Investing Myopia

NOTE: I’m not an investment advisor, I am neither trained, licensed, nor bonded, and this is not specific investment advice, simply some observations after, oh, 30 years of investing in individual stocks. Think about how much you’re paying to read this and respect it accordingly. -Hue

If you’re new to investing in publicly traded companies, there can be a lot of baffling choices to make: go with mutual funds? Play the stocks like horses, resulting in many trades? Learn all about technical trading, wherein a stock’s past pricing patterns guide the decisions of the investor?

If you’re not going into technical trading, there come questions of interpreting a company’s financial results, operations, and market, and here it’s important to not let yourself be led around by the nose. Much is made about companies making their quarterly numbers, which usually means a bunch of business analysts make public their expectations, someone else averages them, and that’s the “market’s expectation.” But what do they know? They’re not sitting in on company strategy meetings, or anything else – they operate on the same information which is available to you. They are paid to take the time to read it and evaluate it, which you may not be able to do so.

And while companies are required to make public their quarterly results, they’re not required to make public their own expectations, although if they do so they’d better be honest about them, or a trigger-happy lawyer is likely to open up the next class-action lawsuit on them.

Worse yet, quarterly results are the hurdle most investors watch closely, even the mutual managers. If a “stumble” occurs and a company doesn’t make its numbers, what happens? The stock price tumbles and you’re a “victim.” You didn’t see it coming and you “lost” money.

But if you’re a properly skeptical & mature investor, your hackles should be rising at my repeated use of the word quarterly. Why should this be an important word to you? If you’re an owner of the company, rather than a trader of bits of paper, then the answer is that it’s not a primary information for you. If you find this a little puzzling, let me direct you to this article by Roger Lowenstein in WaPo, where he tells a small but pivotal part of the baffling story of struggling industrial giant General Electric:

The 126-year-old General Electric was once a company your grandparents knew; it made lightbulbs, consumer appliances and plastics.

In the 1980s and ’90s, a CEO named Jack Welch expanded into broadcast, defense electronics and financial services. Welch was fawned over by security analysts for seemingly making his numbers every quarter. He was lauded for managing earnings, a euphemism for gaming the numbers so he could hit performance targets.

Welch retired wealthy. But it turned out that pursuing a series of short-term managerial goals was not a ticket to enduring prosperity for GE. In finance in particular, quarterly results bore little relation to the long tails of liability or to the intrinsic value of the underlying assets.

Welch’s successor, Jeffrey R. Immelt, was left to clean up the mess. Immelt frenetically traded businesses, doubling down on fossil fuels, selling NBC, buying and later selling water filtration, getting into a predictive (and risky) health-care venture, and dumping most of GE’s assets in finance.

The old businesses were always one that didn’t fit. The new ones all had great potential and fit some strategic plan. Along the way, GE promised that Immelt would be paid only for performance — as shareholders prospered, too.

What GE really did was reward Immelt for a series of near-term goals without respect to whether GE’s value increased in the long run. Which it didn’t.

A year ago, Immelt was retired ahead of schedule. During his 16 years, GE shares (including dividends) returned a pitiable 1 percent annually, while the Standard & Poor’s 500-stock index rose 7 percent a year.

While compiling that abysmal record, Immelt collected hundreds of millions of dollars — $91 million in 2014-2016 alone. He exited with deferred shares and benefits worth an estimated $100 million, to help with the rent I guess.

It’s a good article for the new investor who distrusts mutual funds and technical trading, and therefore is faced with the substantial task of evaluating companies, because it’s contrarian – it always sounds good when a board says their new CEO will have his pay tied to meeting performance goals, but out in the real world this phrase is often code for Hit those short-term goals and don’t worry about long-term goals, we’re all here for the quick buck.

It is, in fact, another form of the infamous Pump ‘n dump stock trading scheme in which a company with little to no prospects is talked up by “analysts” who often have little or no training or experience, but merely sell their names and media mechanisms to the company that wants to be pumped. Via these analysts, the company acquires a reputation for having the Next Big Thing, the stock price zooms, and the pumpers who bought the stock before the pumping began sell out at the zenith, leaving the suckers naive investors holding worthless bits of paper. In this form, the companies are not worthless, but the long-term viability of the companies are jeopardized by executives whose pay is tied to short-term goals, rather than long-term goals.

For the short-term investor, who plans to hold stocks for no more than a few months to a year, this may not actually be a problem if they can find a way to recognize these companies before they experience their short-term jump in price. Get in at the right time, catch the pop, sell out. It’s investment fast food, not as awful as the speed traders who are busy raping each other by measuring their trading speed in microseconds (let’s call that sugar is my primary nutrient trading), but still short term investors are not a particularly healthy ownership model.

But the long-term investor, who hopes to find companies such as Berkshire-Hathaway or Amazon and hold on to them for twenty or thirty years, this is the central problem they have to solve. Are the senior leaders appropriately incentivized? This is probably the primary reason Motley Fool founders Tom & David Gardner tend to put a lot of faith in those companies in which the founders are still heavily involved in the leadership roles and have a substantial ownership stake. While there’s definitely a financial incentive, to my mind there’s going to be a reputational incentive as well, which is to say, I created this, I want it to succeed! Whether it’s a startup trying to build an AI to solve a difficult problem, or a janitorial services corporation, company founders more often than not regard their companies as their babies and want to see them succeed in the long-term. While there are no guarantees, at least their motivations are congruent with the long-term investors’ goals.

Quarterly results are of interest to the long-term investor who wishes to own more stock of some company, but feels the company is currently over-priced. A poor quarter, the naive short-termers and speed traders get out, the price drops 5-10%, and now maybe the long term investor has an opportunity to pick up some cheap stock in a favored company.

But using quarterly results to evaluate the long-term potential of a company is a tricky business, because the focus is often purely on profit & loss, and less on market penetration, the societal good the company’s product might engender, or whatever else is considered important by the investor. Those evaluations often come from somewhere else than quarterly results.

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About Hue White

Former BBS operator; software engineer; cat lackey.

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