Aswath Damodaran warns against disclosure diarrhoea. Why the valuation guru wants Wall Street to end quarterly earnings

While the earnings season is in full swing, valuation expert Aswath Damodaran argued against quarterly earnings reporting, saying that such frequent announcements, in reality, lead to less information being passed on to investors due to a phenomenon he called "disclosure diarrhoea".

While market regulators around the globe call for more transparency, the 'Dean of Valuation' believes that there is nothing inherently good about having more disclosures. In his long blog post, Damodaran noted that most stock market investors in the US and other parts of the world spend their investing lifetimes in an environment where companies not only release full financial statements every quarter, but do so with huge fanfare. He highlighted that these quarterly earnings reports have bulked up in size over time, undercutting their usefulness.

As markets actively await earnings prints to see if they beat or miss analysts’ estimates, Damodaran explained there are no easy wins in this game, and as more and more people play the earnings forecasting game, "new wrinkles" have emerged. Some companies have used the flexibility in accounting rules to find ways to beat analyst estimates, with tech companies, in particular, standing out.


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Why less frequent earnings reporting may be helpful

Much of the debate regarding whether the US should shift away from quarterly to semi-annual reports can be boiled down to the magnitude of time and energy that investors as well as companies spend playing the earnings game, and where that time and energy will be spent in the absence of quarterly reports, said the expert, who is Professor of Finance at the Stern School of Business at New York University.

“Those who advocate for less frequent reporting are of the view that the earnings game, focused as it is on next quarter's earnings estimates and whether the company can beat them, contributes to short-termism and distracts from fundamentals. Those who are pushing for preserving the status quo (of quarterly reporting) believe that removing quarterly reports will just shift the game, perhaps more intensively, into the semi-annual reports and that there is value to long-term investors from having quarterly reports, gaming notwithstanding,” he added.

Benefits of quarterly earnings disclosures

However, what will happen if quarterly reporting is completely wiped out? Damodaran warned that this can lead to insider trading, as insiders (from within and outside the firm) trade and make money on material information that they have access to, but the public does not.

As an investor, Damodaran noted that he also likes quarterly reporting for two reasons. Firstly, there is information in these reports that lets him update his company valuations, and secondly, they act as a catalyst for sharp movement in the stock price of over- or undervalued stocks.

What Damodaran advises

Concluding his arguments, Damodaran said he is less of an absolutist about the quarterly versus semi-annual reporting debate. According to him, rather than reducing the frequency of reporting, the SEC should be looking at slimming down reports, by replacing one-size-fits-all disclosure requirements with targeted disclosures and keeping the focus on reporting what has happened rather than prognosticating about the future.

Speaking about Fed chief Kevin Warsh’s statement that the American central bank should provide less guidance to financial markets on future decisions, the valuation expert said less is more is a better strategy - less guidance from the Fed about what it will do in the future, less opining from FOMC members about interest rates and the economy and less attention to FOMC meetings and the smoke signals that emerge from these meetings. “Markets will step in to fill the vacuum, and that is good not just for investors but for the Fed, since its decisions are informed by those market judgments,” he concluded.

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(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)