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Profit warning: earnings are over-rated

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Via Financial Times

People are suddenly worried about profits. Goldman Sachs chief executive David Solomon reacted to the implosion of property group WeWork this week with the thought that “it’s important for people to grow, but there’s got to be a clear and articulated path to profitability. I think there’s a little bit more market discipline coming into play.”

Mr Solomon was roundly accused of stating the obvious. Of course earnings are what count. Sales are vanity, profits are sanity!

But profits are over-rated. Focusing on the bottom line can produce bad results. There are plenty of profitable companies languishing on moribund European stock markets, which are sapped of vitality or growth.

In the US, public markets have neither lacked discipline nor — as they are often wrongly accused — been guilty of short-termism. They facilitated the growth of Amazon, while it racked up losses and meagre profits during a dash for dominance in ecommerce and as it invested heavily in an entirely different business: cloud computing.

US public investors are not gullible, though. They shunned the attempt by Goldman and other banks to sell them WeWork stock. The lack of discipline was in the private sphere, where investors ascribed a $47bn valuation to a company with a flimsy business model and disastrous conflicts. Goldman itself torched $80m last quarter with its own investment in WeWork.

It is true that ignoring profits altogether can be perilous. SoftBank, the Japanese tech group that is WeWork’s main backer, spent much of its results presentation this week explaining why shareholders should ignore a ¥700bn ($6.4bn) quarterly loss.

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“Not profit from [an] accounting perspective, but shareholder value — that’s the biggest and most important measurement for us when we run the business,” said chief executive Masayoshi Son.

Mr Son mentioned “shareholder value” 22 times. “In the period when we recorded the biggest loss in our corporate history, shareholder value increased by ¥1.4tn,” he said, unconvincingly.

It is not a particularly compelling concept. The biggest component is SoftBank’s shares in Alibaba. Investors may as well buy into the Chinese ecommerce group directly.

But there are other excellent reasons to ignore profits and indeed to make as little as possible. Take John Malone, the “cable cowboy”, who once said: “I used to go to shareholder meetings and someone would ask about earnings, and I’d say, ‘I think you’re in the wrong meeting’.”

While his competitors in the cable TV business were busy issuing equity to grow, which protected their profits, Mr Malone’s TCI did the opposite, borrowing heavily to buy assets and then suffering a hit to profits from the interest and amortisation.

“It made our earnings look awful, but it meant we were sheltered from income tax and we weren’t diluting that common equity,” he said.

Perhaps you are still unconvinced. Profits are sanity! Then go buy some. Mr Solomon’s bank and others will soon try to sell Saudi Aramco shares. The state-owned oil company made net profit of $111bn last year.

Crown Prince Mohammed bin Salman would like a $2tn valuation. It comes with vast financial risks and ethical questions, but, hey, it is the most profitable machine on the planet.

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