Monday, August 9, 2010

Focus On The Short-Term Consequences

Value investors try to outperform the market in the long-term by taking advantage of the market's endless focus on the short-term. For whatever reason, institutional investors and stock market analysts appear to focus solely on the next quarter, instead of the next several years ("long-term" for them means thinking as far as the quarter after next).

This focus on the near-term appears especially prevalent in the outlook surrounding Western Digital Corp (WDC), a company we discussed last week as a potential value investment. The questions asked on a company's conference call can give an investor an idea of what the concerns are of the company's analysts. WDC's analysts appear only interested in the company's next six months. Consider these paraphrased questions asked of the company from the first seven callers:

1) Will the pricing that was set in June change during this quarter, or stay the same?
2) What will demand and pricing be through the fall? What are the key items that will impact the September and December gross margins? Can you take out any costs immediately to improve the gross margin in the September quarter?
3) Did European customers continue buying into start of the September quarter?
4) What's the inventory situation with respect to back-to-school demand?
5) Might some holiday inventory build get pulled into the fall?
6) What does industry capacity look like relative to demand for the next two quarters?
7) How much restocking did customers do in the March quarter?

Even on the rest of the call, almost every caller had at least one (and in some cases, all) of their questions based on the next quarter. I have never seen a group of analysts so concerned with the short-term. (Often, this can lead to a severe mis-pricing of a security, which may be the case here as the company trades with a P/E under 5.)

As a result, I wonder if there are particular attributes of this company which encourage or result in short-term thinking. Are there particular industries or companies which lend themselves to short-term thinking, for whatever reason? What are those reasons? Feel free to comment if you have any thoughts on this issue.


Paul said...

To me, the short term thinking goes something like this.

Normally management will get their bonuses based on quarterly numbers, or at least over the course of 1 year.

The analyst works for fund/institution in some fashion, either directly or via research. The fund/instituion doesn't want to look bad against a market index so it will mirror it and look at quarterly numbers. The company knows the market is looking at quarterly numbers and matches manager compensation to align with what's desired.

Suneet said...

I agree with wht you say. I witnessed this sort of behavior in case of Monsanto (since I was closely following the stock). The company's stock was thrashed by analysts and market participants when it announced that it is strategy had gone astray. The stock price crashed from $78 in Feb to $45 in mid- July. From the market reaction, it seemed MON was soon going to be out of existance. Funnily, before MON announced its poor results, a lot of analysts had mentioned that MON had an intrinsic value of atleast $90 and was an extremely good buy. Suddenly it became a pariah and everybody was totally focused on the short term performance.

tscott said...

I think it all comes down to how people get paid. People get paid for short term results which is due to their clients demanding it. Same problem with Democracy.

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