For several years I have argued, based on comprehensive statistical evidence, that corporate financial reports―quarterly and annual statements―have lost most of their relevance and usefulness to investors. Corporate earnings, in particular, are no longer a reliable measure of enterprise value change, nor are they indicators of future performance and growth. In fact, as I have shown on this blog (“The Unbearable Lightness of Earnings,” April 15, 2018), even if you could predict all the public companies that will meet or beat analysts’ consensus estimates next quarter you will barely cover your transaction costs.
Some, though by no means all, of those exposed to my message, still find it unbelievable. “There is still lost of valuable information in financial reports,” is a comment I often hear, though without much evidential support. An article of faith, so to speak.
So how surprised I was to read a recent study by Tim Loughran and Bill McDonald, both respected finance researchers who developed a widely-used software system for textual analysis. Loughran and McDonald documented the number of downloads of annual financial reports (10-Ks) from the SEC EDGAR (Electronic Data Gathering and Retrieval) server log.* EDGAR is the go to place for corporate financial reports. All public companies have to file their SEC reports through EDGAR, and the SEC makes these filings immediately public. So, if you are an analyst, investor, or a researcher, you go to EDGAR for your information.
So, take a guess: how many 10-K (annual report) downloads gets the average public company? Thousands? Tens of thousands? Not quite. Would you believe 28? Here are Loughran and McDonald (p. 3):
“The punchline of our paper is the surprisingly low number of investors who access the annual reports of publicly-traded companies at the time of their initial filing. The average publicly-traded firm has its annual report requested from the EDGAR site only 28.4 total times by investors on the day of the filing and the following day [28.9 times in five days]. On its filing date, the median publicly-traded firm has only nine 10-K requests.”
28? 9? There are many more people working at the FASB―the accounting regulator―than financial report readers.
Loughran and McDonald mention GE (General Electric) with 40% of its shareholders being retail investors, and with a large pool of retired employees who presumably are interested in the company’s finances. Yet, in June 2, 2015, the Wall Street Journal quoted GE’s CFO noting that its 2013 annual report was downloaded only 800 times from GE’s website during the entire year.
The 10-Ks of large companies with many investors and analysts are downloaded more frequently, of course than 28 times, but not much more. The 20% largest U.S. companies get, on average, 96.2 total 10-K downloads during the filing day and the subsequent four days. 10-Q (quarterly reports) are downloaded even less frequently.
And, as we all know, downloading a document doesn’t necessarily mean that you read and carefully analyze it. All this led the researchers to conclude (p. 4): “Investors do not appear to be trading on information contained in the 10-K at the time of its filing.” That’s what I was saying for quite some time. Most of the accounting-based information is stale by the time it is published, and doesn’t reflect economic reality. No wonder investors shun this information.
In my recent book, The End of Accounting, I (with Feng Gu) devote seven chapters to a detailed statistical analysis demonstrating the sharp decline in the usefulness of corporate accounting information (we also discuss the reasons for the downfall as well as propose improved alternative information). I almost feel that all this evidential effort is redundant in the face of investors’ rejection of financial reports, as documented by Loughran and McDonald. Voting with the feet is the most effective way of voting. In forthcoming posts on this blog I will discuss more timely and reliable sources of information for investors.
* See Loughran and McDonald, 2018, The use of EDGAR filings by investors, Journal of Behavioral Finance, forthcoming.
Baruch Lev is the Philip Bardes Professor of Accounting and Finance at the Stern School of Business, NYU. This article first appeared at the Lev End Of Accounting Blog and is shared here with his permission. Professor Lev is not affiliated with Knowledge Leaders Capital and his opinions are his own.