Matt Levine, 04 May 2021
One theory is that the price of a share of stock reflects the present value of its future cash flows in perpetuity. People buy stock today not because they expect high profits tomorrow, but because they expect high profits over the long run. Investment decisions that cost money today, but that will bring in much more money in five years, increase the net present value of the stock, so the shareholders should support them.
Another theory is that public markets are myopically focused on the short term. Investors care only about this quarter’s earnings; they buy stocks whose earnings go up each quarter and sell stocks whose earnings go down. A decision that reduces earnings today, in exchange for higher earnings in the future, is bad, and shareholders will punish a company that makes those decisions.
These theories obviously conflict, and I am mostly inclined to believe the first one. The number of zero-revenue electric-vehicle companies that go public at multibillion-dollar valuations seems to me like proof that public stock markets can look past this quarter and consider future profits. Still, for most regular companies, this quarter’s earnings probably are the best evidence of what future earnings will look like, so investors do tend to care. And public-company executives — not all of them, but some of them — do sometimes get locked into a myopic obsession with each quarter’s numbers.