Short-term Thinking Magnifies Risk

We always talk about the harm short-term thinking can inflict on your investment portfolio. Now, a new study from Professors Francois Brochet, Maria Loumioti, and George Serafeim at Harvard Business School further explores the risks for companies and investors who are attracted to short-term results.

Not surprisingly, their research shows that companies with short-term mindsets attract short-term investors looking for quick payouts. This naturally puts pressure on the company’s executives to generate positive returns, and short-term oriented corporate managers are therefore more likely to take risks to deliver the performance their investors demand. In fact, the short-term companies studied had more volatile stock returns and higher estimated cost of equity capital, two characteristics that make them riskier than companies with longer-term investment views.

It follows, then, that investors looking to temper the volatility of their portfolio should consider the short- and long-term goals of the company before they invest. But just how does one determine whether a company thinks long- or short-term? The Harvard professors studied transcripts of 70,042 earnings calls held by 3,613 firms from 2002 to 2008. They searched for 14 terms used by management such as "latter half" and "weeks" that would suggest a short-term view, versus 15 words or phrases such as "long term" and "years" that likely would dictate a longer time horizon.

Harvard Business School Assistant Professor George Serafeim said one important takeaway from his research is that many companies are, in fact, being managed for the long term. he noted. According to the researchers, industries focused on long term include beverages, retail, pharmacy, and medical goods. In particular, they singled out Coca-Cola, Ford, and Nordstrom as long-term thinkers. Short-term-oriented industries included banking, electronic equipment, business services, and wholesale, with Cisco, Goldman Sachs, and Chevron on the short list.

Of course, investors should still focus on building a diversified portfolio with the proper allocation based upon their goals and risk tolerance.