In our opinion, one of the most important assets on Seeking Alpha is the tremendous archive of company conference call transcripts. Along with SEC filings, company presentations and news stories, we view them as an indispensable part of our investment process. Four times a year investors go through the ridiculous ritual of "earnings season". Each press release and subsequent earnings call is dissected for "new information" about the company's near-term prospects. It is not uncommon for media outlets and bloggers to report comments made on a call in real time and attempt to explain the immediate stock price reaction to it. Day (noise) traders and algorithmic trading programs and those who have a vested interest in volatility, like business TV anchors and their guests, contribute to the interday volatility and provide something for others to drone on about for the day. However, we believe that, for long-term investors who focus on the underlying business and have a three to five year investment horizon, listening to most conference calls in real time is generally an unproductive use of their time.
Some investors do believe they find value in being on a conference call and then making buy or sell decisions based on certain comments or "tone" of a call. We are not here to convince those individuals that they need to change their investment process. However, we would encourage them to look at their trading records to see just how much incremental, after-tax profits they generate over the course of time to judge if that time and trading activity is actually that productive. We would just like to explain why reading transcripts fits our investment process better.
Generally speaking, within a few hours of the conclusion of a conference call, the transcripts are posted on the Seeking Alpha website. The transcription process has improved over the years, which has reduced the amount of time it takes to publish a transcript and the number of errors that are in it. While there are still times where the comments seem out of context to the area of investing and there are also still "unintelligible" sections, for the most part we find the transcripts are accurate.
Why we as long-term investors gain little value by listening to calls in real time
There is always another company to look at or another SEC filing to read, so time utilization is extremely important in our investment process. Therefore, we try to maximize the amount of time we spend on thinking about and analyzing business and minimize the amount of time spent searching or acquiring the information to be analyzed. This is one of the huge benefits (and curses) of the Internet. Unlike what was available during most of our careers, a virtually unlimited amount of investment information is available in real time. Not only can investors receive notices of SEC filings and press releases in real time, annual meetings and investor conferences are now broadcast live. There is not enough time in the day to gather and read or listen to all the information that is available.
In a previous article, we discussed how we think investors spend too much time looking for "new" information about a company and too little time thinking about a company's business model. An investor should ask himself "what do I stand to gain by listening to the call?" If your answer is, "I am hoping to glean some new information that wasn't known before so I can incorporate that into my analysis and act on it immediately", please go to the back of the class. As a long-term investor, your analysis should always incorporate multiple scenarios and you should have at least thought about a conducting a premortum to understand the many "worst-case scenarios" that could happen. While we admit that occasionally things have changed so dramatically in the short run that the "new" information can actually change our investment thesis, the vast majority of time the "new" information is really just something that was within the range of outcomes in the short run, but does not fundamentally change the company or the investment thesis. Studies have shown (read GMO's April 2012 letter for example) that stock prices are 19 times as volatile as the underlying fundamentals, so equating any daily stock price movement to an accurate prediction of long-term performance would be an error. In the short run, Post Earnings Announcement Drift (PEAD) is a well-documented phenomenon, but it loses its predictive value within a few months.
Everyone can point to a few instances where they found that being on the call mattered. But if you follow one hundred companies, that is four hundred conference calls a year and at least four hundred hours of your time hoping to hear that in that one or two minutes of a call something that is a "game changer". If you are spending most of your time analyzing businesses and are reasonably good at it, you will find the number of times that happens on a call is relatively infrequent. It is also important to put the action in context to the overall contribution to the portfolio performance. Consider the following example. A stock represents a 10% position in your portfolio. Due to something said on a conference call, a stock drops 20% during the call, but you were able to "hit the bid" before the drop. You just saved a grand total of 200bps of return. If your position was only 1% of your portfolio, you saved 20bps. Now, how often does that really happen if you are a long-term value-oriented investor? Now how many hours of calls did you listen to in order to save 20bps?
The structure of the calls provides little opportunity to use your time productively.
Part of the reason why we find listening to earnings calls a tremendously unproductive use of our time is their structure. For example, the first half hour of the call is generally management reading the earnings press release. In fact, some companies even feel the need to read some or all of the Safe Harbor statement. On one of Darden Restaurant's calls, it seemed as though management was reading the entire Safe Harbor statement to "run out the clock" on investor's ability to ask unpleasant questions. Rereading the carefully worded press release adds absolutely no value to investor's investment process. We find it refreshing when a CEO like Steve Wynn simply says the company had a good or bad three months, gives his opinions on the topic of the day and then opens the call up for questions.
Most questions asked by analysts are short-term focused and many of them are just a roundabout way of asking, "How do I fill out my earnings model for the next quarter or rest of the year?" We can't count how many times we have heard an analyst of a retailer or restaurant company ask how "the first few weeks of the new quarter are trending?" just seconds after hearing how the last 90 days went. What does that have to do with the overall way in which management is allocating capital and running the business in the long run?
Analysts aren't going to ask their "best" question and let every other analyst or investor hear it for "free". Occasionally analysts will "pile on" with questions and continue to "come at it from a different perspective" when there is something obviously wrong with a company's recent performance. Sometimes analysts do ask tough questions, but again, do you need to hear the question and answer in real time?
Having said that, in reality, very few tough questions get asked, even fewer get answered. The lawyers in the room rarely allow for "material new information" to be given in comments or answers to questions by management teams. Management pretty much sticks to the "script" and makes references to it constantly. In addition, management's answers are usually, evasive, generic or vague. Short sellers will ask the tough question, but they rarely get chance and rarely get a direct answer. Recall the now infamous "a@@@@@@" comment Jeffery Skilling of Enron made to Highfields Capital analyst Richard Grubman during a conference call in April, 2001.
The benefits we derive from conference call transcripts
While some companies have archives of previous calls, many companies take down the audio recordings of conference calls within days or weeks of the date they were held. Since we are trying to understand the dynamics of a company's business model, we usually go back and review years of SEC filings, presentations and annual reports. Having access to years of previous conference calls helps us gain a better understanding of the historical problems and opportunities the company has faced, management's plans to address them and the results of those actions. We find it is helpful in our investment process to go back and read years of calls to build an understanding of the evolution to the company's business model.
When you read twelve company conference calls back to back, you can see trends in what analysts are focused on (both good and bad), which helps us learn if we have a differentiated view about the company. Sometimes we find that analysts are too focused on a relatively small portion of a business and not enough on the main portion of the business that will create (or destroy) value in the long run. Other times, analysts may be too focused on the obvious problems and not on the potential solutions. When this occurs, there is potentially an investment opportunity (given certain valuation metrics). For example, occasionally a casino company will play unlucky at the tables in a quarter and there is the typical knee-jerk negative reaction to the "earnings miss". The company will spend five to ten minutes discussing the "hold" and "drop" metrics, giving a "hold adjusted margin" and explaining in the long run, the math is in their favor. Volatility in high-end baccarat play is fundamental to the business. So for analysts to spend any time on this shows they are much too focused on their models and short-terms earnings and not focused enough on the long-term value creation that occurred by building casinos in, Macau, which, by the way, increased a casino's exposure to that very volatility, but in the end drove tremendous growth in earnings over time.
Being able to go back and "check the tape" is helpful in assessing the quality and accuracy of management statements. Many times a CEO will make the comment, "as we discussed in previous calls" as a way to lessen or deflect something that has recently happened that investors are not happy with. We like to compare those "backward-looking" statements like those with "forward-looking statements" made on previous calls. We also like to compare statements about growth rates or returns or risks made on a conference call to any references made in SEC filings. There have been many times where a CEO or CFO made statements on a call that were later toned down when distilled to the legal language of an SEC filing. Consistent "bending of the facts" is always a red flag in our process.
We have short enough attention spans as it is. When we used to listen to calls, we frequently found our minds wandering to other companies or topics. Being able to print out or read many conference calls in one sitting, from one industry, helps us get our "mind right with ball" as my old baseball coach used to say. What we like to do is to save all of the earnings call transcripts from an industry we are interested in and then sit down and go through all of them in a few hours, rather than the few days it would take listening all of the calls. Spending time in one industry helps us focus on how the management teams of companies are dealing with the near-term and long-term problems or opportunities they face. While we are long-term investors, we have found that reading many calls at one time helps provide us with a mosaic of information about an industry and it has been easier to detect shifts in long-term fundamentals by doing it this way. This is especially useful when looking at cyclical companies. Some management teams actually spend a significant amount of time talking about their industry and longer-term trends that they see. The management of EOG Resources (NYSE:EOG) is one that we find gives insightful commentary on the oil and gas industry (Note: for the first time in years EOG management was "not really bearish" on natural gas prices for the next two years?!?!).
Another important aspect of reading calls compared to listening to them in real time is our ability to help reduce our emotional reaction to stock price movements and prevent a knee-jerk reaction to them. As we mentioned before, most of the time, the short-term price movements of stocks after earnings announcements are generated by traders or investors that have a significantly shorter-term investing horizon than we do. Therefore, reacting to or trying to explain short-term price movements in the moment seems specious to us. We would prefer to read the conference call oblivious to both the stock price reaction and the media commentary explaining the proximate cause of that movement. We are amazed that a stock can move 10-30% within seconds of the earnings release being issued. One quarter's worth of data is not usually enough to cause us to change our investment thesis and there are many times where we find ourselves puzzled by the magnitude of the movement of a stock after an earnings release that contains only minimal or no "new" information.
One reason cited for being on a call is to assess the "tone" of the call and the amount of "stress" exhibited in the voices of management in their responses to questions. It has been our experience that just looking at the magnitude of the change in the stock price based on the earnings release is enough to guess the "tone" of the call. Counting the number of "good quarter guys" or "not to beat a dead horse, but" on a call will also give an investor a good idea of the "tone". Using audio stress analyzers on a call is impractical for most investors.
It is true that there have been language studies that show that some deception might be detected by analyzing what words a person uses when answering a question (for example, distancing language, the use of third person references or verbal hedges). We feel that having the actual transcript to analyze is actually better when trying to detect deception than listening to the call in real time. You can do word searches to look for certain words. You can also do word searches to skip through the calls to only concepts or ideas you are interested in.
One of the things we like the most about the format of the calls on Seeking Alpha is that it lists what member of the management team is on the call and the roster of analysts and their firms as well. At a glance we can see how many analysts are on a call (the fewer the better) and the types of firms that are asking questions (smaller regional firms vs. investment banks vs. buyside analysts). Not surprisingly, when a company initially starts to have problems the number of analysts on the call swells and many times when the company's fortunes are about to change the number of analysts on the call is at its nadir. One of our favorite phrases to read on a call is "there are no questions at this time". Now there is an opportunity for information arbitrage!!!!
A brief note on "deception (lie) detection"
Over the last five years, an entire industry has developed to help investors detect deception by company management on conference calls. There is a company called Business Intelligence Advisors, founded by former CIA officers, that has analyzed "over 50,000 questions and answer exchanges and over 4,000 earnings calls across more than 1,500 companies" that attempts to detect deception on the part of management. Large financial institutions and hedge funds are counted amongst their clients, some of whom reportedly pay upwards of $800,000 a year for the service.
This article from 2010, lists many of the features of deceptive language that are common when someone is employing deception. We have listed a few of them below. If one were so inclined to analyze calls for deception, it would seem that having a transcript would make it easier to apply these techniques.
- They use more references to general knowledge;
- They have fewer non-extreme positive emotions words;
- They refer less often to shareholder value and value creation;
- CEOs use fewer references to themselves and use more impersonal pronouns like we and team; and,
- CEOs use fewer extreme negative emotions words and more extreme positive emotions words.
A research study has been done entitled, "Analyzing Speech to Detect Financial Misreporting", which looks at "cognitive dissonance" of answers to analysts questions by management to predict future earnings misses. Computer software has been developed to look for stress in answers to questions on conference calls. While some investors clearly find value in these tools and services, we have not found it necessary to use them in our investment process.
Quarterly earnings releases and conference calls tend to reinforce short-term thinking by investors and contribute to reducing time horizons in which companies are analyzed. The internet has "leveled the playing field" in the sense that now any investor of any size can listen to a conference call in real time. This wide distribution of information can certainly lead to high stock price volatility on those days. We do feel that there can be some "informational content" in conference calls that is valuable. However, we also feel that our time is also valuable and that our investment process allows us the benefit of being able to "sit quietly in a room" and digest the calls at a time and place of our choosing for maximum effect. We think that long-term investors can increase their productivity by resisting the temptation to participate in a live conference call and instead spend that hour sitting quietly, thinking like an owner and not a renter of a company's stock.
Disclosure: I am long EOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.