Dec. 20, 2021

Richard's Favorite Episode of 2021: The Charade of the Earnings Call

For the last two episodes of the year, we’re looking back at favorite episodes for both Richard and Will. This week, Richard’s favorite: The Charade of the Earnings Call.

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For the last two episodes of the year, we’re looking back at favorite episodes for both Richard and Will. This week, Richard’s favorite: The Charade of the Earnings Call.


Will Page: Welcome to Bubble Trouble, conversations between the economist and author, Will Page, that's me, and the independent analyst, Richard Kramer, that lay out some inconvenient truths about how the financial markets really work.

Today, we look at quarterly earning cycles, and the charade of the earnings call. More in a moment.

Last week's trouble forms this week's bubble. We're back with Bubble Trouble, the podcast, and we're forever blowing bubbles on this podcast. So far, so good, we've gone from specs, and got back. We've reset the pure standards of the rating agencies. We've adjusted the reality of what people deem profits.

Bubbles are occurring with a level of frequency that's worryingly predictable, like the boy who cried wolf. Every decade or so, we find ourselves back in bubble trouble land. Which means when I quickly look at my watch, we're due to be bursting some bubbles soon. We won't get fooled again, that's our promise to you, our listeners. And that applies not just to bubbles, but to the other recurring event, that quarterly event, that helps stoke them. That is the theater of the earnings calls. Whereas we'll explore this week the charade of the earnings call.

Henry Kravis, the founder of KKR and the original Barbarians at the Gate, once called the quarterly earnings cycle the worst thing to happen to corporate America. Now, I find that comment striking, given who he is and what he's achieved in his career, but what he was criticizing about this cycle of earnings calls is he didn't like how the short-termism of doing this dance meant companies couldn't focus on the longer game.

So what I wanna do this week is to prepare you for that charade that is the earnings calls, so you, the listener, won't get fooled again. Richard, welcome back.

Richard Kramer: Thanks, Will.

Will Page: So I know this is one of your hot topics, something you've been ranting and raving about for a long time, this earnings call, the charade of the earnings call, this dance that you have to do every three months. And let me pick up on that as we get going. I wanna build this up from base, which is, talk to me, first of all, about the timing of the earnings call. Why is it quarterly?

Richard Kramer: Well, Will, in some markets, it's quarterly. In other markets, it's half yearly.

Will Page: Interesting.

Richard Kramer: In any case, companies are obliged to go through this ritual every 90 or 100 days, of, on the one hand, making it sounds like everything has changed, while also promising that nothing has.

Will Page: [laughs]

Richard Kramer: And naturally, you can imagine how, in this dance, the market focuses on minute details, such as a one percentage point change in the growth rate, up or down, to try to extrapolate out a trend for the coming 10 or 12 quarters of periods.

Will Page: So, with the frequency being, typically, here in conventional Western markets, 90 days, was there a debate around that when they decided to make it quarterly? Did some people argue for once a year, twice a year?

Richard Kramer: A lot of large institutional investors would do away with quarterly reporting altogether, and would rather see companies report annually, but provide some sort of data or ongoing performance measurement that people could tap into whenever they want to. And when you think about companies like the big tech firms, the smallest of which has a run rate of close to $100 billion in annual sales, the idea that they're going to change their strategy or operations materially every 90 days is just lunacy.

Will Page: [laughs]

Richard Kramer: But of course, what analysts wanna focus is what's new, and these companies feed this short-term narrative with data points even about monthly performance, which are really designed to deflect away attention from longer-term structural issues in their business models.

Will Page: So, I'm sure there's a bit of a cottage industry that's built up around this frequency that has a self-preservation, right, to kinda keep it quarterly. But if I look at last week, in Edinburgh we have this expression about public transportation, which is, you wait forever for a bus to come, and then three come along at once. There seems to be a sort of famine/feast cycle, and that last week, everybody was having quarterly reportings, and then it goes into a famine period again. Is that an accident? Is that a coincidence? Or is that planned by companies to kind of crash the market together with news?

Richard Kramer: Well, it's- it's partly around the requirement to report after a certain period at the end of the quarter. So let's say the quarter ends on March 30th, companies are obliged to report, say, in the coming six weeks.

Now, coming up to the end of the quarter, most companies will typically go into something called quiet period, where they don't talk to investors at all. So, they may literally not engage with analysts for the last month of the quarter, and then for the first weeks until their quarterly report comes out.

But if you think of an earnings cycle as four days of the year, when investors are gonna shine a spotlight on a particular company and how it's performing-

Will Page: Mm-hmm [affirmative].

Richard Kramer: ... you can see why most companies treat it like any other marketing presentation, and carefully plan it in minute detail to show themselves in the best possible light.

Will Page: Okay, Richard, so you've just positioned it from the company's perspective, how they prepare for the earnings call. Now flip sides, which is, let's put myself in the driving seat of the analyst. How much time do I have to prepare before they pull open the curtains?

Richard Kramer: So, a lot of times, analysts get an earnings release, which could contain 50 pages of text, and tables of numbers, including the profit and loss, the cash flow, the balance sheet, as well as multiple other adjustments we've spoken about in previous episodes. And you have 30 minutes to input all those numbers, and assess the-

Will Page: 30 minutes?

Richard Kramer: Yep, 30 minutes. Now, there's one very large, household name, Chinese internet company that's famous for issuing its release literally 10 minutes before the call starts. Which simply doesn't give analysts any time to assess the numbers. And instead-

Will Page: You better hope that you don't need a bathroom break for that one.

Richard Kramer: No. And instead, you- you end up reacting to a few headline numbers, and deciding whether they beat or missed expectations. And this is a classic case of reductio ad absurdium, in that these... the entire performance of the company gets reduced to, really, a couple of numbers.

Will Page: I'm wondering about this human interaction here, it seems very human to human. Humans present the earnings call, humans listen in to the earnings call, and there's human dialogue between the two. That sounds obvious. But isn't it the case, like, a third of all market transactions right now are algorithmically-driven? And I'm wondering, like, what's the rule for the algorithm here? I had a piece in The Economist a couple of weeks ago which was titled, you know, "And the Winner Is, Who Cares?" And the point being, Oscars and the Grammys, when media is driven by algorithms, who bothers listening to judges. And I'm wondering if that applies here. Can you kind of contextualize the earnings call in the algorithmic generation?

Richard Kramer: So, indeed, the majority of trading activity might be based on algorithms reacting to those earnings releases. But again, those algorithms can be programmed to look for specific numbers, or patterns in numbers, and see, again, whether they beat or exceeded analyst estimates.

And what oftentimes happens is that the initial reaction of the algorithms might send a stock sharply up or down, and then as human scrutiny kicks in, the share price performance reverses. I mean, sometimes a company might miss its earnings estimates, but then management gets on and provides a- a- a really credible explanation for why things will be better next quarter. The market accepts this and the stock recovers. Or, a company might beat its earnings estimates by having some exceptional gains or one-off adjustment, which isn't very disclosed in the headline, but it's buried in beneath the text or the footnotes or some other jargon, and it- it's something that you only pick out after the fact.

Will Page: Interesting. So let's take a stop before we go to part two of the podcast, which is, firstly, we have this frequency issue. And nobody really knows why it's quarterly, but it is. And that might not be a good thing, but there's a cottage industry built up around it being a good thing.

Secondly, we have very little time to prepare for these quarterly events. You have, what 50 pages of text, and how time would you expect to read that? Is that a couple days' work with your analyst teams?

Richard Kramer: Y- you can take a look at a- a set of quarterly earnings in a few hours, and start to discern what would be sensible questions. But the fact that you have so little time tells you that those questions are pre-agreed, or have been around in the market for some time, and are just waiting to be asked at this one of four days when the spotlight shines on this company.

Will Page: I get it from the company's perspective, they pull the curtains back and present their theater. I get it from analysts' perspective, you got the time it takes to boil a kettle to prepare for this deluge of information. Take me through the anatomy of the earnings call, once that theater is actually in action.

Richard Kramer: The company will come on and provide what they call prepared remarks, and then move on to the analyst Q & A portion. Which, it sounds as if the management are getting a grilling, but you can easily observe a pattern whereby almost all the questions are from analysts from big investment banks, who are likely to be bankers to the company, or trading partners of the company, for example, in turning over the cash on its balance sheet.

And the analysts who ask questions tend to be picked in order, and ask pre-agreed questions on specific topics that are well-flagged to the company or are part of the earnings release. And this is why a lot of the analysts start their questions with the phrase, "How should we think about this particular topic?"

Will Page: But what... wait, wait, wait, wait. That- that kind of a fuzzy line there between who's on stage and who's in the audience, surely?

Richard Kramer: Absolutely, and in the case of analysts covering Chinese companies, they even refer to themselves as part of the management team, for example, asking, "How should we improve this result?" Or, "What can our company do to better perform in the market?" They're actively aligning themselves with the management.

Will Page: Back to praise and appraise, correct?

Richard Kramer: Indeed. And- and there's no critical distance here. Their job is to focus the market on the few topics that the management wants to talk about, and not to grill the management team and create enemies of them about the stuff that they're trying to avoid discussing.

Will Page: My thanks for giving us that understanding of the anatomy of the call. I think in part two, what we wanna come back to is the good, the bad, the ugly of calls, so we can see them in process, help our listeners not get fooled again. Back in a moment.

So far, so good. We've learned about listening to earnings calls, these quarterly events. They're like analytical theater, and something I said in the first part, which is, I'm not sure who's on stage and who's in the audience, but they seem to be staged to maximize their marketing impact. Now, I want to get into understanding the stagecraft of the earnings calls.

Predictability of the earnings calls, they effectively know they're gonna happen, they know they're gonna happen with predictive frequency, makes me immediately jolt towards work regulation, because when something is predictable, it's easy to game. And if it's easy to game, then regulation is weak. Walk me through the regulatory aspects of the earnings call.

Richard Kramer: Again, in the US, companies that are listed on the major exchanges are obliged to give a report or give an account of their performance every 90 days, and they have a limited window of when they can give that account. I think it had to be eight weeks after the end of the quarter. And then they have to file their official accounts in, again, in a timely fashion afterwards.

Now, if you go back and look at the Public Choice School of Economics, and the Nobel Prize that was won by George Stigler around the Theory of Regulatory Capture, it's this notion that the collective interests of industry, they can pour a lot more effort into crafting the legislation of what companies should do, which suits them, much more so than the overworked and under-resourced people in the regulatory agencies themselves, who might have thousands of companies to oversee, and really, at best, can spend time on a precious few in any given year.

And those lawyers working in the agencies, they might hope one day to leave government service, and go into private practice, working for law firms that are paid by those same firms that they're regulating. And certainly, that revolving door is getting a lot of scrutiny now in the UK, but it just shows that, frankly, the SEC has been, as we talked about, in the notion of accounting standards, really asleep at the switch, and allowing companies to take liberties with what they're obliged to do, or to fulfill really the least common denominator requirements of the regulation.

Will Page: I'm feeling that, so I could imagine a kind of sketch where, "I did a really good job regulating that market when I was in public service." "Really? How do you prove that?" "Because I did a great job in the private sector when I finished regulating it." It's that type of situation, right?

Richard Kramer: Absolutely.

Will Page: Okay. So, let's give the listening here an example of how to spot the good, the bad, and the ugly when they're on earnings calls. So they're tuning in, using some antiquated software to listen in, and you want to be able to kind of understand what makes an earnings call a good one. How do you know that you're in for a good effort reporting a company's quarterly results? What's the signs of good quality or best practice in an earnings call?

Richard Kramer: The best companies are the ones that they tell you to read the release, and give you time to do it. And then dispense with the marketing spiel of prepared remarks before they begin their questioning. It's really only the rare company that limits its opening remarks to five or ten minutes, as opposed to spending half an hour telling you what's in the release, oftentimes reading it, and then therefore limiting the time that they're actually under scrutiny from the analysts.

Will Page: And in terms of deflecting questions, I watched a documentary about Ronald Reagan called The Reagan Show, and the way that his publicist or his PR team were able to make sure that no journalist got to ask him an awkward question that he would have to answer, was to always him to the press when he was boarding a helicopter making all the noise in the world, point being that he couldn't actually hear the questions, therefore he couldn't give the answers. So I guess the good side here is to avoid that game, and make yourself open to Q & A.

Richard Kramer: Well-

Will Page: And while they're talking, you can't ask questions.

Richard Kramer: Well, indeed, and some companies tend to go into long-winded answers, or they just simply deflect the question.

Will Page: Now, in American politics, is that filibuster technique?

Richard Kramer: In a way, yes. But it's more like, if I asked you, "Will, could you please tell me what your net worth is?" And you'd say, "Well, I think measuring the value of assets is a critical function we have to perform as part of our fiduciary duty to our shareholders."

Will Page: [laughs]

Richard Kramer: The quick shift of a direct question to something into a glittering generality, I think, is a tendency you can see very frequently on earnings calls, when management wants to avoid talking about a subject.

Will Page: So being transparent to the audience, I guess. And now, let's go from the good to the bad. So let's say one of our listeners is listening to an earnings call, and they smell a rat. What are the signals that could deem an earnings call be going in a bad direction?

Richard Kramer: I mean, one of the things that makes a bad earnings call is long, rambling recitations of highlights from the quarter by the management team, or relentless-

Will Page: Which you've already read, right? They've already given that. That's duplication.

Richard Kramer: Whi- whi-... they've already given it in- in the statement, or relentless boosterism of their performance. And then taking a small number, say, five or six or seven questions, from analysts they know are already favorably disposed to the company.

And one thing you might look at is the number of people who are invited to ask questions on analyst calls, and the likelihood that their ratings on the company will be positive. So companies don't tend to want to-

Will Page: [laughs] Now we have correlation and causation.

Richard Kramer: They don't want to listen to critical questions on their earnings calls, they wanna leave people with a warm and fuzzy feeling that they're doing a great job. And a lot of times, those analysts will get on the call and ask about some incredibly minute, tiny detail, and try to inflate it to an importance and a significance that it just doesn't have.

Will Page: So we've got an example of a good earnings call, being transparent, getting to the audience, ducking no dodgy questions, just taking it all on the chair. And we've got bad earnings call, which is chewing up the clock, deflecting attention, talking across the audience. Let's get ugly. What's the signs when an earnings call's just got really ugly, where you should be pressing that cell button on your trading platform as soon as possible?

Richard Kramer: The ugly earnings call is typically one where the stock is plunging, oftentimes because of this incredibly myopic focus on a single number, and I call it, forget about missing the wood for the trees, there are people examining the lichen on the bark of the tree. They are looking at a tiny little number that may have no relevance to the business, long-term.

For example, an earnings per share number in a given quarter, which may reflect the timing of contracts, or exceptional gains. And they may lend that a weight or a significance that it just doesn't deserve. But the management either rallies around that celebration, or avoids it, and simply doesn't want to address the reasons why there's a problem.

And so they skirt the issue, or fall back into the meaningless marketing jargon along the lines of, "We have wonderful opportunities waiting for us just around the corner."

Will Page: Now, this reminds me of the film, The Big Short, as many of our conversations seem to take me back to that film, which is apt and ironic. But there's that scene with Steve Carell, who's asking questions from the floor to this investment banker on stage, whilst the stock is plunging, and he's completely deluded, and realizing what's happening to the stock price, and defending the company's position. Any reflections from the credit crunch where you're on earnings calls when the Titanic was clearly tipping towards the water? Any reflections on bad or ugly earnings calls from that period?

Richard Kramer: What we saw throughout successive bubbles is that companies will be in denial even after the writing is on the wall. So, you have the insulation of management from the practical realities of what's going on on the ground in their companies, is something you frequently see teased out in quarterly earnings.

Because oftentimes, the CFO is the last one to hear that the sales guys didn't seem to close the deals the quarter.

Will Page: Right.

Richard Kramer: Or that they've promised a big contract to come in, and-

Will Page: 'Cause you're surrounded by yes-men and yes-women.

Richard Kramer: Right.

Will Page: You don't actually get to hear the bad news in time for the bad news to hit.

Richard Kramer: So our key question, when something goes wrong with a company, it's a simple dichotomy. On the one side, are management simply incompetent?

Will Page: [laughs]

Richard Kramer: And if they stood up in front of you and said, "Everything was great," but they simply didn't know what was going on in their own business, or the alternative explanation, is they knew exactly what was going on in their business, but because they maybe have psychopathic tendencies, which lead them to be, uh, CEOs, they decided to tell you a story that they knew was untrue.

So they looked in the eyes of the investors, metaphorically, and told them something that they knew was false. And they did it to sustain confidence in the company, maybe to keep the confidence of the customers of the company, to make sure that they wouldn't abandon them. But that willingness to promote the company, irrespective of what's happening in the reality of the company, is something you see frequently on these earnings calls.

Will Page: So I wanna wrap up by just touching on the- the syntax of some of the words that we constantly hear here, and this goes back to what we said in part one about the algorithm looking for key words.

Now, when we had Theresa May as our Prime Minister in this country, she often referred to a strong and stable recovery. And that [laughs] almost became a catchphrase. Indeed, at the Edinburgh Festival was Strong and Stable Theater Production Companies doing shows just to make a mockery of that expression, strong and stable. What does a strong and stable recovery look like?

Richard Kramer: So there's a terrific example in just that word "strong," because you hear it all the time from companies. "We had another strong quarter."

Will Page: I hear that, you're right. You're right.

Richard Kramer: "It was a strong performance." You hear it all the time. And do you know why those companies use that word?

Will Page: I- I don't understand why Theresa May used that word, so forgive me for not understanding the companies either.

Richard Kramer: Because it's legally undefinable.

Will Page: [laughs]

Richard Kramer: Does strong mean that you-

Will Page: Ah.

Richard Kramer: ... can bench press 400 pounds? Smell like Muenster cheese? What does "strong" actually mean? There is no precise legal definition to say what strong and weak are. It's entirely contextual. And that means, if they get sued by an investor in a class-action lawsuit that says, "You misled us, you told us things were strong," they'll say-

Will Page: [laughs]

Richard Kramer: ... "Well, what does strong mean? You can't pin us down on that word."

Will Page: It's precisely vague. [laughs]

Richard Kramer: Absolutely. Another one of my favorite words on earnings calls-

Will Page: I gotta hear this.

Richard Kramer: ... and ana- analysts talk about this word all the time-

Will Page: Make it a 10.

Richard Kramer: ... they say, "It's another solid quarter. We had a solid quarter." Now, when I think of the word "solid," I think of it in the chemical context, and I say, "Well, I suppose it's better than the quarterly being gaseous, liquid, or plasma, because those are the other three states it could be if it wasn't solid."

But this notion of solidity, that it's a tangible reflection of the results, the reason it's used, and the reason lawyers who look over the language in these earnings releases, the reason those words are used is because they're legally undefinable. They are sufficiently imprecise that you can never be held to account, which is why, when a politician says, "We wanna be strong and stable," well, does any politician stand up and say, "We'd rather be weak and chaotic?"

Will Page: [laughs]

Richard Kramer: Um, no.

Will Page: These chemistry references make me wonder whether Walter White should start discussing your dividing words to be used i- in earnings calls, from the Breaking Bad series. And it also reminds me of the most famous lyric in hip-hop for me, which is the Jungle Brothers, "getting the message across without crossing over," how can I sell the company's earnings results without crossing over into liability? So just use a bunch of words that impress the market, but don't, you know, [crosstalk 00:21:28].

Richard Kramer: Absolutely. And there's a whole... there's a whole dog-whistle language that goes into earnings calls, where companies will hint that something good might happen, by suggesting, "Well, there's a lot of optionality there," or, "We see a lot of potential operating leverage."

Will Page: [laughs]

Richard Kramer: And this is like catnip to analysts that, frankly, a- as we say all the time on this podcast, they're paid to believe, they're there to be the cheerleaders. So they're going to take those statements about optionality or operating leverage, or fantastic opportunities, and write the fantasy script around them that assumes that the management is on track to deliver what they promised to investors.

Will Page: Yes, Richard, we have an example of that in the music industry as well, where we have words that we can use to get ourselves out of jail, when you haven't done your homework, you haven't listened to the album, you haven't got any feedback to give a band, you can always describe an album as just being a little bit too angular.

Richard Kramer: [laughs]

Will Page: And that band will rush back into the studio, hire an engineer, pay over the... over the arse to get a producer, and make the album slightly less angular. What the F does angular mean, when you're describing music?

Richard Kramer: As opposed to curvaceous?

Will Page: [laughs]

Richard Kramer: And Will, just to end, because we do it every session-

Will Page: Sure.

Richard Kramer: ... lemme give you a couple smoke signals on earnings calls. When managements are constantly beating their chest, and talking about how strong their performance was, the more time they spend promoting themselves, the less you should trust those promotions.

And the second thing to watch out for is just, take a look at an earnings call script of the prepared remarks, and cross out all the superlatives. One of the biggest tech companies in the world, fantastic marketing company, constantly talks about how incredible and amazing and wonderful and fantastic their technology is. But, you know what, cross out all those words, and just focus on the details of the numbers that they present, not the gushing self-praise. Because these are marketing events, these are the companies putting their best foot forward to investors, and you need to take a skeptical view of what the companies are saying, not simply write it down the way the stenographers do.

Will Page: Wise words. Grateful for that, and I'm sure our listeners are too. Again, the purpose of this podcast is to make sure you don't get fooled again. And I think this earnings call really contributes to that goal. And next week, we want to discuss benchmarking. Why is it that if you read all these analyst notes that are circled around your inbox, you'll just become a tracker fund. But for this week, I'm Will Page, here with Richard Kramer, and this has been Bubble Trouble.

If you're new to Bubble Trouble, we'd encourage you to follow the podcast wherever you listen. Bubble Trouble is produced by Eric Numen and Jesse Baker at Magnificent Noise. You can learn more at See you next time.