I am about to tell you something that flies in the face of conventional wisdom. If you believe me, you could make a pile of money in a hurry. If not, I will do my best to change your mind.
Let me explain.
Wall Street and legions of academics, economists, and accountants want you to believe that more information equals better profits.
Not so.
In fact, there’s a good argument to be made that less is more when it comes to your money, especially when it comes to quarterly reporting.
Quarterly numbers rob our economy of innovation and opportunity. Worse, they rob YOU of the profits that go with both.
How many times have you seen numbers released that should have made stocks pop, only to watch them head lower? How many times have you seen otherwise terrible information turn into huge gains? And how many times has that worked against you, because you didn’t know how to “see through” the shenanigans?
Now – and this is very important – ask yourself how different your profits would be if you had the knowledge to see through this, to correctly anticipate which way company stocks would move, and why.
You could enjoy bigger, faster, and more consistent profit potential, year in, year out, in all sorts of market conditions.
I’ll share one of my favorite metrics in a moment – one that will help you see through the quarterly noise in pursuit of life-changing wealth and turn less into more (profitably).
First, though… let’s talk about how to…
Protect Your Money – Quarterly Reporting Is Overrated
Quarterly reporting has been with us for 84 years since it was implemented as part of the Securities Exchange Act of 1934. Sections 12(g), 13, and 15(d) require that companies file periodic disclosures intended to keep shareholders, the markets, and the investing public informed on a regular basis.
The intent was transparency, but that’s hardly what we have today.
Quarterly reporting institutionalizes “short-termism” in the markets. That, in turn, leads to an unhealthy focus on meaningless results.
You may as well be throwing darts at the wall.
Short-term numbers and quarterly earnings data can – and are – frequently driven by factors beyond any executive team’s control. Berkshire Hathaway Inc. (NYSE: BRK.A) CEO Warren Buffett and JPMorgan Chase & Co. (NYSE: JPM) CEO Jamie Dimon both argued as much this past April in a jointly written op-ed that appeared in The Wall Street Journal.
They wrote that, “companies frequently hold back on technology spending, hiring, and research and development to meet quarterly earnings forecasts that may be affected by factors outside the company’s control, such as commodity-price fluctuations, stock-market volatility, and even the weather.”
That’s been my experience, too. And, not surprisingly, I agree.
The quarterly earnings process is a lot like betting on a horse race after you know the results.
CEOs lay out guidance on sales and profits every 90 days to Wall Street analysts, very few of whom have an intricate understanding of what the numbers actually mean. But that doesn’t stop ’em from guessing.
Those same analysts then go on to set “price targets” for specific stocks and make conflict-laden investment recommendations. Much of that is under the guise of “research,” but, in reality, it’s closely tied to the firms they work for or represent… commissions, trading revenue, and even in-house proprietary funds… those things all stand to benefit from the “right” findings when they’re released to the investing public.
Companies that “beat” earnings often see their stock price jump, while those who “miss” often get hit hard. Especially lately.
For example, just a month ago, investors watched in horror as Facebook Inc. (Nasdaq: FB) received a $119.07 billion buzz cut after the company missed expectations on revenue and showed slowing user growth.
Executives are in much the same boat, and it’s a huge problem. It’s not uncommon for compensation packages to reflect short-term changes rather than long-term value. That means your interests as an investor are frequently at odds with their interests as executives, especially when it comes to massive bonus packages tied to a company’s stock price.
Here, too, I agree with both Dimon and Buffett who note that “quarterly earnings guidance often leads to an unhealthy focus on short-term profits at the expense of long-term strategy, growth and sustainability.”
The dark side to all this is something most investors don’t think about… but should.
The number of U.S. publicly traded companies has dropped by 50.99% over the past 20 years, from 7,382 on Sept. 30, 1998, to only 3,618 at the end of 2017, according to Bloomberg. Businesses (and their leaders) simply don’t want to put up with the high cost of compliance and the gamesmanship that is required when you’re publicly traded in today’s information-addled world.
Not surprisingly, many stay private to avoid the mess. That, in turn, deprives savvy individual investors of huge profits. Others simply “go private” or sell out to a larger player, which also removes the problem. Elon Musk’s public meltdown and his desire to take Tesla Inc. (Nasdaq: TSLA) private is a perfect example of the pressures involved (and what happens when an otherwise brilliant executive “caves”).
So, now what?
Quarterly guidance isn’t going to go away any time soon. Wall Street’s simply not ready. Besides, the regulators who are woefully understaffed and outmaneuvered at every turn wouldn’t have a clue how to provide the reform needed to cope with the required changes anyway. But that doesn’t mean you’re out of luck.
In fact, quite the opposite is true.
The key is to know where to look and how to find longer-term–oriented information that can get you around the shorter-term gyrations associated with the quarterly earnings cycle in pursuit of the bigger, longer-term profits we all know are out there.
One of my favorite metrics in something called “Free Cash Flow Yield.”
Free cash flow yield, in case you are not familiar with it, may just be the best fundamental indicator available today because it measures the true profitability of a business – any business – over the longer term.
Nobody ever went broke on accrual accounting, which measures when revenues and expenses are incurred, even if there is no cash exchanged. But plenty of businesses that are apparently in good health have gone feet-up because they ran out of cash.
And free cash flow yield measures that… the amount of cash into and out of a company’s coffers.
As such, I think it’s a far better reflection of a company’s true financial health because “free cash” reflects the amount of money – cash – left after a company has paid all its expenses and accounted for all its capital expenditures, including stuff accrual accounting often doesn’t reflect.
A company with a positive free cash flow yield is creating more cash than it needs daily and is commonly accepted to be in a position to reinvest and grow. Conversely, companies with negative free cash flow yields are spending more cash than they have on hand, which typically means they’re either: a) growing rapidly through investment (think startups here); or b) in serious financial trouble.
The other thing that’s great about free cash flow yield is that you can use the metric to compare companies within otherwise tightly banded industries to find the “winners” that are likely to run to the front of the pack.
Take Western Digital Corp. (Nasdaq: WDC), for example. The company is a U.S.-based data storage and hard disk drive manufacturer.
They have nearly 50 years of experience in manufacturing, designing, and selling data storage devices, data center systems, and cloud storage to businesses and creative professionals across the country.
Western Digital…
- Lines up with the Unstoppable Trends we follow – namely, technology
- Makes “must-have” products and services
- Has grown annual EPS by 120% since 2016
- Has increased free cash flow per share 89.96% from $5.78 as of June 28, 2016, to $10.98 as of June 28, 2018
- Sports a free cash flow yield of 16.68%, which means it’s got the cash on hand needed to support current operations AND invest in growth. That’s higher than competitors like Seagate Technology Plc. (Nasdaq: STX) or NetApp Inc. (Nasdaq: NTAP).
Ergo, it’s properly positioned to get around the quarterly “noise” that confuses many investors and latch onto the longer-term growth, generating the huge profits you deserve.
— Keith Fitz-Gerald
Source: Money Morning