Headstart: Management - Injecting realism into the market.
The semi-annual publication of results is a company’s key means of communicating with the market. Analysts pore over the information provided to produce their buy, hold and sell recommendations. Institutions consider these recommendations and their own analysis in making the buy and sell decisions that drive prices. Is this a good game to play? Well it’s capitalism and it has made the world rather wealthy so it is a good game. But could it be played better? Of course it could. The analysis that analysts do is essentially to forecast the future results of the company in order to judge whether the current share price is too high or too low. And very laudable this is too. It keeps management on its toes and makes the market better informed. But the market would be much better informed if management were to make the forecast in the first place and analysts were to criticise it. This would be a wonderful incentive for managements. Make the forecast too low and you will be removed for lack of ambition, make it too high and you will be removed for lack of achievement. We might get some realism in the market. Can managements make such forecasts? Of course they can. They do. They call it a budget (or a five-year plan). If the annual report and accounts contained management’s forecast for the coming year – that is management’s budget – the whole market would become much more efficient.
The debate between analysts and management would become more incisive, constructive, insightful. There would be a more informed approach to rooting out bad management and directing capital towards the good companies. My pension fund would improve in value.
So why doesn’t this happen? An excuse that is often proffered, with some justification, is that if a company has made a forecast, then in the event of a transaction arising while that forecast is still current, reporting accountants will be required to verify the forecast.
However, this Stock Exchange rule could easily be withdrawn. The real reason is of course that no management in its right mind will offer a forecast if it doesn’t have to, since in the absence of this being a requirement, they are merely making themselves hostage to fortune.
Answer: let the Stock Exchange require there to be a further column of numbers in the annual report and accounts giving management’s budget for next year.
And three cheers for the ICAEW which in its recent report, Prospective financial information: challenging the assumptions, set out guidelines for how the Stock Exchange should handle forecasts and projections. A very useful step forward towards efficient capital markets.
– Neil Chisman is a member of the Financial Reporting Council and a former finance director of Stakis and Thorn.