The top corporate conference calls are attended by dozens of Wall Street analysts whose job it is to maintain detailed earnings and valuation models filled with minutiae. Quarter after quarter, they populate their spreadsheets with revenue and cost assumptions to predict exactly what earnings per share will be months and years into the future. But sometimes that pursuit of the ideal model can lead them to miss the forest for the trees. At least that’s how JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon seems to feel about it.
On the bank’s call Friday, executives were peppered with questions aimed at backing into a forecast for net interest income, a measure of how much banks make on their interest-bearing assets net of how much they pay out on their liabilities. It’s hard to predict, in part because it depends on the trajectory of the economy, the path of monetary policy, how much consumers save and borrow and the very mercurial shape of the yield curve, which measures short-term interest rates relative to longer-term ones in the marketplace.
At one point, Dimon had a sharp retort. Here’s the key excerpt:
Can I just say something? First of all, next time they should give me the damn number. I don’t want to spend all the time on these calls like going through what they’re guessing what NII is going to be next year. And I just — can I just also point out that NII, all things being equal, is a number, but all things are never equal. And the yield curve, you know if you have a recession, the effect of the yield curve would be very different than if you have continued growth. ... I think we spend too much time on just this irrelevancy, so you get a model — number in your model.
I’m extremely sympathetic to this view.
In financial markets, the best investors aren’t those who can predict the future, because no one has a crystal ball. Rather, the most successful ones appreciate the panorama of risks and position themselves accordingly. As a general rule, many stock watchers spend too much time estimating earnings to the decimal point and too little digging into the ways that their thesis might be wrong. Each stock is a story that’s being written in real time, not a math problem with a bunch of static and knowable inputs.
In a best-case scenario, Wall Street equity analysts would help us appreciate the panorama of risks and outcomes. They would each think independently and come up with differentiated projections that serve as a sort of illustration of the various risk scenarios that investors should consider. Instead, analysts tend to herd around corporate executives’ own “guidance,” because that’s the safest way to avoid looking foolish or losing access to management. Earnings estimates and target prices tend to be clustered so close to one another that an uninitiated investor would get the false impression that the range of outcomes is actually quite small. To the extent that “guidance” contributes to that herding behavior, Dimon is right that we spend too much time focused on it.
Analysts hewing to corporate guidance is nothing new, of course. In research originally conducted in the early 2000s, Julie Cotter, Irem Tuna and Peter D. Wysocki showed that analysts quickly respond to management guidance.
And corporate managers often report that one of the primary reasons they provide it is because analysts and investors keep asking for it. In a recent survey of 357 corporate managers published in the Journal of Accounting and Economics, some 41% of managers that issue guidance were “very much” concerned about the “short-termism” associated with it, and only 11% were “not at all concerned.” In their paper “Corporate managers’ perspectives on forward-looking guidance: Survey evidence,” the researchers also found that the corporate managers had misplaced confidence in their own guidance. They reported that an overwhelming majority of respondents were at least 70% confident that earnings would be within the initial guidance range. In actuality, the initial guidance was right less than a third of the time.
Granted, I feel sort of bad for the analysts who were made an example of Friday; they’re just doing their jobs, and it’s not their fault that the game has turned out like this. But Dimon is right that there are more interesting and useful ways to spend an hour with the leader of the nation’s largest bank.
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