Short-termism is a wolf stalking the equity market
Pay packages that incentivised excessive risk-taking in the pursuit of short-term gains played a central role in the financial crisis. We cannot go down that road again
A share price is the net present value of all future income from that share. And it’s not the bosses who decide what that net present value is either, but the larger market in general. So, if sharebuyers (or sellers) think that management is fucking up the long term for the sake of quick profits today then the share price will fall. Equally, if they think that the management is forgoing short term profits in the expectation of massive future ones then the share price will rise.
That is, the market in general judges the value, not the management.
And we have an example too: Amazon. The company has never made de3cent profits, is currently making a loss, yet the market rates the stock highly. Because they can see that current profits are not being chased but the long term goal of value is.
If markets were short term then how the hell would Amazon have the share price it does?
I’m broadly in agreement with the rational market theory, if only because all the other theories I’ve come across are so much worse. However, it is said that the IQ of a crowd can be calculated by taking the IQ of the thickest member and dividing that by the number in the crowd. The market consists of an awfully big crowd. Amazon could just be the South Sea Bubble of our time.
“So, if sharebuyers (or sellers) think that management is fucking up the long term for the sake of quick profits today then the share price will fall.”
As a corollary to K. R. Lohse’s point above, the share price should fall. But will? That’s a bit of a leap, I think. It depends on how many are investing based on sound financials, and how many are investing because of a gut feeling that “this one’s gonna be the next $WHATEVER”.
Everybody knows markets aren’t THAT rational though. Anybody who has been in a room when accounts are being prepared know the pressure to recognise as much income as possible this year not next. As much as the market shouldn’t care about something as trivial as that, the fact is that the market will only perform a finite amount of work and that financial results weigh heavily on share price (especially to the extent that the analysis is performed by a computer).
The correct analysis of the Amazon stock price isn’t “this show all markets are rational”, it’s “you can still maintain your stock price if you can explain your financial results clearly, concisely and rationally, and you are a big enough fish that people will expend the time to digest that.”
That, and also that Amazon is overpriced. Not facebook or twitter overpriced, but overpriced.
Even if Tim is right, the nature of share option based pay can go wrong. Simplified example: current share price of a company is 100. Current CEO is retiring in three year, and has the option to buy shares in 3 year time for 100. CEO has two strategy options on the table:
Option A will increase the value to 120 over 3 years, with probability 100%.
Option B will increase the value to 150 in 3 year with probability 50%, and bankrupt the company with probability 50%.
“Rational” move for the CEO is option B – he’s likely to get paid more on average. “Rational” move for investors is Option A.
Broadly, rewarding people for the upside without penalising them for the downside is always going to encourage excessive risk.
Yes Amazon is still considered a growth stock. After stripping out stuff not easily delivered door to door (petrol, lumber, etc.) then Amazon’s retail share, even in its home market, is about 1%.
So plenty of potential. Maybe. Unless some other way of doing it turns up in the meanwhile. Example: click and collect seems a much more sensible way of getting your groceries than Ocado.
It’s a silly and rather boring argument in the end. Investors are savers, so more long term. Traders are seeking profit, so short term. Both are in the market. So what?
Yah, but since the share price is constantly changing it’s always wrong as that measure of current discounted value of future income etc. The price moves every second with supply and demand, not changing fundamental information about the company’s future performance.
Plus that future performance is little more than educated guesswork. If we knew what it would be we wouldn’t need a stock market.
Of course Amazon is overpriced, it’s basically a charity hoping that it can keep losing enough money for long enough to secure a lot of monopolies. But those will probably not last long once secured, other than proprietary formats like Kindle, which there really ought to be a law against.
@ MB
Anybody who has been in a room when accounts are being prepared know the pressure to recognise as much income as possible this year not next.
Not necessarily. If next year looks like it might be a tough one the pressure will be on holding as much over as possible. Similarly, if expectations for the current year have been beaten there may be pressure to put something away for later rather than take the glory now and get hammered next year for not repeating it.
The usual priority is to bring the results in line with whatever you’ve been forecasting. If you have long-term forecasts then you should be mindful of long-term results. Markets like stability, and if the accountants think that they are in years of plenty, and the fallow is sure to come, they will do whatever they can to smooth that out.
I was auditing during the pre-crisis boom, and would estimate that 75% of ‘discussions’ about profit manipulation concerned over-provisioning to depress results.