A little over a week ago, two of American businesses' high profile CEOs - Jamie Dimon of JPMorgan Chase (NYSE:JPM), and Warren Buffett of Berkshire Hathaway (NYSE:BRK.B) - posted a thought-provoking editorial to the Wall Street Journal.
I found the editorial's content to be interesting and relevant for individual investors. Not only do Buffett and Dimon identify one of the fundamental weaknesses of Wall Street, but they also highlight one of the key things investors can look for to find truly wealth-building investments.
Let's summarize and break down the editorial's contents, then identify a few things we can learn from it to improve our investing outcomes going forward.
The Danger of "Short-Termism"
The editorial itself is titled "Short Termism Is Harming The Economy". In it, Buffett and Dimon argue that a focus on hitting short-term, quarterly earnings guidance forecasts is a detriment to the long-term health of both the business and the U.S. economy at large. To begin to remedy this, they - along with 200 other CEO's from the Business Roundtable - advocate that public companies stop providing quarterly earnings-per-share (NYSEARCA:EPS) guidance.
Why would this be a good thing? Buffett and Dimon argue that quarterly EPS targets cause companies to hold back on technology, hiring, and R&D spending, in order to hit their targets and "please" Wall Street. The flip side is that, over the long-term, withholding necessary investment can cause them to lose to competitors that are more proactive about attacking growth, efficiency, and adjacent business opportunities.
They also argue that the intense focus on short-term profits has led to a decline in public companies willing to go public. Clearly, we've seen numerous very high-profile private companies hold off on entering the capital markets. Uber, Airbnb, Pinterest, and several others come to mind. By not going public, these companies are depriving the general populace the opportunity to build wealth by investing into them through IRAs or brokerage accounts.
Dimon and Buffett were very clear that they were NOT against quarterly and annual reporting. They still believe this is an essential aspect in providing transparency to investors as to their recent performance.
What We Can Learn As Investors
There is an old business parable called "The Bucket Carrier and the Pipeline Builder", that perfectly illustrates the lesson we can learn from this editorial.
The parable goes like this. Years ago, there was a small village located some distance from a river. The villagers needed water from the river for drinking, for cooking, for bathing... etc. Two villagers with entrepreneurial spirit decided to attack and solve the problem for their village.
The first villager though to himself: "This will be easy! I can carry two buckets of water back and forth, and charge customers for the water. I can do over 100 buckets a day at a coin each! I will make 100 coins a day and be wealthy!" Sure enough, that day he gathered his buckets and started lugging water from the river, earnings his coins and feeling pretty good about himself.
The second villager, though, took some time to think about the problem. "I could do the same thing", she thought, "but there might be a way I could get water to the village more cheaply, reliably, and with less work." She settled on building a small pipeline from the river to the village, spending her money and time to start constructing it.
The first villager thought this was crazy and laughed to himself. "You are SPENDING money, not making it!" he laughed. He continued to merrily lug his buckets and collect his cash.
Weeks and months went by. After a time, though, the pipeline was finally completed and water rushed into the town's well. The second villager, with a steady and automatic supply of water, decided to charge just half a coin per bucket. Overjoyed, the villagers flocked to her well, eagerly paying the same for double the amount of water! And now, they didn't have to wait for the buckets to be delivered, could bathe every day instead of once a week, could afford enough water for more livestock... Life was so much better!
The second villager just sat by the well and collected her coins. And the first villager? Well, you can probably guess - he was put completely out of business and had to find other ways to make a living.
The moral of the story is pretty obvious. It is easy to make decisions that, while they may deliver attractive results in the short-term, are BAD decisions for the long-term health of a business. As investors, we should always take this into account. We want to invest in companies and management teams that focus on the big picture, EVEN IF that means it affects short-term revenues and profitability.
Buffett and Dimon's recommendation to cease with quarterly earnings guidance is one we can get on-board with. The management of public companies to hit 3-month profit targets can be counter-productive, starving a firm of necessary investments to build growth and competitive advantages over the long term. It is also a lesson to investors to focus their investments on companies and management teams that make decisions for the long-term health of the business.
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