The problem with short-termism in investing

The market has a major problem – investors are too short-term in their thinking and it causes wild share price swings. The situation is getting worse, and it presents a problem for everyone with money in the market, even those who are in it for the long haul.

Being patient and not swayed by ‘noise’ is good practice when you are investing money. A financial adviser might say it is best to focus on the long-term, and fund managers will also follow this path. That is easy to say, but it can be hard to ignore day-to-day share price movements.

It is important to understand why shares are moving in a certain way, particularly if they are falling. However, making investment decisions purely off short-term share price movements can be dangerous. You are at risk of making knee-jerk reactions without any rational analysis.

Airbnb is a victim of short-termism

Airbnb is a perfect example of short-termism at work. Its share price fell 7% on 9 May despite reporting nearly double the level of earnings forecast by the market for its first quarter. Unfortunately, Airbnb’s weak guidance on the second quarter gave the market a bite worse than bed bugs.

The bulk of the Easter weekend falling in March rather than April effectively pulled forward seasonal demand into Airbnb’s first quarter reporting period. That removed a traditional second quarter sales catalyst. Throw in one-off payment processing issues and higher marketing expenses and investors have taken it to mean the end of the world. In reality, this is only one quarter’s performance potentially being weaker than normal.

The stock market is forward looking and prices in what it thinks will happen in the future. However, put a single obstacle in the way and investors cannot think beyond two or three months. By the time summer is over, Airbnb will have the fallout from the Easter timing in the rear-view mirror, so why is the market fretting so much now?

Certain company bosses are part of the problem

There is evidence to suggest investors are not the only ones being too short-term in their thinking. In certain instances, management teams have been too focused on hitting quarterly targets and are not running the business with a long-term perspective. That seems to have rubbed off on investors as they increasingly judge a company on what it has done over a mere 12-week period.

For example, management teams might have prioritised near-term shareholder interests and short-run profitability over the long-term growth of the firm.

Certain companies do everything they can to meet quarterly earnings estimates at the cost of long-term investment. It is easy to trim back spending on research and development, advertising, maintenance and hiring, for example, but what if that means competitors do clever things in the interim and get a step ahead? These rivals might reap the benefits of taking a longer-term view about what is best for their future.

The oil industry is a good one to consider. The world is shifting to renewable energy but companies like BP and Shell are under pressure from shareholders to sweat their oil and gas assets and not rush with their energy transition investments. That might keep current earnings sweet, but is this short-term thinking going to backfire down the line when they are behind with establishing power in the green energy world?

Too many people are impatient

Equity research also places a big emphasis on short-term performance and that can rub off on investors. Furthermore, the rise of social media has fuelled the ‘I want it now’ mentality for information, and companies can receive widespread criticism if they fail to hit market expectations at quarterly or half-yearly results. This creates a vicious circle where other investors start to put more emphasis on quarterly performance because they can see that is how the crowd is judging a company.

Five years ago, the European Securities and Markets Authority (ESMA) started to collect evidence of short-term pressure from capital markets on corporations. Its report published in 2020 pinpointed examples of short-termism including remuneration for company executives, and fund managers running portfolios on behalf of investors, rewarding short-term profit seeking.

The fact chief executives are spending less time in the role before leadership changes also implies short-termism. The mean duration of departing CEOs from the world’s largest 2,500 companies declined from approximately 10 years in 1995 to around six years in 2009, according to ESMA’s report. Company bosses get the top job, do everything they can to grow earnings and make their mark, and then move on. There is a risk they make the wrong decisions simply to show rapid results.

What can investors do?

It is clear there is not a single solution to these problems. All an investor can do is take a step back, show restraint when they obtain a new piece of information relevant to their portfolio, and take time to weigh up the facts.

A wise man once told me to stop looking at share prices each day. They suggested ‘a sneaky peak once a week’ might suffice. Even that is too often.

You buy a car hoping it will be roadworthy for years to come, but very few people – unless they are fanatics – will look under the bonnet each week. They may check the oil or windscreen fluid once a month or so, but otherwise they rely on an annual MOT to ensure everything is on track. Try following that approach with investment portfolio management.

Past performance is not a guide to future performance and some investments need to be held for the long term.