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.
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What We’re Reading Today
Paul Ryan runs for Speaker, finally
The Wisconsin Representative will run to replace John Boehner as Speaker of the House after shunning pleas from colleagues that he was the only person who could unite Republicans after Boehner’s resignation. But with promises of support from GOP House factions, including the highly conservative Freedom Caucus, he wrote colleagues that he’s “ready and eager” to take the role. Republicans are expected to vote on Ryan’s bid next Wednesday, followed by a House floor vote Thursday. NYT
Tesla plans China production in two years
In a blog post on the company’s website, Tesla founder Elon Musk outlined his vision to produce cars in China by 2017. Tesla will work with a local partner, which will also reduce the vehicle’s price in the country. Tesla has struggled to make inroads in China. Yahoo Finance
Hillary’s presidential run survives Benghazi hearing
After 11 hours of testimony, Benghazi committee chairman Trey Gowdy admitted he didn’t think much came to light during Hillary Clinton‘s testimony about what happened in Libya in 2012 when four Americans were killed. The committee mostly ignored Clinton’s use of a personal email server while Secretary of State. And unlike the last time she testified about Benghazi, Clinton remained poised. But it’s clear Republicans will continue to use the issue against her through next year’s election. Politico
U.S.-Israel ties strained during Iran negotiations
As the Obama administration worked to secure a secret Iran nuclear deal in 2012, it began to use spies in Israel to learn whether the country planned to attack Iran’s nuclear facilities. Israeli Prime Minister Benjamin Netanyahu then deployed spies to learn about the secret deal. The mutual distrust has frayed relations between Netanyahu and President Barack Obama. WSJ
Building a Better Leader
Companies value creativity…
…but they don’t do a good job of encouraging it. Harvard Business Review
Your business model is about to change
And in a friction-free economy, it will be built on speed. Fortune
Getting a promotion while working remotely…
…involves selling yourself every day. Glassdoor
Valeant accused of shady pharmaceutical practices
The company that came under fire for buying old drugs and jacking up their prices is now accused of inflating reported sales. Citron Research’s Andy Left says Valeant owns a pharmacy company called Philidor, which runs a number of other pharmacies. He alleges that Valeant under CEO J. Michael Pearson ships its drugs to these pharmacies, inflating sales. Valeant denies the accusation. Fortune
The Vatican, media debate the Pope’s health
An Italian newspaper claims that Pope Francis is being treated for a tiny, curable brain tumor. The report is thinly sourced and the Vatican denies it. But it raises the question of whether the Pope’s critics in the Vatican have potentially trumped up health issues to seed doubt while the church meets to discuss homosexuality and divorce. NYT
Ben Carson jumps past Trump in latest Iowa poll
The quieter option of the two alternative GOP candidates has gained a large lead over the vociferous Trump in Iowa, with 28% of likely caucus goers picking Carson as their choice for the Republican nominee. Trump ranked second with 19%. Carly Fiorina continues to slide, with only 4% support, placing her seventh. USA Today
Up or Out
Raf Simons has stepped down as creative director of Christian Dior to start his own label. Financial Times
Walter Gerken, a cofounder of the investment firm Pimco, has died at age 93. NYT
Fortune Reads and Videos
Jack Dorsey gives $200 million in Twitter stock…
…back to employees. It’s about one third of his stake. Fortune
Obesity is rising in Silicon Valley
Apparently, stress and long hours aren’t good for your health. Fortune
The Jordan brand gets its own store
Nike will open it in Chicago, dedicated solely to His Airness’s line. Fortune
Microsoft may have found its growth engine
And investors are liking CEO Satya Nadella‘s efforts in the cloud. Fortune
On this day…
…in 1973, President Richard Nixon agreed to give investigators subpoenaed tapes in which he discussed the Watergate scandal. National Archives
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|Produced by Ryan Derousseau|