Warren Buffett and Jamie Dimon want companies and investors to embrace a new idea of value. Here’s where to begin
The evidence — supported by icons of American capitalism including Warren Buffett, whose company Berkshire Hathaway has never offered earnings guidance and is up more than 1,000,000% on a book-value basis since 1964 — suggests that a long-term focus pays off. Long-term companies tend to outperform short-term companies, and long-term investors tend to outperform their short-term peers.
A 2017 McKinsey & Co. study estimates that had all U.S. publicly listed firms operated like their long-term counterparts, the U.S. economy would have added more than 5 million additional jobs and generated an additional $1 trillion in GDP from 2001 to 2015, gains that would have benefited the U.S. economy and Americans broadly. The numbers are overwhelming, so why aren’t more companies operating this way?
One impediment to long-term thinking is the pull of near-term goals and short-term pressures. To be sure, no company can thrive in five years without surviving for five months, but sometimes this comes at the expense of long-term value creation. Investments in innovation or talent or capital projects that have the potential to reap benefits for years into the future are often discounted and take a backseat to the immediate concerns of Wall Street.
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Buffett and J.P. Morgan chairman and CEO Jamie Dimon penned a clear-eyed attack on quarterly guidance and the resultant short-term mindset last year. This summer the Business Roundtable redefined the purpose of a corporation to explicitly include delivering value for all of its stakeholders: customers, employees, suppliers, communities and shareholders. In a “Statement of the Purpose of a Corporation,” 181 CEOs of U.S. corporations affirmed that companies generate long-term value for shareholders by serving their corporate purposes, inclusive of a broader group of stakeholders.
Now that the corporate community is focused on this issue, the task is to address the many real obstacles to building long-term value. Here are three concrete steps companies can take.
Eliminate quarterly EPS guidance
More than half of corporate executives (55%) would rather delay a net-positive-value project than miss quarterly earnings targets by a penny, according to a 2016 survey from FCLTGlobal. A simple way to alleviate this pressure is to stop issuing quarterly guidance for earnings-per-share.
Many companies that continue to issue this type of guidance do so under the influence of three misguided assumptions: that it improves valuation (it doesn’t); that it reduces volatility around earnings season (the opposite is true); and that it’s required by law or the market (it’s not).
Most investment decision-makers don’t find it useful — just 9% of global buy-side investors believe that earnings guidance on a less-than-annual basis is important. Releasing quarter-by-quarter estimates attracts the transient investors that companies might well avoid if they’re looking to cultivate long-term value.
Share the right metrics with investors
Over two-thirds of investors agree that communicating long-term plans builds trust, but just 8.7% of companies listed on MSCI ACWI index issued guidance for periods over a year.
Instead of making 90-day earnings predictions, a “long-term roadmap” focused on the fundamental elements of the business over the next three to five years provides investors with guidance they can use. This can include objectives such as market share goals or revenue targets as well as strategies to achieve those objectives like plans to launch new products or enter new markets.
Outlining a company’s competitive advantages and capital allocation priorities alongside long-term oriented key performance indicators (KPIs) can lead to frank discussions around the company’s broader purpose and provide accountability to its shareholders. The best corporate roadmaps include details relevant to all stakeholders, too — such as customer satisfaction, investment in talent, and environmental impact. This strategy has been employed recently by global companies such as BP, GlaxoSmithKline and Tata Motors.
Align board and management incentives with companies’ long-term interests
A common hurdle for public companies is misalignment between the goals of the company and the priorities of its senior leadership. Both executives and board directors can be tempted to steer companies to pursue projects that increase short-term return at the expense of long-term value creation. But significant stock ownership by directors provides greater incentive to focus on long-term strategic choices.
Evidence from the U.K. suggests that if a board collectively invests upward of $1.1 million in company shares over a five-year time frame, it improves the likelihood of strong outperformance in terms of return on invested capital in the years ahead.
Holding those shares over time is equally important, and that includes encouraging directors and executives to maintain their position even beyond their term of service. An extended holding period like this moves them closer to the experience of the company’s long-term investors, diminishing their attention to short-term changes in stock valuation and volatility.
Fostering long-term value in a multi-stakeholder context has always been the responsibility of a public company. These three tangible steps are a place to start for companies eager to reaffirm their commitment to long-term shareholders and stakeholders. The corporate community’s focus on this area is well placed. Now it’s time to act.
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