Short-termism in investing – is this really what’s happening and is it a problem in markets? Let’s talk about how the market is so strong, despite the devastation we are seeing in the real Economy from the Global Pandemic with high unemployment and businesses boarded up. Are public market investors truly short-term oriented, or are they accurately discounting future cash flows from businesses? Does it make sense that the market is up due to government support from the federal reserve averting mass bankruptcies?
Let’s talk about how the stock market is up this year despite the devastation that we’re seeing in the real economy from the global pandemic where there’s high unemployment and businesses are boarded up over the last few years conventional wisdom has been that investors are obsessed with short-term returns compelling publicly listed companies to seek impressive quarterly
Earnings at the expense of good long-term investment decisions research and development we’re told suffers as does long-term investment in plant equipment and investing in future productivity of the workforce through employee training startup founders are frequently quoted saying that they’re better off remaining private because they fear the short-termism of
The public markets some public company ceos want to go private in order to escape this short-termism case in point the elon musk 420 scandal commentators argue that investors laser-like focus on the next quarter’s earnings destroys long-term value if this is true short-termism must be bad for the economy right well it would be if it was real on closer inspection
The supposed negative consequences of investor short-termism appears to be not happening at all while institutional investors do buy and sell stock regularly and sometimes quite rapidly most large mutual funds have maintained 12 to 15 month holding periods of stocks for decades they do this both to minimize transaction costs and for tax efficiency while much
Has been made of high frequency traders that buy and sell stocks in nanoseconds the idea that this trading makes it difficult for corporate managers to adopt a long-term perspective is in no way supported by the facts in the united states neither r d nor overall business investment is declining as you would expect if companies were just buying back stock and
Never investing according to the national science board the amount of money spent on r d has actually been increasing over the last 20 years with the majority coming from businesses as opposed to government r d investment as you can see on the chart on your screen right now so maybe many businesses do pursue long-term investments notwithstanding their short-term
Stockholders pharmaceutical companies for example cannot develop new products on a quarterly basis they must operate with multi-year time frames the oil industry cannot open and close oil fields on a quarterly basis they spend a decade or more investing in developing new fields staying on the cutting edge of innovation requires the tech giants like apple intel
Amazon and google continue to play the long game if publicly traded u.s companies as a group under-invested in innovation and didn’t take a long-term view you would expect to see substantial opportunities and great return streams available for venture capital firms vc firms make long-term investments in innovative companies with time horizons of five to ten years
And sometimes more harris jenkinson and kaplan three academics studied the returns of venture capital funds and found that while returns were particularly high in the mid 1990s in the lead up to the internet boom then there was a large flood of capital that came in and that led to poor returns afterwards since 2000 vc returns have not been unusually high so
What did we learn about short-termism during the market sell-off and recovery that we’ve seen so far in 2020 many people struggle to understand why the stock market is so cheerful while the economy is so bad with many businesses closed and workers laid off financial theory tells us that a company’s stock price is the present value of the company’s expected future
Earnings if you build a dcf model to analyze this you’ll quickly see that over 90 percent of the value of a stock is dependent on earnings more than a year out into the future if companies lose profits for a while and then get back to having profits again and if discount rates are low in a zero interest rate world then stocks shouldn’t go down that much even if
They have no revenue for months it is just months after all and stock prices reflect decades of expected future earnings it’s worth highlighting that because future cash flows are being discounted at an interest rate to take into account the time value of money in a zero interest rate or really low interest rate environment a cash flow occurring in a few years
Time is worth roughly the same as a cash flow occurring next week this is why unprofitable companies that will hopefully flip to profitability at some point in the distant future are not really trading at a discount to companies that are profitable right now it would appear that in 2020 investors are not thinking six months ahead as critics of short-termism would
Have had us believe they’re thinking a year or two ahead by which point they possibly expect the pandemic to have ended whether there’s a v a u or a k shaped recovery investors are right now looking at a long-term picture of the economy and they’re seeing the light at the end of the tunnel the timing or shape of the recovery does not really matter here or even
How long it takes for a vaccine to be discovered what is of interest is whether investors are being rational or not it does appear that investors are being rational and taking a long-term view in 2020 a pandemic came along and destroyed corporate revenues stocks fell due to general uncertainty and a fear of financial crisis and widespread bankruptcies which
Would wipe out the profits in perpetuity the fears of financial crisis were more or less resolved by the federal reserve the congress and governments around the world pumping money into companies to prevent panic and to stem unemployment so bankruptcy risk is more contained stocks were then able to return to a price level that suggests a terrible year followed
By mostly normal years going forward the market might be wrong about that of course but that does not seem to be what is implied right now i’ve always had my doubts about the short-termism critique it’s often a way for corporate managers to defend bad decisions by saying that they’re actually wise long-term decisions now we have a clear data point where companies
Have announced that next quarter’s earnings will be terrible for almost every company and the stock market has essentially shrugged it off investors have allocated capital to the types of companies that are thriving or doing well in this environment investors of course do favor the type of company that will both do well in the short term and in the long term
Especially if they get a choice of that because that’s always preferable than ones that will struggle right now and then rebound in the long run so you are seeing this sort of change in the market of which companies are in favor and which are not it’s worth adding in that the idea of being short-term oriented is not necessarily such a bad thing it can also mean
That a company is flexible and adaptable actions that are criticized as short-term thinking may in some cases be steps towards abandoning old approaches and failed solutions helping the company adapt to a changing economy clothing companies who saw that sales might dry up due to the global pandemic were not being short-term thinkers when they adapted and started
Manufacturing things like face masks they were being flexible let me know in the comments section if you can think of any smart examples of short-term decisions made by companies over this period critics of short-termism often argue that management compensation is too tied to a company’s stock price this compensation structure incentivize pushing up the stock
Price in the short term in order to boost the next pay package if this is the case it doesn’t have to be that way boards can and often do choose to time managers compensation to longer range targets and they increasingly are doing this in order to maximize long-term share value if you found this video interesting please do hit the like button and subscribe if
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Transcribed from video
Why Is The Market Up When The Economy Is So Bad? | Are Investors Too Focused on the Short Term? By Patrick Boyle