We’ve all been there… it’s the morning of a company’s financial results and the pressure’s on to get the gist of the update. It could be a personal holding already, or a stock you’ve been stalking for a while. Either way, it’s important to find the good news (and any bad news) to anticipate how the share price might respond. Yet what you’re faced with is a complex narrative that leaves you with more questions than answers.
Companies and their advisors are skilful at managing how and what they communicate to the market. Many work hard to do it clearly. Some will admit when things aren’t going to plan, but it’s also true that there is considerable scope in these announcements to smooth over bad news. Especially if that means meeting market expectations.
There is evidence that investors are prepared to put up with a degree of earnings ‘manipulation’ by management if it keeps the results stable and predictable year in, year out. But it’s still something that auditors and regulators take seriously. Not least because earnings manipulation can be the start of a slippery slope towards fraud and even corporate collapse.
Certainly when it comes to presenting accounts, the use of ‘adjustments’ and other (albeit legal) methods of presentation - both in the numbers and the narrative - can make it difficult to understand how well a company is really performing or where the risks are. It creates a grey area where investors are at risk of being mislead or just left downright confused.
This is a particular problem for individual investors. Because without accounting experience, a direct line to management or a team of analysts on hand, you’re on your own when it comes to interpreting earnings reports.
With all this in mind, it would be easy to think that companies can act at will to bury bad news and use complexity to present results in their best light. Yet research suggests that clarity and readability in these reports is rewarded by the market.
Plain English pays off
Researchers in Chile and Spain have dissected the relationship between firms that meet (or slightly beat) their previous year’s earnings performance with how their share prices behave over the following month. There were two main findings:
- Meeting or beating the previous year’s earnings results in lower stock return volatility over the following month
- This connection is even…
