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Markets take a longer view than you think.
What Moderna's vaccine tells us about short-termism
According to the conventional wisdom, corporations and capital markets suffer from a bad case of myopia. At face value, critics of business seem to have a point. The signs seem to be everywhere.
Across the West, the share of GDP invested in physical capital, such as machines and industrial equipment, has been on a steady decline for the past five decades.
Corporations are giving up on science. The great corporate research labs in the US, such as Bell Labs and Xerox PARC have been on a dramatic decline. In 1980, 30% of US corporates published scientific papers; the share has halved since then. And when they do publish, it is now much less likely to be in ‘high-impact’ journals dedicated to basic research. They still do invest in R&D but now they spend more time (and money) on the D, which delivers more immediate returns, rather than the R.
At the same time, we have seen a wave of share buybacks. In 2019, the S&P 500 spent $728bn on buying back their own stocks. If you factor in dividends too, as short-termism critic William Lazonick did, then between 2003 and 2012 corporates returned 91% of their earnings to their shareholders and left little for long-term investment.
Workplace training appears to be another casualty. According to the Chartered Institute of Professional Development, between 2011 and 2017 per trainee spend on workplace training has fallen by 16.7%.
Some, such as Nesta’s Chris Haley, argue that the way executives are compensated bakes in short-termism. He found that CEO remuneration packages are weighted towards conditions that discourage investment in innovations at ratio of 3:1. So-called long-term incentive plans rarely extend beyond three years.
The average investor used to hold a share for six years – they now hold them for just six months.
I could go on, others have, but despite all of that I’m a short-termism sceptic. I think financial markets take a much longer view than the conventional wisdom suggests. In fact, I’d go as far to argue that they’re one of the most long term-oriented institutions we have.
If you are looking for a counter-example to the idea of myopic financial markets, then you will struggle to find a better one than Moderna. Consider a few facts about the company that this week announced a 94.5% effective COVID-19 vaccine.
Last year, Moderna’s annual revenues were just $60m.
None of its drugs have ever been approved by the FDA.
In fact, no drug using mRNA, the technology Moderna specialises in, has ever been approved by the FDA in the two decades-plus that researchers have been trying to develop RNA therapeutics.
By the time Moderna floated on the Nasdaq it had lost over $1.5bn cumulatively.
In spite of all of that, Moderna is valued at $35bn and even before the COVID-19 pandemic was valued at around $7.5bn.
In retrospect that $7.5bn valuation looks visionary for a company that is set to, if not single-handedly save the world, at the very least play an important role in ending the COVID-19 pandemic.
But at the time, it had many sceptics in the press. One article suggested it was the next Theranos. Another quoted a rival executive who describes Moderna’s valuation as “preposterous.”
The right kind of long termism
Now you might suggest holding a stock for just two years (Moderna floated in 2018) is hardly what most of us would call long-termism. Yet, it is perhaps the right kind of long-termism. As Tom Chivers writes: “Most candidate drugs don’t work, or don’t work very well. So most of the time you have to abandon research, after spending a lot of money on them… part of being good at making money is not throwing good money after bad.”
The idea that short-term share holdings lead to short-term decision-making seems to run against common sense too. To use an analogy from housing, suppose that I knew I had to sell my house in six months time. I would hardly trash the place as it would mean less money when I come to sell it.
A volatile share price is somewhat surprisingly a sign of the market taking a long view. If a company’s value is a function of the present value of its future cashflows and the longer we look into the future the more uncertain it gets, then any new information, even if ultimately inconsequential, could radically alter our long-run forecasts. That’s especially true in an industry like pharmaceuticals where the majority of a company’s revenues may end up coming from a single drug.
Rising payouts to shareholders such as buybacks and dividends may in fact be an example of this kind of long-termism. Some companies’ best days are behind them. Contrast Moderna with Biogen, the pharma giant that Moderna briefly overtook in market cap this week. Last year, Biogen bought back $5bn worth of its shares. Rather than looking upon that as an example of short-term corporate greed, we could instead see it as the market redistributing cash from a 42 year old business with limited investment opportunities to younger, nimbler businesses with more exciting prospects, such as Moderna. Buybacks and dividends don’t vanish into the ether, after all, they are typically reinvested.
Moderna’s case isn’t unusual either. Chicago Booth Business School economist Steven Kaplan notes that “if short-termism is such a problem today, it should show up in low current P/E Ratios. Instead, the opposite is true. Current P/E ratios are historically high.” In layman’s terms, if the world of business had become more short-term oriented, then we would expect that on average a businesses value would be a low multiple of its yearly earnings, but that’s simply not the case. Amazon’s P/E Ratio is famously in the low 90s (it briefly got as high as 3,633!). By contrast, the historical median of the S&P 500 is 15. A high price to earnings ratio is a sign the market is much more interested in your future earnings and growth, than your short term performance.
If anything, the market may be too long-termist. As Chris Dillow notes: “If stock market investors were short-termist, they’d under-price growth stocks and over-price those offering near-term cashflows. In fact, more often than not they’ve done the opposite. Growth stocks have under-performed value ones in the UK over the last 30 years.”
Blaming the real culprits
To be clear, I’m not arguing that we should be relaxed about declining levels of physical investment, falling spend on workplace training, and the corporate world’s retreat from basic science. But I am arguing that short-termism is likely not the underlying cause. For example, the introduction of quarterly reporting in the UK had essentially no effect on any kind of investment or R&D. HT Chris Dillow - again
Rather than short-termism, for each problem there are alternative, more plausible explanations. As the era of large conglomerates with hundreds of only loosely related product lines has declined, so too has the ability of corporates to commercialise basic science. Falling investment in equipment and machinery may be a side-effect of the rising importance of intangible capital and flaws in the tax system. And a decline in spending on training, may reflect misaligned incentives and a more footloose workforce. Put differently, it is not short-termist to neglect to train up a worker when there’s a good chance they’ll move firms in a few years. It’s realistic.
To end on a reassuring note, we have policy remedies to address the above problems. We’ve got R&D tax credits, investment allowances, and training levies. By contrast, we would be screwed if our main problem required us to change the way corporate executives and hedge fund managers think and behave.