Tag Archives: clinton

How Regulation Promotes Short-Termism

Every so often some prominent individual in the investment community reaches the erroneous conclusion that earnings guidance is the root of all evil. The latest to promote this idea is Larry Fink, CEO of BlackRock (NYSE: BLK ). BlackRock, which has $4.6 trillion in assets under management, claims to be the world’s largest investment firm. Fink has held the top post ever since he co-founded the company in 1988. He is rumored to be at the top of Hillary Clinton’s list of candidates for Treasury Secretary, should she win the presidential election. Fink might even be petitioning for the job. CNN Money recently pointed out that he is beginning to sound a lot like Clinton herself, even to the point of using the same terminology. Both of them are on the warpath against what they call “short-termism” in corporate America. Fink penned a letter on February 1 to the CEOs of major corporations and used that term in the very first sentence, calling it a powerful force that is afflicting corporate behavior. Frankly, I can’t argue with much of what he says. I agree with him that there is too much attention paid to how a company performs over the short term and not enough paid to how it does over the long term. I consider myself a long-term investor, and I much prefer to see the companies I invest in managed with a long-term perspective in mind. For example, management can easily boost earnings in any particular quarter simply by slashing capital expenditures or by cutting spending on research and development. Yet doing so comes at the cost of long-term growth. I take exception, however, to Fink’s call to CEOs urging them to put an end to quarterly earnings guidance. This is not a new position for me. Because I feel so strongly about this issue, I devoted an entire chapter to it in my 2008 book, “Even Buffett Isn’t Perfect.” I favor guidance for a number of reasons. First, it comes straight from the horse’s mouth. Guidance is provided by the very people who are running the company. These people know better than anyone how the company is likely to do. I want to hear from them in as specific terms as possible. I don’t take what they say at face value. But I do want to hear what they have to say – then it’s up to me to judge what to make of that information. Second, studies show that analysts’ earnings forecasts are not particularly reliable to begin with… and it turns out they are even less accurate when guidance is not provided. Third, although some investors believe that executives are more likely to take actions that will increase company value over the long term if they don’t have to deal with the pressure of living up to quarterly guidance, studies on the topic uncover no evidence that companies increase capital expenditures or investments in research and development after they eliminate guidance. Fourth, studies also show that there is a negative stock price reaction when companies announce that they will no longer provide guidance. Interestingly, although management usually says they are eliminating guidance because they believe it is in the best interest of investors, it turns out they usually eliminate guidance when the company is having financial difficulties. What’s even more interesting is that these very companies often change their minds and begin providing guidance again when business conditions improve. There is one critical issue I wish everybody would understand. While it’s true that there is too much focus on short-term results, this isn’t the result of guidance. The reason investors pay so much attention to quarterly earnings in the first place is that the SEC requires corporations to report their financial results every quarter. That’s right. Short-termism is a direct result of regulation. So if you really believe that short-termism is a problem, instead of urging CEOs to stop providing guidance, it would be more effective if you urged the SEC to end the quarterly reporting requirement. To be clear, Larry Fink is not in favor of that. Neither am I. Perhaps this is the greatest irony of all. Our country recently went through a financial crisis that was in part caused by a lack of transparency. In response, regulators implemented all kinds of new rules specifically designed to increase transparency. Eliminating guidance, however, does exactly the opposite. It reduces transparency. To say that we’d be better off with less guidance is the equivalent of saying that we’d be better off with less information. That’s simply nonsense. As I said earlier, research studies show that there is a statistically significant loss in share value when companies eliminate guidance. These studies also show that companies that eliminate guidance continue to underperform for as long as a year. So if you own shares in a company that has regularly provided guidance and then stops doing so, you might want to think about getting out of that investment. On the other hand, if you are invested in a company that has never provided guidance, you need not worry. Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ) and Alphabet (NASDAQ: GOOG ) (NASDAQ: GOOGL ) are two companies that have performed well over the long term. Neither one has ever provided guidance.

Valuation Dashboard: Healthcare – November 2015

Summary 4 key factors are reported across industries in the Healthcare sector. They give a valuation status of industries relative to their history. They give a reference for picking stocks in each industry. This article is part of a series giving a valuation dashboard by sector of companies in the S&P 500 index (NYSEARCA: SPY ). I follow up a certain number of fundamental factors for every sector, and compare them to historical averages. This article is going down at industry level in the GICS classification. It covers Healthcare. The choice of the fundamental ratios has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. A link to a list of individual stocks to consider is provided at the end. Methodology Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). They are compared with their own historical averages “Avg”. The difference is measured in percentage for valuation ratios and in absolute for ROE, and named “D-xxx” if xxx is the factor’s name (for example D-P/E for price/earnings). The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and size biases, which is necessary when going out of a large cap universe. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors. Industry valuation table on 11/2/2015 The next table reports the 4 industry factors. For each factor, the next “Avg” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference as explained above. So there are 3 columns for each ratio. P/E Avg D- P/E P/S Avg D- P/S P/FCF Avg D- P/FCF ROE Avg D-ROE HC Equipment&Supplies 34.5 27.18 -26.93% 4.12 3.18 -29.56% 45.64 30.51 -49.59% -20.09 -12.14 -7.95 HC Providers&Services 28.81 20.88 -37.98% 1.09 0.85 -28.24% 22.4 17.75 -26.20% 7.46 5.78 1.68 HC Technology* 56.41 56.13 -0.50% 4.11 3.39 -21.24% 32.35 35.77 9.56% -15.66 -6.2 -9.46 Biotechnology 47.8 39.78 -20.16% 50.92 29.01 -75.53% 41.33 43.74 5.51% -62.42 -64.42 2 Pharmaceuticals 32.96 26.26 -25.51% 12.28 8.25 -48.85% 29.82 32.55 8.39% -38.03 -30.3 -7.73 Life Sci. Tools&Services* 31.78 29.52 -7.66% 2.89 3.39 14.75% 32.39 27.28 -18.73% -8.87 -18.37 9.5 * Averages since 2006 Valuation The following charts give an idea of the current status of industries relative to their historical average. In all cases, the higher the better. Price/Earnings: Price/Sales: Price/Free Cash Flow: Quality Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF (NYSEARCA: XLV ) with SPY (chart from freestockcharts.com). It also includes the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) and the SPDR S&P Pharmaceuticals ETF (NYSEARCA: XPH ) as industry benchmarks. (click to enlarge) Conclusion The broad Healthcare ETF has almost the same return as SPY in the last 6 months, with large discrepancies between industries. The biotechnology index has underperformed by about 4%, the pharmaceutical index by about 14%. Two series of news have hit the latter: political announcements on overpriced legacy drugs initiated by Mrs Clinton, then suspicions of unduly inflated sales involving specialty pharmacies. Valeant Pharmaceuticals Intl (NYSE: VRX ) is at the core of both cases, but the market has punished most names linked to generic drugs and specialty pharmaceutical products. As it includes hedge fund darlings, an ETF replicating famous managers’ holdings has also suffered from this: the AlphaClone Alternative Alpha ETF ( ALFA). Taking into account valuation charts above, all healthcare industries look overpriced. There is no contradiction with the positive value score reported for Healthcare in my latest S&P 500 sector dashboard . Here, mid and small caps have been added in calculations. It is a clue of a significant discrepancy between market cap segments inside the sector. The most influential valuation factor from a statistical point of view is P/FCF, and it is more optimistic than other ratios. It points out to a slight under-pricing in 3 industries: Healthcare Technology, Biotechnology and Pharmaceuticals. However, there may be quality stocks at a reasonable price in any industry. To check them out, you can compare individual fundamental factors to the industry factors provided in the table. As an example, a list of stocks in Healthcare beating their industry factors is provided on this page . If you want to stay informed of my updates, click the “Follow” tab at the top of this article. You can choose the “real-time” option if you want to be instantly notified.