The Long View

Warren Buffett may be the most celebrated stock picker of our time, but many investors ignore his advice. Instead of taking long-term positions in undervalued businesses, they fixate on short-term performance and clobber companies that miss quarterly earnings forecasts. That goes double for the aggressive hedge funds.

Corporate managers have long complained about the pressure to focus on the short term, but now, for the first time, critics and business groups are racing to their defense. The U.S. Chamber of Commerce recently called short-termism one of the biggest threats to America's competitiveness. "This focus on the short term is a huge problem," agrees William Donaldson, former chairman of the Securities and Exchange Commission. "With all the attention paid to quarterly performance, managers are taking their eyes off of long-term strategic goals."

The cure for the myopia? Stop giving quarterly earnings guidance, says Donaldson, the Chamber of Commerce, and others. "In the life of any public company, no three-month period is ever going to be that important," says David Chavern, the chamber's senior vice president and chief operating officer. The Conference Board has also called on companies to abandon quarterly guidance. And in March, the CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics proposed a standard template for quarterly earnings reports that would, in their view, obviate the need for earnings guidance.

Not everyone agrees that the focus on the quarter is such a big problem. Indeed, some observers reject the diagnosis altogether. "It's not a problem at all," declares Baruch Lev, a finance professor at New York University's Stern School of Business. Lev, along with University of Florida professors Joel Houston and Jennifer Tucker, recently published the results of a study showing that companies that ended quarterly guidance reaped almost no benefit from doing so.

Meanwhile, many companies are hesitant to give up issuing quarterly guidance. Some take advantage of the practice, using it to lowball earnings expectations. Most insist that guidance attracts analyst coverage and prevents nasty surprises during earnings releases. Small companies in particular find it valuable.

"At some companies that don't have an analyst following, the only way to let investors know what is going on [in between earnings releases] is to provide some earnings guidance," says Lou Thompson, former president of the National Investor Relations Institute (NIRI) and now a partner at Denver-based investor-relations consultancy Genesis Inc.

As the debate over guidance heats up, companies have already begun to change the way they communicate with shareholders. Some have abandoned quarterly guidance in favor of annual projections, or none at all. Others are seeking new ways to draw investors' attention to longer-term strategy and value creation, stressing longer-term goals and nonfinancial measures, and laying out three-to-five-year strategic plans.

Trouble in Toy Land
One of the first companies to stop issuing earnings guidance was Gillette, in 2001. The decision was urged by board member Warren Buffett, whose own Berkshire Hathaway Inc. had never practiced the quarterly ritual. Gillette's move came after the razor company missed its own earnings targets seven times in a year and a half — and took a hit to its stock price each time. The next year, Coca-Cola (where Buffett also sat on the board) and Intel also abandoned quarterly guidance, as did McDonald's in 2003.

It became a trend. By 2005 just 61 percent of companies were offering quarterly projections to the public, according to a NIRI study that year, and the number declined to 52 percent in 2006. Instead, companies have moved to annual guidance — 82 percent at recent count. Thompson says that few companies now give single-number guidance and that the performance ranges continue to widen.

A poster child for the problem with short-term focus could be toy maker Mattel Inc., which decided to discontinue earnings guidance in 2002 after a series of missteps. Indeed, CFO Kevin Farr says that short-term thinking was the primary factor behind the company's troubles. "We got on that treadmill where we set [near-term] performance goals that were very unrealistic, and [we] started doing things that didn't make sense," says Farr.

In 1999, Mattel acquired The Learning Co., a manufacturer of computer games and software located in Cambridge, Massachusetts, 3,000 miles from Mattel's El Segundo, California, headquarters. "It was a bad acquisition outside our core competency," says Farr. He says that quarterly guidance and the short-term focus that resulted were big factors in the company's disastrous move. Mattel sold The Learning Co. the very next year to turnaround firm Gores Technology Group for a share of its future earnings. Mattel posted a loss in 2000 of $431 million, mostly because of the acquisition, and eventually paid $122 million to settle shareholder lawsuits related to overly rosy projections of previous years. By 2000, Mattel's stock had declined to $10 (from a high of $45 in 1998), and CEO Jill Barad was forced to resign.

In 2002 Mattel swore off quarterly earnings guidance, says Farr, as a new management team worked to instill a long-term focus. The company now gives guidance only on a three-to-five-year outlook on a range of financial and nonfinancial goals.

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