| ‘Earnings no longer enough’ |
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| Companies must release quantified, earnings predictive news |
Past and current earnings explain less and less of the variation in stock prices, said Eamonn Walsh, PwC Professor of Accounting at the Michael Smurfit Graduate School of Business of UCD, at the inaugural PwC lecture in February.
‘In 1958, 20 per cent of the variation in stock prices was explained by earnings. By 1999, this had fallen to 7 per cent’, he said. The difference was explained by the scope of stock market listings. Forty years ago, Walsh said, companies were listed in the steady earnings phase of their lives, whereas now, a lot more start-ups with negative or low earnings were listed, as were companies in decline with over-capacity. ‘Stock markets have changed fundamentally’, he told his audience of bankers, finance professionals and faculty at the Blackrock campus.
‘Earnings have ceased to be an unambiguous signal of value’, he said. ‘Alternative sources of information that complement earnings and remove that ambiguity are necessary’ to help markets assess prospective earnings and hence stock valuations.
Walsh then addressed the problems facing companies which believe their shares are under-valued. He asked his audience, somewhat mischievously, for a show of hands of those who believed their company shares were over-valued. No hands were raised. Most responded when asked if they thought their stock was under-valued.
Walsh cited ‘seven deadly sins, from the perspective of an analyst examining a company that she believes is correctly valued’ committed by companies believing their stock was actually undervalued:
• telling markets they were wrong
• engaging in once-off actions
• bluffs (such as MBO announcements that were not followed through)
• consuming more perks
• increasing executive compensation
• diversifying by acquisition; and
• delaying bad news.
Among the solutions were announcements of discrete events, such as restructuring, capital expenditure, new products, major new contracts and R&D spending. To be effective, these had to quantify the expected impact on earnings. All too often, press releases were sent out with no communication of earnings impact, and management left disappointed that the markets weren’t impressed.
‘Quantitative announcements of discrete events are a palliative. The cure involves the provision of information that complements earnings,’ Walsh added.
This was information which tapped into the drivers of future value for the business in the minds of analysts. The product pipeline and its earnings impact was critical. Walsh urged company managements not to release raw data but always to explain its earnings impact.
Questioned from the audience about scepticism on the Irish economy in the UK and undervaluation of Irish stocks, Walsh said that the worst thing to do would be to blame the analysts or the market. His approach would suggest focusing on discrete events which could be shown to be supportive of a strong story going forward, in the eyes of those international analysts. |
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| Article appeared in the March 2000 issue.
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