Is short-termism the scourge of capitalism? If you asked 100 people I suspect you’d get 95 yeses. But I’m a skeptic of that view, and Amazon’s earnings report on Thursday reinforces, surprisingly, the case that just maybe the stock market is not irrationally short-term oriented. Getting this question right is vital for business leaders because it deeply influences the way they lead and whether they succeed.
There’s no disputing that many business leaders do manage for short-term results. In one study, 26% of CFOs said they’d make a moderate or large economic sacrifice—for example, cutting R&D or marketing below optimal levels—to meet Wall Street’s quarterly earnings expectations. Other types of research support the general point. Those managers believe they must manage each quarter’s results because Wall Street will punish them if they don’t. Are they right?
Amazon is the most famous counter-example. CEO Jeff Bezos keeps reporting little or no profit, yet investors keep bidding up the stock. On Thursday, the company broke the pattern, reporting a substantial profit, and the stock jumped. So doesn’t this show that investors are indeed obsessed with quarterly numbers?
No. Investors care only about the future, not the past, and they apparently saw yesterday’s report as reassuring evidence that Amazon can indeed report big numbers if it wants to. The company, in fact, forecast that this quarter’s operating profit could be 80% less than last quarter’s, which didn’t discourage investors. The larger point, supported by research, is that investors look beneath the surface of quarterly numbers. If profits were low, is it because the company is spending for future growth, or is its business weak? When investors flee on news of a small earnings miss, they may be acting on sound long-term fears.
Amazon reveals another overlooked reality that many leaders need to understand: The earnings that companies report every quarter only occasionally coincide with the measures that actually drive stock prices. The most important such measure is economic profit, which is after-tax operating profit minus a full capital charge. That’s not a GAAP measure, so most companies don’t report it, but investors can calculate it, or they can turn to the EVA Dimensions consulting firm, which calculates it for thousands of companies, and whose numbers are studied by many Wall Street analysts. Research shows that stock prices follow economic profit much more closely than they follow reported earnings.
Take a look at economic profit, and the supposed mystery of Amazon’s spectacular stock performance disappears. Reported earnings may have looked puny over the years, but the company’s economic profit has marched strongly upward, with nary a stumble, since 1999, mirroring closely the stock’s rise. Bezos has thus established credibility with investors, who believe he’ll keep managing for the measure that counts, and they price the stock accordingly.
Rampant short-termism isn’t a curse. It’s a self-imposed penalty that hobbles many business leaders. They can escape it if they want. Bucking conventional wisdom takes courage, but it’s what the most successful leaders always do.