It is increasingly obvious that the market's obsession with short-term earnings has pushed many companies into unwise or cosmetic business practices. Tactics such as accelerating revenue recognition and managing accounting reserves to smooth earnings are based on the assumption that investors will pay a premium for steady and predictable earnings growth. As confirmation, some point to Jack Welch, whose management of GE's accounting reportedly smoothed the company's earnings and earned its stock a so-called Jack Welch premium.1 Executives today regularly cite stable earnings growth as a reason for strategic actions. For example, the CEO of Conoco justified its pending merger with Phillips Petroleum in part by asserting that the merger would offer greater earnings stability throughout the commodity price cycle.2
It would seem to make sense that the market should place a higher value on companies that exhibit steady profit growth quarter after quarter, year after year. Yet in today's environment, in which financial accounting is closely scrutinized, emerging anecdotal evidence indicates that the market is increasingly suspicious of overly smooth and predictable earnings. When companies beat analyst estimates by exactly one penny, for example, quarter after quarter, it is typically their lack of variability that raises eyebrows....