Investors should question company stories

Company reporting in the UK is set to change, with new regulations coming in from September 30. The aim is a simpler, clearer and more focused presentation. Investors should also get a strategic report instead of the current business review. But, are these new rules on narrative reporting too little, too late? Recent reporting from a number of large companies suggests that they are adept at guiding analysts and investors, playing on the human weakness for stories. Analysts’ biases to optimism and herding are also evident. How can investors best prepare themselves?

Analyst optimism has been well researched and documented. Over 25 years, consensus forecasts for S&P 500 earnings have over-estimated in all but 2 years – those happening just after severe recessions. And, the major investment banks have tended to make market forecasts largely based on anchoring to the start of the year position, adding a set percentage.

But, what has been less well documented is the herding pattern, where forecasts bunch closely together. In July, Apple reported its iPhone unit sales for the previous quarter, with the number being well outside the range of all 30 analysts. This key metric is a subject of detailed analysis, involving channel checks and other supplier analysis, so was a particular embarrassing outcome. Facebook also managed to catch analysts off-guard, gaining over 70% in the 2 months following its July results, which beat all analysts’ forecasts. These are widely researched companies, yet herding predominates, with suggestions that company guidance encourages this.

Other companies have returned to the practice of pre-announcement announcements, a practice pioneered by Autonomy. UBS, for example, in July updated its quarterly earnings in a summary just days before the actual results were announced. It seems odd for a company to report that it “will report” something, but politicians understand just how expectations can be managed in this way. Other companies may be guiding similarly, but in private, making it difficult to assess just how prevalent this practice is. But, the clues are bunching of forecasts and wide misses by analysts on numbers. Analysts, eager for every scrap of information companies produce, can find it difficult to put the timing into context, or to spot patterns. The City is blamed for forecast errors, but the biases are hard to correct, and companies understand that.

More insidious, is the over-arching meta-narrative, which may be a short story or even just a phrase. Earlier this year, BP’s results were heralded in the press and many analyst reports as “poised for growth”. This neatly encourages the view that a disappointment or hiatus is all part of the preparation for a much better future. The confidence boost certainly worked briefly, but since then the shares have moved down to a 3 year relative low – almost back at the worst relative levels since the Macondo accident. (BP now refers to this as an “incident”.) Corporate narrative reporting may include more strategy in future, yet the emotional appeal of succinct but superficial stories is strong.

Stories are useful shorthand to connect events or possibilities. Yet, we often fail to probe them too deeply, when we should really question whether the outcomes are connected. These narratives can discourage analysts from focusing on the facts, or from analysing a company’s results systematically. The problem with the new focus on narrative reporting and strategy may be that it remains the least objective aspect of company reporting. Analysts should start with the numbers.

Disclosure: The opinions expressed in this article are my own, and may not represent the views of any firm or entity with which I am affiliated. Data and content provided are for information, education, and non-commercial purposes only. The information presented in this article has been obtained from sources believed to be reliable, however, I make no representation as to their accuracy or completeness and accepts no liability for loss arising from the use of the material. I may have positions in companies referred to, but have no plans to trade in these in the next 72 hours. Articles and information do not represent investment advice.