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Forecasting quarterly earnings isn't the issue, it's CEOs

Key Points
  • Warren Buffett and Jamie Dimon said they support companies' no longer offering quarterly financial forecasts.
  • The idea is not new, and many companies have already started the practice.
  • Still, Buffett and Dimon's shift could pave the way for CEOs and boards to shift their focus away from benchmarks and stock reactions.
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Buffett and Dimon's warnings on short-termism will drive change, says expert

Warren Buffett and Jamie Dimon want companies to get away from a short-term approach to management and are therefore suggesting they ditch quarterly financial forecasts.

But quarterly guidance — which only 28 percent of companies offered in 2016 — is only part of the problem. The bigger problem for boards and CEOs is a fear of rattling a company's stock price.

"This price decline we believe CEOs are terrified of ... they find that embarrassing ... instead of telling the truth, they try to strengthen [their quarterly numbers] and by doing so, they can damage the firm," B. Espen Eckbo, the Tuck Centennial chair in finance at the Tuck School of Business at Dartmouth College.

Getting rid of quarterly guidance does not get rid of analysts creating benchmarks for a company to miss or make. It doesn't prevent share dips of a company when it announces that a new drug trial was not successful or it must close stores.

A CEO's job is to brave that impact and the board's role is to give a CEO leeway. The best a company can do is to prepare the market for the reality. The ability to do so is particularly important in industries like food and retail, which are in the process of reshaping their portfolios and business models in the glare of the public eye. Those efforts are costly and not always predictable.

Kroger, which has been making investments its e-commerce business to battle Amazon, weathered an 11 percent drop in its share price in March when it warned analysts of lower profit margins for 2018.

"You should expect gross margin to decline somewhat in 2018," Kroger CFO Mike Schlotman told analysts. "We aren't giving guidance on the individual amounts."

Kroger shortly thereafter announced two significant e-commerce acquisitions, putting more context around that caution — and Kroger's broader plans.

Meantime, there are other changes a company can make: getting rid of payment incentives based on earnings, and changing corporate culture to shift focus away from the stock price.

"Implicitly [Dimon and Buffett] are telling CEOs we need to change things — we can't have you manipulate internal earnings just to fit some predictions. You're supposed to tell the truth, the way things are, without cutting short on any investment," said Eckbo.