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Investors like cost cuts, but consider long-term outlook

By ASSOCIATED PRESS
Published November 15, 2006

Corporate America has discovered a new formula for winning over investors: Tell them you are skimping on costs.

Amazon.com Inc., JetBlue Airways Corp. and other companies have managed in recent months to get shareholders to look the other way when reporting weak earnings news and instead cheer their plans to curb spending outlays, whether it be for new factories, stores or technologies.

It's not surprising that companies want to stretch every dollar they can. The U.S. economy is slowing down, and it is unclear how long the downturn will last. But the question investors need to ask is whether preserving profit growth now will come at the expense of what could be earned later - as some technology companies learned to their regret after the last recession.

Gross domestic product grew at a tepid 1.6 percent annual rate in the third quarter, the slowest in three years, according to the Commerce Department. Economic growth is expected to come in around a 2 percent pace in coming quarters. That could eat away at corporate earnings into next year.

With that kind of pullback likely, investors seem willing to reward companies that are imposing spending discipline to protect profits.

Internet retailer Amazon.com was one of them. It paired news of a decline in third-quarter profits with an announcement that it planned to slow its increase in technology spending. Investors liked that news, sending shares of the Seattle company up 12 percent to more than $37 a share a day later. Since then, the stock has continued to rise.

JetBlue swung to a loss in the third quarter, but investors instead choose to cling to news that the carrier planned to scale back growth for its fleet of airplanes. The airline reduced its capacity growth expectations for 2007 to between 14 and 17 percent, down from the 20 percent estimated for this year.

Wal-Mart Stores Inc.'s stock also rallied when world's largest retailer announced plans to slow the pace of store openings and sharply reduce capital spending growth next year. The retail giant will ratchet down its space expansion to a 7.5 percent clip in the fiscal year starting Feb. 1 from its 8 percent growth rate. That translates into 305 to 330 new U.S. stores in fiscal 2008, down from 332 to 340 this year.

But while shareholders embrace these slower spending initiatives, that might not give them the results they are looking for over the long term.

Just think back to what happened during the recession this decade, when telecommunication and technology companies including Lucent Technologies Inc. and SBC Communications Corp. slashed their spending budgets amid an industry downturn. As a result, some lost their competitive edge to foreign rivals that had been ramping up their innovation and infrastructure.

"As we enter a period of slow GDP growth, companies with either innovative products or processes, that either command market share or improve margins, are likely to be rewarded," said Morgan Stanley quantitative analyst Parin Gandhi.

Such thinking seems to be lost on investors right now. That might end up costing them later.

[Last modified November 14, 2006, 23:57:08]