What Company Earnings Calls Should Be About (But Are Not)

Most of the discussion on quarterly calls is of little use to long-term investors...

Over 50% of the discussion during a typical earnings call with management is focused on short-term demand trends that will have little to no impact on the long-term value of the business. This is not helpful to long-term shareholders.

“How did the business trend intra-quarter?”

“Was the first month of the new quarter better than the last month?”

“Are you seeing any green shoots in demand?”

And so on. Thus “investors” spend about an hour of the CEO’s and CFO’s time four times a year. Except they aren’t really investors, are they?

No, they aren’t. They are folks who are trying to guess how other traders will react to new information.

Why? They are trying to predict the short-term price movements of the stock. To that end, they aren’t searching for the answer to the question of “what is this business worth?” Rather, they just want to know the answer to “what happens next?” so that they can out-guess other short-term market participants about how the share price will react.

I often find myself waiting for the CEO to say something to the effect of “we are just not going to indulge short-term speculators, but rather focus our comments on information useful to long-term investors.” Yet exceptionally few do.

Perhaps they don’t want to offend. Or they don’t want to take a chance and negatively impact some sell-side analyst’s stock rating. Maybe they are into the managing expectations game to try to massage their stock price with their quarterly commentary. Who knows.

What we do know is that these types of questions have three negative effects:

1. They disproportionately focus management on short-term results.

2. They risk changing how they manage the business to prioritize short-term outcomes to the detriment of long-term results.

3. They squeeze out time for questions that are relevant to long-term investors.

If you owned a private business, would you spend a lot of time grilling your CEO on monthly demand trends? Or would you focus on items relevant to the value of your investment? What would long-term investors want to know from a quarterly earnings call?

A good test is to ask yourself: “Would the answer to this question affect the business 3 years from now?” Usually, questions failing that test aren’t that relevant for investors.

The exception might be if some danger lurking along the way might prevent the achievement of long-term objectives. An example might be if a company’s balance sheet might not withstand a temporary severe decline in demand. Then even a long-term investor would care about the short-term trends. However, that’s the exception that proves the rule – most of the time when you look back in 3 years, would you really care that much about how January trended vs. December a few years ago?

Here are some questions that investors want to pay attention to each quarter. These are also the ones that good CEOs with a long-term mindset should want to address before they are even asked:

How is the competitive environment changing?

For most businesses there won’t be much of a change, if any, most of the time. However, if there is a change this is something that’s important to know, as it could substantially change the long-term economics of the business, and consequently its value. If the management doesn’t mention anything about this, investors should ask.

What did the company do since the last earnings call to improve its competitive advantage?

In many cases this just means continuing with activities that the company does on a regular basis. This might mean excellent customer service, innovative R&D, and so forth. It would be good to get a better understanding of how the management is thinking about this, and most importantly to get evidence that management is thinking about improving its competitive advantage.

What did management learn since the last call that might affect the long-term economics of the company?

This is a catch-all for everything and anything that might change the long-term cash flow stream of the business. That is what investors should care about learning during an earnings call, not how demand wiggled on a weekly basis.

What is not going according to plan, why, and what is management doing about it?

Warren Buffett put it well: "Almost every business has problems, and we would just as soon the managers tell us about it. A lot of companies have IR people and they are dying to just pump out good news all the time."

If you are an investor and you don’t hear managers periodically discussing business challenges and how they are addressing them, be wary. The challenges are still there, you are just dealing with a CEO who is less than fully honest with the shareholders.

If you are a CEO, and are afraid to highlight business problems, don’t be. Doing so isn’t a sign of weakness, it’s a sign that you are on top of the business and are treating your shareholders with the candor that they deserve.

How is shareholders' capital being allocated and why?

Companies should have a well-thought-out capital allocation framework. During the earnings call it would be useful to hear how it’s being applied in practice. Generic platitudes don’t do much for increasing value – concrete actions do. A good sign is when management is very intentional about comparing the potential returns on capital from different alternatives. A bad sign is some generic corporat-ese about “buying back shares to offset stock option dilution.”

As an investor, you should enter the earnings call with a thesis about the long-term drivers of the company’s value. Your goal should be to search for evidence that challenges those assumptions in either direction. As the CEO, your goal should be to communicate clearly what’s happening to the business and your team’s actions that a long-term private owner would want to know. Your communication helps you select the shareholders who will choose to invest in your company – don’t miss this opportunity simply because you are uncomfortable behaving differently from most of your peers.

If you liked this article, please “like” and share this article. If you are interested in learning more about the investment process at Silver Ring Value Partners, you can request an Owner’s Manual here.

About the author

Gary Mishuris, CFA is the Managing Partner and Chief Investment Officer of Silver Ring Value Partners, an investment firm that seeks to apply its intrinsic value approach to safely compound capital over the long-term. He also teaches the Value Investing Seminar at the F.W. Olin Graduate School of Business.