with 13 captains of U.S. industry at his golf club in Bedminster, N.J. General Motors (GM) chief Mary Barra and JPMorgan Chase (JPM) CEO Jamie Dimon also attended.
Since then, SEC officials have ruled out a change anytime soon for big companies. But they’ve signaled less frequent financial disclosures are possible for smaller companies. And big investors are on the alert.
“I don’t think quarterly reporting is going to change for our top names anytime soon,” SEC Chair Jay Clayton told the media on Oct. 11.
Yet numerous investment pros interviewed by Investor’s Business Daily are keeping a hawkeye view on future regulations that would change the reporting rules. They see better ways to foster long-term investment by companies.
Earnings Reports Frequency Going Backwards?
Looser rules would be a big step in the opposite direction from steps taken by corporations’ chief regulator, the SEC, since it was born in 1934. Also, Wall Street is used to getting monthly reports on key metrics in a wide range of industries, including auto sales, airline passenger traffic and rail car shipments.
Wall Street veterans oppose any change that could lead companies to release an even smaller amount of timely information to investors.
They point out that the SEC’s Regulation Fair Disclosure (Reg FD), enacted more than 18 years ago, already dramatically limits the situations in which corporate managers share critical views on how business is going. They argue that investors need timely data on companies’ performance to make good decisions on which stocks to buy and hold.
Wall Street pros also say that changing the reporting cycle for American companies and foreign firms listed on U.S. exchanges would fail to influence the way CEOs plan for the future.
“From our perspective, anything that reduces transparency is a bad thing,” Bryan Anderson, executive vice president and market strategist at Austin-based Beck Capital Management, told IBD.
Trump tweeted in August that a 180-day reporting cycle would “allow greater flexibility and save money.”
Earnings Reports: Historical Requirements
But, Anderson said, “If you look at the SEC mandate, it doesn’t say anything that you should lessen the burden of reporting on business. When it comes to capital formation, there are more important factors than simply preparing quarterly reports.”
The Securities Act of 1934 now requires all publicly traded companies to disclose financial results to investors every 90 days. Any other material news must go out immediately and be shared to the entire public via a news release or filing to the SEC.
That wasn’t always the case. In 1955, government regulators forced public companies to speed up their reporting of results to twice a year from annually. In 1970, Wall Street then shifted to a quarterly reporting cycle.
Less information could mean investors will be less willing to pay higher prices for both equities and debt securities. Companies could be forced to sell additional stock or new bonds at lower prices. This means the cost of capital would rise.
Impact Of Risk Premiums
Robert Maltbie, president of small and micro-cap stock research firm Singular Research in Los Angeles, notes that equity risk premiums have historically been 8% per year. Private equity and venture capital (VC) firms tend to show return premiums of 12% to 17%.
“Private equity and VCs don’t report quarterly. They’re annually at best,” Maltbie said. “A lack of transparency means that risk premiums will be higher. Investors will want to be paid more.”
In general, high risk premiums mean that corporations must sell equity shares at lower valuations — that is, at lower price-to-earnings or price-to-EBITDA multiples — to attract institutional demand. The equity premium is the amount of return above long-term U.S. Treasury bonds that investors generally seek to be paid to take on extra risk. U.S. government bonds are judged to be an ultra-safe investment.
The yield on the benchmark U.S. Treasury 10-year note traded at 3.12% late Thursday.
Quarterly Earnings Reports Vs. Semiannual
At least one study has found that semiannual reporting failed to boost capital investment that targets long-term returns.
The CFA Institute Research Foundation commissioned a study, “Financial Reporting Frequency, Information Asymmetry, and the Cost of Equity,” to test the theory.
In the United Kingdom, securities regulators changed reporting requirements for public companies twice in the past decade. When U.K. regulators switched to a quarterly reporting rule in 2007, researchers Renhui Fu, Arthur Kraft and Huai Zhang found that the change did not reduce R&D spending over the next three to six years. That might have been the expectation of those who feared long-term thinking and investment would suffer.
When the rule reverted back to semiannual reporting, did business investment rise materially? Researchers found no such evidence.
Trump is not the first president to criticize quarterly earnings reports.
In 2015, the New York Review of Books’ website quoted former President Barack Obama as saying, “If they’re paying their employees more now because they think it’s going to help them retain high-quality employees, a lot of times they feel like they’re going to get punished in the stock market. And so they don’t do it, because the definition of being a successful business is narrowed to what your quarterly earnings reports are.”
The Shrinkage In U.S. Stocks
Some professionals openly wonder if reducing the reporting burden would encourage entrepreneurs to turn their private businesses into public ones.
“It would be interesting to see how companies that are privately held would possibly become public as a result of potential new legislation,” George Mateyo, chief investment officer at Key Private Bank in Cleveland, told IBD.
Good point. Consider the Wilshire 5000 index. Today, it doesn’t house 5,000 companies. It’s shrunk to a gauge of 3,618 publicly traded stocks as of the end of 2016. More than 20 years ago, it boasted 8,000 firms. Of course, mergers and acquisitions, bankruptcies and other factors have likely contributed to the long-term drop.
Limiting earnings reports to twice a year would force analysts on the buy side and the sell side to work even harder to find investing insights.
“If this idea were to become law, the need to have an analytical edge would become more magnified,” Mateyo said.
How, then, could Wall Street and the government promote more long-range thinking? Here are three ways.
Idea No. 1: Stock Incentives
One alternative is to change the stock option-based compensation of the C-suite.
Many companies hand their CEOs and CFOs options and restricted stocks that they can sell within one year.
Maltbie, who also runs the hedge fund Millennium Asset Management, suggests requiring options to vest after three or five years.
Idea No. 2: Timing Of 10-Q Filings
A second way involves the timeliness of SEC filings. While a few companies issue their 10-Q quarterly SEC filing on the same day as the news release on their quarterly earnings reports, most file as much as two weeks later.
“The SEC should therefore try to integrate those press releases with its quarterly filing requirements. Most investors read these timely summaries and trade in reaction to them, rather than the quarterly tomes later filed with the SEC,” Robert Pozen, former chair at mutual fund giant MFS Investment Management and now a senior lecturer at MIT’s Sloan business school, and Harvard Law Professor Mark Roe wrote on CFO.com. “The appropriate direction is to coordinate the earnings releases with the 10-Qs to cover, in a timely manner, the important information for investors without undue repetition.”
“Company executives who articulate a persuasive, multiyear business plan should not worry too much about quarterly reporting,” they add. “And if they are worried, moving to six-month reports will not help them.”
Idea No. 3: Leave The Market Alone
A third option is to make no change in the requirement that companies file quarterly earnings reports. The stock market remains chock-full of superb, game-changing growth companies. And they seem not burdened at all by the 90-day reporting rule. Square (SQ) went public in November 2015. The transactions innovator seems to announce some new product or service every quarterly conference call.
Square’s revenue rose from $ 203 million in 2012 to $ 2.21 billion in 2017. The Street sees earnings rising 67% to 45 cents a share this year and, in 2019, 73% to 78 cents.
Until its latest correction, Square shares had vaulted 1,023% since its November 2015 IPO at $ 9 a share.
Paycom Software (PAYC), Adobe Systems (ADBE) and Five Below (FIVE) join scores of small-, mid- and large-cap stocks that have smashed the returns of many blue-chip names. Throughout the past year or two, Square and fellow leading companies have routinely ranked in the IBD 50, Big Cap 20, and Sector Leaders. For growth-stock hunters, these are three of IBD’s best lists of the best stocks to buy and watch.
“In the end, all companies have to balance short-term and long-term performance,” PepsiCo’s Nooyi was quoted by CNN.com as saying.
Please follow David Saito-Chung on Twitter at @IBD_Chung for more on growth companies, chart analysis, breakouts, sell signals and financial markets.
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