Don’t Get Caught Up in Optimism from Company Management

Aside from company-specific issues at Yahoo! (YHOO), the main takeaway from the search giant’s poorly received first quarter earnings report should be to take what management says with a grain of salt. Yahoo! stock soared from the high 20’s to the low 30’s after CEO Terry Semel went on the record saying how great its new online advertising system, Panama, was going to be. Obviously, when investors saw poor results and a lackluster outlook from the company, they felt blindsided.

Why would Terry Semel be so optimistic when the numbers didn’t reflect that optimism? Because he’s the CEO. Management always sees the glass half-full. Many of them believe it is their job to be company cheerleaders. Very few executives refrain from trying to spin anything to be as positive as they can. Investors need to keep that in mind. Don’t go out and buy a stock just because you saw the CEO on television and he or she was bullish.

It can be hard to ignore that sometimes. After all, if you watch shows like Jim Cramer’s Mad Money, these guys are always brought on camera to defend their company against negative press or to hype their next big thing. A lot of these people are pretty darn good at telling their stories.

Since management will often spin the truth, does that mean that investors should dismiss everything a CEO or CFO ever says? Absolutely not. This is how I would judge these comments. Don’t just take what they say as gospel. Managers should earn your trust. Carefully monitor what they say over an extended period of time and compare that to what actually happens.

If you follow this logic, only managers that tell the truth and consistently understand their businesses should earn your trust. Armed with this knowledge, namely a management’s track record talking to investors, you know who to listen to and who to dismiss as merely a cheerleader.

Successful investing is not easy. If you could just watch TV and make money like Jim Cramer says, everybody would be rich. However, we know that doesn’t work. After all, most professionals can’t consistently beat the market. If you want to be in the small group that does, be skeptical when company management teams start telling you how great things are unless you have reason to believe they know what they are talking about.

Full Disclosure: Short shares of YHOO at time of writing