A CONKERS3 FEATURE : The Analytical Surveyor

Analytical Surveyor has worked for over 40 years in the City and West End of London as a real estate investment manager, an equity analyst, a multi-manager, a fund manager and as a researcher and strategist. In his area of expertise, he is highly regarded and currently works as a consultant.

There is an enormous amount of academic research that provides insights into the functioning of investment markets. Rarely will this help with stock selection, but much of it will help in understanding how and why the market functions the way it does. The Analytical Surveyor trawls through the work that is available in the public domain and summarises the work into usable notes for investors.

I recall that, as an equity analyst, I sat next to an accountant whom I knew well, at a company results meeting.  One of my peer group (from a competing house) asked the CEO about the performance specifics of a shopping centre that the company owned.  After talking around the subject for a few minutes, the CEO gave a couple of answers – but to a somewhat different question than the one that had been asked.  ‘The wrong answer’, I mumbled to the accountant.  ‘How do you know?’ she asked.  ‘Because we all know what the right answer is’, I replied.  ‘Then why ask the question?’  ‘Because we wanted him to just say it’.

I am sure that we all experience similar reactions when we see politicians being questioned in the media by astute journalists.  Their answers can have a bearing on their potential to secure votes, but the safest course for most of them is to avoid saying something that could be embarrassing or might have the opposite effect to attracting votes.  Better to say nothing than to say something risky appears to be the advice that they receive.

Similar situations arise when managers are questioned by analysts or investors, as my example above indicates.  But does the action of the management not responding to the requirements for information have an impact on the share price of the company?

Some analysis has been undertaken of the written communications by company managers to their investors, including attempts to quantify the complexity of language, the volumes, etc., but little about how managers actually perform in presenting and interacting.  Yet, with the advent of increased bandwidth of audio and video communications, this has surely become more important than it was even a decade ago.  Research[1] undertaken by Andreas Barthy, Sasan Mansouriy, Fabian Woebbekingy, and Severin Zoergiebely explores the oral side of information provided by managers.

They introduce an innovative approach for measuring managements’ unwillingness to orally share precise information, which they call ‘management blathering’. Their measure is based on the prevalence of financial words in the Q&A section of earnings calls for all financial firms in the S&P 500 Index, and is defined as the inverse of the factual content of management responses as measured by the number of finance-related words relative to the total word count.

The relevance of financial words, in particular, to financial companies is obvious and it is also likely that, for most companies, questions will focus on financial aspects of the companies’ performance. It is, however, a fairly crude approach, and therefore probably is a good measure in the round rather than in specific circumstances.  But the paper also deals with tone sentiment and the uncertainty of the language used in earnings calls, and these characteristics are also analysed.

The main objective of the work is to address two research questions.  First, how stock markets react to blathering and whether it is perceived as noise that reduces the informational content and leads to higher uncertainty, which eventually results in lower stock returns. The results show strong evidence that markets react negatively to management blathering: Increased blathering leads to decreases in abnormal stock returns.

Second, whether ‘earnings management[1]’ motivates the managerial team to blather. If firms are prone to earnings management, blathering might be particularly high in earnings calls with little or no positive earnings surprise.  Indeed, the authors find evidence that blathering is particularly pronounced where the reported earnings are just around the analysts’ expectations.

The sample set of companies’ oral results presentations are divided into four quartiles.  The abnormal stock returns around the day on which an earnings call is held are plotted for the highest quartile of blatherers and the lowest quartile of blatherers.  The returns of these two groups show hardly any difference in the days prior to and after the earnings call.  However, there is a clear pattern for the two groups around the day of the event: as the earnings surprise is positive on average, both groups show a positive cumulative abnormal return around earnings calls. Yet, the magnitude of the positive change is larger for calls with low blathering.

Further analysis confirms that markets react with positive abnormal returns after an earnings conference call if the management uses more positive words relative to negative words.  Blathering has a negative effect on returns; it never pays off whether it is a small amount or blathering or a large amount.  The argument that the amount of blathering is due to managers deliberately obfuscating information on their earnings is supported by the empirical evidence.

The results show that the market punishes blathering managers, i.e. having a lack of factual content.  Firms in which managers blather more, experience significantly lower cumulative positive abnormal returns following their earnings calls.  So, if you feel irritated by blathering or obfuscation, you are apparently not alone.  Markets react badly to it, either because of how the analysts reported (perhaps in their tone and language) on the results or because of the investors’ direct reaction.

The implication is that either the management is not aware of what it is doing, or it sees this as a better alternative than being clear and open.  If it is the latter, it suggests that there is something to hide.  What this research does not reveal is the alternative: if the managers were open and honest about some negative aspects, would the market have responded better than if they had blathered?

[1] How to talk down your stock returns, 18 February 2019, Andreas Barthy, Sasan Mansouriy, Fabian Woebbekingy, and Severin Zoergiebely.

[2] Earnings management is the use of accounting techniques to produce financial reports that present an overly positive view of a company’s business activities and financial position. Many accounting rules and principles require company management to make judgments following these principles. Earnings management takes advantage of how accounting rules are applied and creates financial statements that inflate earnings, revenue, or total assets. (Source: Investopedia)

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