Managers get punished harshly for failing to meet expectations, even unrealistic ones, so in growing numbers they’ll try to hit their targets by doing things they shouldn’t. According to Geoff Colvin here are some stupid things to do to “make numbers”.
The easiest way to hit profit targets is to cut expenses. Trouble is, many of the expenses that managers most frequently cut — R&D, marketing, and employee training — are expenses only under accounting rules; they’re actually investments that pay off later. Unfortunately for those managers, investors aren’t as clueless as they think. Research shows that markets whack the stocks of companies that cut today’s costs in ways that hurt tomorrow’s performance.
It makes no sense. Corporate profits as a percent of GDP are near their post-World War II high of about 10%, which was reached at the apex of the last boom. Are they really going to gallop ahead from that level? Their postwar average is about 6% of GDP. Long term, profits can’t grow faster than the economy. Of course some of those profits come from regions growing much faster than the struggling West, but that provides little comfort. The World Bank’s forecast of 2012 world GDP growth is all of 3.6%. Yet analysts surveyed by Thomson Reuters expect S&P 500 profits to grow 10% next year.
It’s not that the analysts are oblivious. It’s that they’re forecasting profits for individual companies, not for the whole market, and they still tend to fall in love with the companies they’re covering. They also still rely heavily on guidance from those companies. So they repeatedly fool themselves into believing that even if the economy is going nowhere, the company they’re analyzing will blow the doors off. And occasionally they’ll be right. The result is that individually they think they’re being reasonable, yet collectively they’re nuts as the rule continues to be “instant gratification takes too long”.
- Here comes the big profit lie (finance.fortune.cnn.com)
- U.S. Economic Recovery Gains, But Headwinds Persist (ibtimes.com)
- Consumer Spending At Weakest Level In Post-World War II Period (huffingtonpost.com)
- The Biggest Stock Scams of All Time (mint.com)