The Financial Times reported yesterday that an embarrassed GE CEO Jeffrey Immelt had to tell GE shareholders that the 10% growth in earnings for 2008 that he had promised analysts in March was not going to be possible. GE missed its quarterly forecasts and halved its 2008 forecast to 5% growth in earnings (as opposed to the 10% growth promised). The Financial Times article mentioned a “sense of shock among the investor community” and noted that one analyst, after Immelt’s downward revision, “compared GE’s promise of long-term improvements to the Chicago Cubs, the US baseball club that hasn’t won a championship in 100 years.”
Upon reading this FT article this morning, I thought “oh, dear God. Do we remember none of the lessons learned just a few years ago about the perils of over-promising results to analysts?” Why, exactly, does Immelt feel the need to promise a 5% increase in earnings for 2008 when (a) we are in a credit crunch, (b) GE is likely going to have to do more write-downs this year, (c) the cost of inputs is increasing, if not skyrocketing, (d) inflation is high, and (e) the economy is weak (among other things)? Why is Immelt promising *growth* in earnings when the reality is that just achieving positive earnings for 2008 is likely to be good thing? Why is Immelt putting pressure on himself and his officers to produce growth?
Memo to Immelt: Earnings do not have to grow each year. In some markets, in some economies, in some industries, in some “downturns,” simply having earnings – any positive earnings – is a good thing. Matter of fact, sometimes earnings should NOT be growing each year. Were I a GE investor, I would not want Immelt promising 5% growth for 2008 because I would figure that the only way he can promise to hit that number in such an uncertain market and gloomy economy is by commiting to fudge year-end 2008 numbers if needed. And, as we learned several years ago, fudging year-end numbers tends to catch up with companies, and, when it does catch up, the valuation fall-out is worse than if the forthright disclosure (e.g. “2008 earnings might be flat”) had been made initially. Am I the only one who remembers back to the not-so-distant past, when unrealistic promises made to analysts by corporate officers led to companies cooking their books at year end to make the numbers? As I recall, things did not always work out so well in those cases. Enron, anyone?
Surely it is enough for a company in some years to produce returns that are merely equal to the prior year’s, as opposed to “besting” the prior year’s earnings. Didn’t we learn this lesson several years ago? Investors are supposed to invest for the long term and diversify.According to the FT, one of the reasons why GE missed its quarterly numbers recently is because GE was unable to close “$900m-worth of real estate asset sales,” which the FT referred to as “a traditional way for GE to boost quarterly returns.” If I were a GE investor, I would be peeved to read this. I would rather GE just do the real estate deals when they make the most sense, when the market is most favorable for the deals at issue, regardless of when the gain/loss woulbe be booked. If that means GE misses its numbers sometiemes due to the lack of a crystal ball regarding the best time to sell the assets, and I take a short-term valuation hit (on paper) as a GE investor, so be it. It doesn’t create long-term value for shareholders if GE rushes through real-estate transactions just to make the numbers if the timing is not sensible for the transactions and waiting a little bit of time would garner value for shareholders.(The FT reports that “GE slashed its 2008 earnings forecast from $2.42 per share to $2.20-$2.30 – still an increase of as much as 5 per cent from last year.” Slashed? Slashed? Are you KIDDING me? “Slashed” implies something negative. Earnings of $2.20-$2.30 per share for a year that is not likely to shape up particularly well would be good.)
The reason companies do it is to keep the investors fat and happy. Doesn’t always work, but that’s the goal.
And Welch was able to keep the earnings up in the range he predicted. Those of us long in GE flourished throughout his reign.
Now we’ve got Immelt who overpromises and underdelivers. That was $50 billion in shareholder value that went away as a result.
I don’t care how you massage the numbers or manage expectactions — just keep hitting targets and don’t do anything illegal. Is that too much to ask?
Apparently for Immelt it is.
Immelt may be no Jack Welch, but he is his progeny. Welch was a master of earnings management in both the good and bad sense of the word.
Look at the disclosed earnings per share of GE over Jack’s reign. Steady growth—10 to 15 percent per year—just as promised, year after year. I used to show GE’s earnings chart to Wall Street analysts that I trained on governance issues and asked them, “How many of you believe this chart? How many of you believe that a company in cyclical industries like medical devices, aircraft engines, and financial services can deliver such regular growth. Jack must be a genius. One industry surges ahead just as another one hits a bump–year after year.” No one ever raised their hands, including the analysts covering GE.
Immelt’s misfortune is being groomed as CEO by a master earnings manipulator, but becoming CEO in an age where some of those manipulations are no longer acceptable.
Why only some?
I define two classes of earnings management: (1) accounting manipulation and (2) short-term decisions. The former simply affects how numbers lay on the page; it has no effect on actual cash flow. The latter represents things like deferred investment or, in the case Elizabeth points out, ‘timely’ asset sales; these items actually current and future affect cash flow. I note that the first class of earnings management has gotten severely constrained by tighter accounting rules and oversight.
So, guess what managers bent on earnings management will resort to? A 2005 study by Graham, Campbell, and Rajgopal found that over 75% of top managers would sacrifice economic value via short-term decisions in order to “make their (promised) earnings numbers.” This second class of earnings management is not even on anyone’s radar. Most directors don’t know about this issue until I introduce them to it. Like Elizabeth, I’m appalled that companies do this stuff, but I’m more appalled that they do it so openly (like they used to get aware with accounting manipulation), and no one is calling them on it.
The real problem is that Immelt seemed to be “surprised” by the earnings shortfall, and that’s why the shares got hammered after the announcement. Instead of managing expectations, Immelt raised them unrealistically.
40% of GE earnings come from financial services, and he didn’t see this coming? Even if the non-financial divisions see a 10-15% increase, that’s wiped out by the financial division losses.
Immelt is no Jack Welch, and he should go. He has brought no shareholder value to the company.
GE would be best served by breaking up the company, since it can’t perform successfully anymore as a huge conglomerate.