Earnings Don't Matter After All!

Via The Knowledge Leaders Capital blog,

Our long-time readers are familiar with the work of Professor Baruch Lev of the NYU Stern School of Business, whose research forms the basis for the Knowledge Leaders investment strategy. In his decades-long study of financial records, Lev first discovered a link between a firm’s knowledge capital and its subsequent stock performance, ultimately identifying a market inefficiency that leads highly innovative companies to deliver excess returns. We call this market anomaly the Knowledge Effect.

In a new article in Financial Analysts Journal, Lev and co-author Feng Gu continue to advance the findings on intangibles. The article, “Time to Change Your Investment Model,”  identifies that earnings prediction has lost “much of its relevance in recent years.”

As a form of predicting corporate results, “earnings no longer reliably reflect changes in corporate value and are thus an inadequate driver of investment analysis.”

The basis for this shift, the authors explain, occurred after the emergence of the semiconductor.

Starting in the early 1980s, investment in traditional, tangible assets (structures, factories, machinery, inventory) – considered assets by accountants and reported accordingly on the balance sheet – dropped precipitously from 15% of gross added value in 1977 to 9% in 2014, a 40% drop.


In contrast, the investment rate in intangible capital (R&D, patents, information systems, brands, media content, business processes) – mostly expensed in corporate income statements – increased continuously from 9% to 14% of added value, a 56% increase. This radical business model transformation came to be known as the knowledge – or information revolution, an irreversible trend in developed economies.”

As a result, for companies, “the only way to survive and prosper in such a competitive environment (is) through constant product and process innovation, achieved primarily by investing in intangible assets.” Therefore, “earnings’ usefulness to investors declines sharply for companies that increasingly rely on intangible value-creating assets.”

For these reasons, “GAAP-based reported earnings no longer reflect the periodic value changes (growth) of most business enterprises, and thus conventional earnings-based security analysis has lost much of its usefulness for investors in recent years.”

In summary, the authors observe:

“The disappointing returns on managed funds in recent years should raise doubts about the continued usefulness of conventional security analysis. Our extensive empirical evidence on the loss of relevance of GAAP numbers, in both this article and our recent book, confirms these doubts. Certain major investors have already departed from the status quo. … We propose a different course: Rather than replace analysts with robots, substitute an improved investment methodology for an outdated one.”

If you’re interested in reading Lev and Gu’s article, download it here. Stay tuned for more on Professor Lev’s research in early 2018 and an in-depth Q&A on his latest research on intangible capital.


yogibear weburke Thu, 12/07/2017 - 11:05 Permalink

That's right. All that matters is that central banks keep pushing their infinite moneies into stocks. Now all the markets are too big to fail, so they are forced to keep it elevated. Central banks have created multiple spinning plates they cannot allow to fail.The central banks are beyond scared to keep everything elevated.  

In reply to by weburke

brianshell yogibear Thu, 12/07/2017 - 11:24 Permalink

Rinse and repeat. Central banks make money up AND down. Ask any stock broker how they pump and dump.Expand this game's logic out. You no longer need workers. Take GE. They make money on their loans. Guess what, they have access to (almost ) free money. Why hassle over products?Sure there's an end to it but then they just start making product again.

In reply to by yogibear

Endgame Napoleon silverer Thu, 12/07/2017 - 11:01 Permalink

Don’t drive by any big financial services company from about 2:30 to closing, expecting to see it full of cars, no matter how busy with paying customers it is. That is leave-early-for-baby time, and along with mornings off for baby and frequent weeks off for things like travel soccer or get aways for busy working crony moms to recoup from part-time work, it often frees up the parking lots for the few people who actually come to work every day, stay all day and meet the quotas—you know, the churnable chumps who have to live on low, earned-only income from wages between $9 and $12-per hour, while many absentee moms finance their frequent babyvacations with child tax credits between $3,400 and $6,318, freed up for mom indulgences due to rent and groceries covered by taxpayers, child support or spousal income. A lot of the finer, momma manager’s cars will be gone from the lot at the same time. You scratch my back, I scratch yours. Keep a couple of hard workers on board to keep your numbers high while you babyvacation and then churn them. A unicorn business model it is not. It is the exact opposite of that. They just focus on the unicorn-obsessed companies because it sounds better.

In reply to by silverer

LawsofPhysics Thu, 12/07/2017 - 10:31 Permalink

No shit.  Especially now the the publically traded "markets" are nothing but a fucking political tool used to manipulate public perception and keep oligarchs in power, duh."Full Faith and Credit"same as it ever was...

wmbz Thu, 12/07/2017 - 10:38 Permalink

"Earnings don't matter after all"Wow, what a bombshell! Did you just now figure that out. The "earnings matter" ship sailed from port a long time ago and then sank.

TuPhat Arnold Thu, 12/07/2017 - 13:53 Permalink

If earnings don't matter, and it does look that way right now, then the article should tell us actual reasons why.  The intellectual capital bull crap is not real.  Elon Musk is the king of that but it only means he is good at fraud.  It has much more to do with central bank destruction of price discovery than anything the article mentioned.  One thing it does prove is that most economists are not worth their pay and that applies especially to those that write articles and books.

In reply to by Arnold

Endgame Napoleon MonetaryApostate Thu, 12/07/2017 - 11:38 Permalink

You forgot:

1) Fake, womb-productivity-based, feminist careerism that seeks pay for sex and reproduction for working moms in layered forms from government, including free food, free rent, free electricity, cash assistance and child tax credits. The tax welfare for womb productivity extends from $3,400 (for lower womb productivity @ 1 child) to $6318 (for higher womb productivity @ 3 children). But that is not enough womb-productivity pay for fake feminists; they also demand womb-based workplace absenteeism privileges galore. They demand the freedom to cry sexism, while discriminating themselves by favoring childbearing-age moms. They often hire 99% fellow moms, excusing the frequent and lengthy absenteeism of fellow moms, bullying out women that do not fit in their womb-based cliques and advertising jobs as the “best place for working moms,” not to mention making free child care part of the pay package in many low-wage jobs, where earned-only income does not cover rent for the non-womb-productive employees who often work far more hours, generate more accounts and retain more accounts before being churned by frequently absentee moms.

2) Fake, Victorian-style, feminist shock over jocular sex talk, frat-house antics, suggestive gestures, etc. by men, even though it prevails—society-wide—thanks to fake feminism and the sexual revolution endorsed by fake feminists, including the young fake feminists attending all these sexed-up, wild, drunken college parties. This also includes the [majority] of moms, discarding marriage in droves to reproduce out of wedlock due to the array of free household bills and tax welfare available to single moms who work part time for low wages, staying below the income limit for welfare. After having kids, many, many fake-feminist moms, very much including the married ones, do not refrain from consuming popular, mainstream cultural products with graphic discussion of sex during hours when their kids can hear or see the content. That is why such products are so popular, decade after decade, including the MSM sex gossip shows, the sex-gossip psychobabble chat shows and most of [family] sitcoms loved by the fake, fainting-couch, feminist moms. This type of content has not been opposed by [protective, shocked] moms en mass since the Hayes Act was still intact, i.e. before the victory of the 2nd wave of fake feminism and the sexual revolution, which was embraced by feminists.

The first wave feminists were the only non-fake feminists. They’re all long dead.

In reply to by MonetaryApostate

buzzsaw99 Thu, 12/07/2017 - 10:43 Permalink

the only analysis that matters is what central banks will do next.  looking at individual companies is useless.  when the central banks are like they are now you have to buy the most worthless piece of shit most highly shorted stock right along with the big earners like aapl.

Deep Snorkeler Thu, 12/07/2017 - 11:14 Permalink

Capitalism has Reached a New Plane1. all values are ephemeral and phony 2. fraud = success3. anything goes, nothing matters4. America is a nation of fools in hierarchical order5. all data are juiced

RealChairmanMeow Thu, 12/07/2017 - 10:58 Permalink

The market now values assets on their "disruptive" quality instead of earnings. The everthing bubble is driven by disruptive technology; bitcoin, tesla, amazon, etc. Chairman Meow intends to invent a disruptive cat-currency (kitcoin) that will be disruptive to government fiat, and redistribute global wealth.  https://longlivethekitty.com

Consuelo Thu, 12/07/2017 - 11:02 Permalink

   "In contrast, the investment rate in intangible capital (R&D, patents, information systems, brands, media content, business processes) – mostly expensed in corporate income statements – increased continuously from 9% to 14% of added value, a 56% increase. This radical business model transformation came to be known as the knowledge – or information revolution, an irreversible trend in developed economies.” R&D = Yes. All the rest...? How about: Floors of people banging away at their keyboards, zipping off to various 'meetings', creating process flows and all other manner and myriad of whiz-bang paperwork.The good news?   Staff cuts as a result of recession have a rather unique way of culling these 'knowledge-based' important positions, while returning the focus on Product and Sales

Muppet Thu, 12/07/2017 - 11:23 Permalink

Each day, algos compute the increase in their AUM from the prior day and their margin reach.  They then begin buying.  All algos do this.  Buying whenever cash/margin exists; selling whenever profit targets are hit. On any pullback, the algos withdraw, volume evaporates, thus curtailng the drop.  The algos collectively increase equity prices without consideration of the value of the money involved.  Regardless of valuations.  Regardless of fundamentals.  Just ones and zeroes. The computers with the fastest trading, the computers with the fastest cryptocoin mining... Wealth is shifting to those with the best computers.  This is our future. 

personal109 Thu, 12/07/2017 - 11:40 Permalink

Ok, I have a lemonade stand which earns nothing, but because I track my zero sales on an app I wrote, people think my business is worth something by giving me money.  Makes sense to me.

Phillyguy Thu, 12/07/2017 - 12:11 Permalink

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Historically, a primary driver of economic growth has been business spending. When companies are growing, they are building new factories, employing more workers, who have more disposable income to purchase houses, cars, furniture, etc. This entire process is driven by the ability of large corporations to make profits. Capitalists are always searching for ways to maximize profits- accomplished through increased worker productivity- better machine tools, worker training, etc. This paradigm changed in the mid-1970s as corporate profits began to stagnate/decline- a direct consequence of increasing competition from rebuilt economies in Europe (Marshall Plan), Japan (Korea, Vietnam wars) and more recently China. The US government/corporate response to this economic decline have been- 1. Attack labor and provide multiple tax cuts, including cuts to inheritance taxes for wealthiest segments of US society (Reagan, Bush II, Trump), 2. Cuts assistance to poor families, out-source jobs (NAFTA) and de-regulate finance (Clinton). In 2001 Bush II became President, immediately cut taxes for the wealthy and following the 911 terrorist attacks, committed the country to, still ongoing wars in Afghanistan and Iraq. So where do stand in 2017? In 2008, much of the world experienced the largest financial collapse since the Great Depression. Unfortunately the conditions giving rise to this financial implosion have still not been resolved. Instead of increasing investments in new plants and equipment, US corporations have continued to out-source jobs, set up offshore tax shelters and use any gimmick possible to avoid paying US taxes. These actions have been greatly facilitated by Congress. Indeed, Trump is promoting new $ trillion + tax cuts, that not surprisingly will benefit the wealthiest segments of US society and blow a huge hole in already substantial federal deficits. Since 2008, Wall St has been propped up with an infusion > $ 4 trillion of ultra-cheap money from the US FED for speculative investments and financial engineering- share buybacks and MA deals in what David Stockman has described as an “orgy” of corporate debt. > 90% of “new” jobs created since the 2008 financial collapse have been temp jobs- low pay, no benefits and no job security. The dire financial conditions facing the average American can be summed up in one statistic- 60% of US adults do not have $500 in savings (see: money.cnn.com/2017/01/12/pf/ americans-lack-of-savings/ index.html). As the US financial position continues to decline, US foreign policy has become increasingly reckless and bellicose. Ongoing wars in Afghanistan (longest running war in US history) and Iraq have become taxpayer funded $ multi-trillion strategic disasters. Currently the US war theater now stretches from the Levant, to Caspian Basin, Persian Gulf, China Sea, Indian Ocean, Horn of Africa, to Eastern Europe and Russian border. Trump has recently upped the ante by aggressively confronting North Korea and Iran, policies which indirectly threaten China and Russia. This is going to end very badly.

BitchezGonnaBitch Thu, 12/07/2017 - 12:29 Permalink

You're only finding this out now? I've said this before loads of times - customers are a thing of the past; modern company has no need of them as TBTFs can/do exist solely on indefinite 0% roll-overs and refis. If you can borrow infinite money for free, why would you bother working for it?

desertboy Thu, 12/07/2017 - 13:16 Permalink

This article is yet more proof that analysts will produce complete revisionist horseshit to underwrite fraud. "the only way to survive and prosper in such a competitive environment is through constant [product and process]  FINANCIAL innovation" fixed it for you.

In.Sip.ient Thu, 12/07/2017 - 15:50 Permalink

ROFL!Of course earnings ( and at this point everything else )don't matter. Let's face it, if BtC can act as a barometer of stupid,so can the stock market.  And yeah, thats how far out of wack money printing hastaken things... 

Central Ohio Thu, 12/07/2017 - 17:01 Permalink

I skimmed the article.  It is very interesting.  It I had to sum it up I would say that theses guys are saying you need to focus on what is creating a distint competitive advantage for a company. (One of the few key concepts I remenber from business school.)  What are the assets?  How healthy are the assets?  How do they maintaine the advantage.  R&D, Acquistition?  They also talk about customer loyalty.  In more simple terms, does the distinct advantage produce and maintain loyalty.   They claim that getting this info. from GAAP financials isn't really possible.  For the depth of analysis they use, I agree, but for armchair market watchers I suggest this for a glancing evaluation using their ideas:

  • Looking at revenue on the Income Statement.  If revenues are increasing that probably means more customers are using the product or service.
  • Given the author's premise that R&D relates to competitive advantage, looking at R&D on the Income Statement is worth a glance.
  • Looking at cash from Operations on the Cash Flow statement.  Is it at least positive?  If it is then the company is using operations to make money rather than finance and there product or service is the driver.
  • Looking at Long Term Debt on the Balance Sheet.  If there is spike then they might be doing the buy-back thing or acquiring to  grow.  It is worth investigating.

  Of course none of this means anything if the market tanks.  Looking at Microsoft (https://finance.google.com/finance?q=NASDAQ%3AMSFT&fstype=ii&ei=FrUpWpn…, R&D-OK, Cash from Operation-OK, LT Debt-Flag.  Overall Microsoft's price curve has the same slope as the NASDAQ.  Why LT Debt increase?  Looking at GM (https://finance.google.com/finance?q=NYSE%3AGM&fstype=ii&ei=6LcpWukH2KG…, R&D-No Entry, Cash from Operations-OK, LT Debt-Steady in Growth.  With the author's paradigm, the lack of R&D as an entry is of concern.  Why is LT Debt growing?  Does it match revenue growth?   What advantage does GM really have?  GM doesn't follow the DOW to well.    The author's have a lot of time to analyize.  Many of us don't.