The economics of short-term performance obsession

In theory, discounted cash flows (DCFs) set prices in well-functioning capital markets. In practice, investment managers attach substantial weight in stock selection to short-term performance, particularly earnings and tracking error. Corporate executives blame this behavior for their own obsession with short-term earnings. Are stock prices likely to allocate financial resources efficiently when short-term earnings dominate investment decisions? Can investment managers who identify stocks as mispriced on a DCF basis earn excess returns? This article explains why maximizing long-term cash flow is the most effective way to create value for shareholders and charts a course for alleviating the obsession with short-term performance. ©2005, CFA Institute.