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The stock market evokes the image of a child who has eaten too much chocolate and is running around blowing bubbles, and then smashing them. There were the Amazon.com bubble, the competitive local exchange carrier bubble, the dot-com bubble, the electronic commerce software bubble, the Lucent Technologies bubble, the optical equipment bubble, the Oracle bubble, the Yahoo! bubble and, biggest of all, the Cisco Systems bubble. Pure excess.
Who fed the child the chocolate? There is no lack of culprits: Bankers, venture capitalists, securities analysts, day-traders, ignorant investors, a Ponzi scheme.
A favorite target has been the loosening of financial reporting and analysis standards. Hardly a company has not been accused of violating the canon, and analysts have been blamed for going along with the charade. Get back to basics is the cry now. Show us the earnings.
“The pendulum has swung too far. The focus is now obsessively on earnings,” says Robert Eccles, president of Advisory Capital and a senior fellow at PricewaterhouseCoopers.
This obsession just plays into the earnings game with security analysts and the rise of whisper numbers, and uber whisper numbers about a companys next quarterly report. “It is a crazy game,” Eccles notes, “and just causes more volatility in the market.”
In a new book, The Value Reporting Revolution, Eccles and three colleagues from PricewaterhouseCoopers argue earnings are only loosely tied to value creation. A companys strategic direction, market share, speed to market with new products and growth rates are more useful in estimating future cash flows and the value of a business, Eccles says. This “value reporting” puts short-term earnings in context.
Information will always be faulty to a degree, but business, accounting bodies and others could work to ensure the information is comparable across companies. Until value reporting arrives, hang on for the Nasdaq ride.