Skimpy financial disclosures leave plenty exposed
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Jeffrey Goldfarb
NEW YORK, Sept 25 (Reuters Breakingviews) -Sometimes less is just less. Imagine being tasked with understanding a $160 billion company that helps sell billions of products to shoppers around the world. And yet, upon opening its most recent annual report, there is precious little to see. While some chief executives prefer to keep as much secret as possible, financially speaking, new guidelines are set to at least reduce some of the opacity. Furtive number-crunching also comes at a price.
Consider the aforementioned example, e-commerce outfit PDD PDD.O, which owns marketplaces Temu and Pinduoduo. It can afford to be stingy with specifics, at least for a while, safe in the knowledge that fast growth will attract more than enough investors fearful of missing out. For more diligent allocators of capital, management notes that it uses “certain key operating metrics to evaluate the performance of our business.” Whatever those may be remains a mystery. Available to outsiders in the yearly foundational document are the two sources of the company’s $35 billion in revenue and generic buckets of lump-sum costs like “sales and marketing.”
Interested in how PDD is doing in China, the United States and dozens of other markets? Try figuring it out with the knowledge that it has 90,000 square feet of office space worldwide. Even such basics as how many different products and the total value of merchandise it peddles are left for independent research firms to guesstimate.
And so, despite a near doubling of revenue and profit in the most recent quarter, the China-based, U.S.-listed enterprise suffered a roughly 30% hit to its market value in a single day last month. Investment analysts partly chalked up the damage to the dearth of financial information. The stock price has since recaptured less than half its losses.
Such disadvantages compound for the reticent. For instance, fuller disclosure tends to lower a company’s cost of capital, according to research published in the Annual Review of Financial Economics and elsewhere. Investors backing companies that provide more detail also typically are rewarded with steadier returns and more liquid markets to buy and sell shares. After all, they can better scrutinize cash flows to reach a more informed assessment of valuation. Little wonder that 75% of those polled by the CFA Institute a few years ago rated disclosure on business segments as “very important,” with eight out of 10 respondents expressing dissatisfaction about how much is made available.
Frustrated investors are finally getting a helping hand. Two separate organizations that oversee U.S. and international accounting standards are poised to roll out similar changes requiring companies to release more detailed explanations of their expenses.
PDD is one of many that will have to make significant updates when the rules take effect in a couple years. There’s plenty of room to open up. Take Home Depot HD.N, another sprawling vendor with bountiful shelves. In its annual report, the $390 billion home improvement chain led by Ted Decker specifies that a typical store stocks 30,000 to 40,000 items in an average of about 130,000 square feet, with a state-by-state breakdown of its locations. This facilitates a sales-by-area figure alongside an inventory turnover ratio the company discloses. There are even net sales listed for 14 broad categories of merchandise, such as appliances, lumber and tools, to help illustrate more granular variations in growth. The company also makes available the number of customer transactions and how much shoppers spend per visit. It spells out return on invested capital, too, with a step-by-step explanation of how the figure is calculated.
Home Depot says it aims to give shareholders the information they need to “measure the health of our business,” periodically updating what it provides based on accounting rules and industry norms. For a company so intimately tied to the health of U.S. consumers, it offers a wide array of investors the chance to probe for worrying or encouraging signs in the economy.
It also knows the harmful power of surprises. Home Depot suffered two one-day drops of 28%, in 1984 and 2000, after catching shareholders off-guard with weaker profit forecasts. Since then, though, it has experienced only a handful of daily market-cap losses of more than 10%, according to LSEG. Moreover, the company commands a premium to rival Lowe’s LOW.N, measured by a multiple of its expected 2025 earnings, per Visible Alpha, while PDD trades at a discount to peers Alibaba 9988.HK, JD.com 9618.HK and Meituan 3690.HK.
Many companies are nevertheless reluctant to go along with the revised disclosure program. Paint-maker Sherwin-Williams SHW.N, IT services provider International Business Machines IBM.N and drugmaker Pfizer PFE.N are among those that pushed back against the Financial Accounting Standards Board’s plans to force quarterly reporting of some disaggregated expenses, including inventory purchases, employee pay and depreciation of intangible assets. They balked at the cost, without enough perceived offsetting benefits, and claimed that it would be virtually impossible to compile the information using their existing systems.
Tom Quaadman, lobbying on behalf of the U.S. Chamber of Commerce and its Center for Capital Markets Competitiveness, went further, questioning the basis for the disclosure initiative by arguing that half of publicly traded equities are held by passive investors who are presumably less inclined to act on any additional information. He also noted that two-thirds of U.S.-listed companies aren’t tracked by a single analyst, implying that companies could be spending time and money only to send all the new data into a black hole.
The flimsy complaints failed to carry the day, with the reporting changes due to take force in 2027, though the U.S. accounting overseer did tweak some provisions. There is another, perhaps less noble, reason for management to rationally oppose the reforms: South Korea’s experience two decades ago.
In 2004, the country’s financial regulators ended mandatory reporting of expense specifics related to raw materials, labor and overhead. Research from the University of Chicago’s Booth School of Business subsequently found that gross profit was almost 2 percentage points higher and productivity growth stronger for companies that stopped disclosing such information. A follow-up experiment also discovered that managers they surveyed said they were less likely to seek new ways to cut costs if granular figures had to be revealed, because rivals would copy them, and instead would devote resources to improve and invent products.
However realistic the concern may be, it’s less compelling for any economy-wide authority. Diffusion of cost-saving techniques is a net positive, and sufficiently competitive markets should theoretically act as a backstop ensuring that companies keep exploring new ways to slash expenses. Ultimately, to ensure that markets stay deep and open, stock valuations reflect reality as much as possible, and capital gets where it’s best deployed requires ever-improving disclosure, standardization and trust in the price mechanism to sort everything out. It may not be great for guarded CEOs or fund managers with proprietary research that discerns the ingredients in a company’s special financial sauce. For them, though, there will always be places to take more risk.
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Investors want more info about business segments https://reut.rs/3THB1TU
Editing by Jonathan Guilford and Pranav Kiran
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