Are you leaving money on the table every day?
By Geoffrey Colvin
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Does the stock market shackle creative managers by systematically and unjustifiably over-discounting returns
from long-term projects, while obsessing on the next quarter? We can seek an answer in many different ways,
but I’m telling you right now, they all lead to the same place.
And the Wall Street bashers don’t want to go there. To begin most basically, does the proposition make sense?
To say that Wall Street gives excessive weight to short-term results is to say that investors as a group
fail to take advantage of available information about a company’s prospects.
Evidence of a bright future is out there plain as day, yet investors refuse to bid up the stock in line
with an appropriate discount rate. (Note that this theory applies in one direction only;
no manager ever complains that Wall Street gives inadequate weight to long-term bad news.)
In other words, it’s to say that investors as a group are consistently passing up worthwhile opportunities,
leaving money on the table every day, for illogical reasons, as can be seen by anyone with half a brain.
Is it likely that people really act this way?
Well, who knows, maybe they do. If 10% of Americans think Elvis is alive, if 2% of us believe we’ve been abducted by aliens,
as we do, then maybe we also enjoy giving up substantial returns on our investments that are there for the taking.
But I’m skeptical.
Moving past the thought-experiment approach to the question, it’s useful to see what reality tells us.
It tells us loudly that Wall Street is anything but a den of heartless, visionless gnomes.
On the contrary, the history of technology stocks suggests that America’s most hopeless romantics,
the dreamers who believe in sunny tomorrows only they can see, like nothing better than common equities.
Open today’s newspaper, and you’ll find hundreds of companies in the stock tables with no price/earnings multiple
because they have no earnings — but they do have prices, sometimes very high ones.
Think of any new biotech stock, any Internet stock.
Remember Amazon.com, one of 1997’s champion IPOs, it had no earnings, but its stock went from 15 3/4 to 66.
Another standout IPO, Star Telecommunications, went from 92 to 364 without earnings.
Of course these stories don’t all end happily. Can you say “Netscape”?
Yet time and again Wall Street proves extraordinarily willing to take a flier on companies with no record.
This is scant comfort to the determined whiner from an established company who believes
Wall Street won’t let him invest in R&D with a long-term payoff because doing so will reduce earnings and tank his stock.
This scenario has practically become conventional wisdom, but broad-based evidence to support it is hard to find.
Just the opposite, in fact: The evidence refutes it. A study by Baruch Lev (New York University)
and Theodore Sougiannis (University of Illinois) finds that, on the whole, companies with higher R&D
expenditures produce higher returns to shareholders.
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