Publications
Earnings is not enough
Ask most chief executives in the UK what they are required to focus on, if they are to satisfy the stock market and maximize the stock price of the company they run, and almost invariably the reply is: "I need to maximize earnings and to show a steady earnings growth, quarter by quarter". Most of what one hears from UK finance professionals seems to confirm this perspective. Chief executives are taught to fear that a drop in reported earnings – or an equity analyst's 'adverse earnings report' – will lead to an immediate (and often substantial) fall in the stock price. Many chief executives consequently bemoan the short-sightedness of the market and the fact that, apparently, a long-term perspective is not rewarded by the market or its commentators.
The view that 'earnings is everything' influences the vocabulary of stock market discussions. In particular, two measures have come to dominate discussions of stock prices: earnings per share (EPS) and price/earnings ratios (P/Es). There is a strong consensus about the ways these measures are correlated with stock price: commentary such as, 'EPS should rise by 10% over the coming period, with a corresponding increase in stock price' or 'the P/E ratio is at an all-time high – can this be sustained?' is commonplace.
The issue may seem trivial – an academic dispute. But if UK managers do not have a clearly articulated, and communicable, vision about what drives their stock price, then agreeing a coherent business strategy becomes far more difficult. Investment decisions; internal performance measurement; the basis for managers' rewards: all of these, and more, become distorted. PA Consulting Group believes it is essential that UK companies move away from the EPS-P/E bind and start focusing – in this capitalist economy of ours – on the real issue: return on equity capital.
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