Last week I met the manager of a global fund who made a very interesting comment about the companies he meets in Japan. He said his most rewarding conversations are the ones about industry rather than quarterly earnings.

Japanese directors, in his view, are more likely to engage in a lively discussion when talking about their sector and its opportunities rather than dissecting numbers for a short trading period.

It’s an interesting point. Corporates should have a view on how their business fits in the marketplace and how they will grow it. The eye should be on the longer term prize and not three months’ worth of trading.

TOO MANY INVESTORS ARE IMPATIENT

Many investors are making knee-jerk reactions to quarterly trading updates. They can also be impatient, demanding almost instantaneous gain or they walk away, rather than waiting for value to be created or realised in the share price.

So has this driven a culture of short-termism among corporates as well? Harvard Business Review made a very good point in an article last year saying that too many companies prioritise quarterly earnings over long-term innovation, human capital investment and brand development.

‘The popular argument goes as follows: Short-term investors – those who hold onto a stock for less than, say, a year – aren’t interested in the company’s prospects beyond that year,’ it wrote. ‘So, if the company misses its quarterly earnings target, they sell their shares.

‘The fear of such selling forces the firm to fixate on meeting the target, cutting investment to do so. Moreover, since shareholders can sell at the drop of a hat, the firm has no stable source of long-term capital, and so cannot make long-term plans.’

Companies may be better off trying to focus on the long-term picture in order to attract long-term shareholders. And investors shouldn’t judge a company on a three month trading period – but they should rightfully scrutinise a company if a 12 month period disappoints.

Consultant McKinsey last year wrote that companies should make more effort to attract and retain longer-term shareholders to ‘blunt the effects of short-termism and best support a strategy of long-term value creation’.

Ways in which to achieve this goal include pursuing long-term value creation even at the expense of short-term earnings, proactively structuring investor communications, resisting artificial efforts to meet earnings targets, and rethinking management’s approach to quarterly earnings calls.

BEING PUNISHED BY SHORT-TERM ACTIONS

A point related to short-termism was raised last month by Fundsmith Equity (GB00B41YBW71) fund manager Terry Smith in his annual investor letter.

He criticised activist investors, saying too often they follow a playbook that involves buying a stake in a business, engaging in a public row, pushing for a spin-off, merger or sale of assets and then, if the demands are met, selling their stake.

‘We and other long term shareholders are left with a company that has incurred fees and diverted time from running the business to respond to the activist and execute the changes, which is now potentially more fragmented, more highly leveraged and has had to install new management,’ comments Smith.

In effect, Smith implies the activist has enjoyed a short-term gain yet the longer-term shareholders have potentially been left with an                        inferior business. (DC)
DISCLAIMER: The author has a personal investment in Fundsmith Equity

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