Earnings expectations: Why most big companies beat the Street's predictions
With earnings season under way, I was surprised to learn from an AP article that 81 percent of companies that have reported so far this quarter have exceeded Wall Street's earnings expectations. Are these companies doing so spectacularly well in their businesses despite the worst recession in 70 years? Absolutely! As long as you think that their business is influencing Wall Street's earnings expectations.
By that measure, public companies have been remarkably successful. The AP reports that 81 percent of the first 199 S&P 500 index companies to report earnings came in above expectations on their third-quarter 2009 results. But it's not just this quarter -- over the past two years, 65 percent of earnings reports have beaten estimates. And after last fall's financial crisis, companies beat expectations at about twice the rate as they missed in the following two quarters.
Why is this happening? It's simple, really.
The Wall Street analysts whose earnings forecasts get averaged to specify quarterly earnings expectations are not paid directly for their work. Their forecasts are subsidized by their employers' investment banking and trading businesses. Did you think that those analysts were looking out for the interests of the general investing public?
If so, I am sorry to disappoint you. Their real bosses are the folks who run their institutions' investment banking and trading units. And in order for those analysts to keep their bosses happy, the analysts must avoid making the banks' corporate clients angry.
The best way for an analyst to stay on a client's good side is to agree with whatever quarterly earnings number management wants them to promote. If analysts at banks did their own independent research and came up with more realistic estimates, it could cost their corporate clients some serious money.
How so? As I posted in 2006, stock prices change based on companies' performance relative to expectations. If a company beats expectations and raises guidance, the company's stock pops. Otherwise, it falls. If an analyst raises expectations so high that the company misses them, then its stock price falls.
And then that company's executives will suffer a painful drop in their net worth -- assuming they are big owners of the stock. Their response to that will be to go to the bank's heads of investment banking and trading, and tell them that they will avenge themselves for that loss of worth by switching the company's business to a competitor, one whose analyst promoted earnings numbers that the company could beat.
And then the punished bank will replace its aberrant analyst with one who toes the corporate line.
Any questions?
Peter Cohan is a management consultant, Babson professor and author of nine books, including Capital Rising (due in June 2010). Follow him on Twitter.
Why is Oprah going to cable? Hint: It's nothing to get teary about
Kisses from Hershey: Candymaker may court Cadbury with $17 billion bid
D-Day for Harry Reid: Can he wrangle 60 votes for Senate health reform bill?
Reader Comments (Page 1 of 1)
10-26-2009 @ 10:57AM
Paul said...
I see a Nervous Government and Wall street Twiddling the numbers again in a attempt to Lure in the Unsuspecting. The Hooks are sharp and the Bait looks Juicy and tempting But Beware, the Numbers are Not Real. There is Nothing to sustain them. The House of Cards Will blow completely away by the end of the year. All Calculations are on coarse for at least a 40 percent Collapse of Most Markets by December. Unemployment has Nothing to do with this, nor does housing, Banks or Government regulations. The World has Simply Overbuilt and Over Produced Mainly due to Modern Manufacturing and Building methods which require Far Fewer Workers than in the past. Computers are also part of the problem. Remember when it took 200 or more people to run a fair sized Office ? or Hundreds of Thousands of Workers to build cars in America ? That was in the years B.C. ( before computers ) Before the 1980s. I remember in the 1980s they were bragging how computers will be the wave of the Economic Future. Maybe they were for some but for many they were the Job Terminators as Offices and Business in general were able to get by with far fewer emplyees using computers which are now Made in China. Also worth mentioning is the fact we have used up well over Half of this Planets Natural Resources just in the last 100 years as a result of turning from Farming to Industrials
Reply
10-26-2009 @ 11:13AM
SpeedNY said...
While I agree that analysts may be biased, Companies are usually required to create fire-walls between the research and the IB departments, as per the CFA code of ethics and professional standards. Research analysts are required to be completely independent and unbiased in their research opinion.
IMHO, I agree that historically more companies match or beat analysts expectations, this is more so because management can easily manipulate it's financial statements, while still be in compliance with SEC.
In other words, i believe that companies are 'gaming' the system to meet or beat analysts expectations.
www.jsheth.net
Reply
10-26-2009 @ 11:26AM
Lord Enki said...
Good if they are doing that great then pay the tax payes back you dead beats. Are you listening Wall Street.
Reply
10-26-2009 @ 11:29AM
Lord Enki said...
Oops I meant Tax payer's
Reply
10-26-2009 @ 11:34AM
Lord Enki said...
I can't wait till the GOV/CORP Ship sinks and it's coming numbers can be manipulated to say anything, I believe they call that cooking the books, and if you had been paying attention that is the very same thing that got ENRON in to trouble and caused their collapse, this money game is all over but the crying. So start preparing for the Financial melt down of the Millennium. And learn how to grow your own food.
Reply
10-26-2009 @ 12:30PM
Mike said...
Sure helps the bottom line when you don't need to make a payroll. Just GREAT for shareholders...
Reply
10-26-2009 @ 12:49PM
Dave said...
Yes, its that simple. Its called the government printing press.
What are all these people--who chortle about free enterprise--going to do when the government quits giving them free money? Its like being out in the wilds and feeding a huge bear fig newtons..you had better not run out or all hell
might break loose. Hungry voters might be worse than hungry bears.
Reply
10-26-2009 @ 12:55PM
Winfield Joad said...
You all don't get it. The 787 billion was given to the big boys so they could prop up their stock prices by buying self same stock, preventing a complete collapse of the stock market. Only "troubled assets" were their own stock.
Reply
10-26-2009 @ 1:11PM
fred said...
I knew about this for years so it is nothing new to me. It always had somewhat of an impact on financial reporting in prior years but since the recession it had a huge impact to all aspects of BS, IS, and CF call reporting. Hopefully in future periods (2010 and beyond) we will return to traditional analysis reporting/calls.
Reply
10-26-2009 @ 1:45PM
Iridium said...
CORPORATIONS BEAT EARNINGS ESTIMATES BECAUSE THEY ARTIFICIALLY SET THE BAR LOWER THAN THE PROFITS THEY BELIEVE THEY WILL MAKE IN ORDER TO BEAT ESTIMATES AND SEND SHARE PRICES UP.
Earnings, like the stock market, are nothing but a con game. A corporation will only miss earnings if something drastic happens between the point of estimates and the reporting of earnings.
APPLE HASN'T MISSED EARNINGS ON A QUARTER SINCE 2001!!! Is it really good business or setting the bar so low that it would be immpossible to hurdle it? Apple has blown away estimates so many times that you have to wonder how good the analysts are if they get it wrong so many times. With a record like that I don't think I could keep my job. But thier job isn't to be right, it is to make sure stocks go up instead of down.
SO what we had this year was absolutely terrible earnings. Revenues were down at the majority of corporations that beat the street. Most could only beat earnings through cost cutting. Yet the stock market went on a tear becuase so many corporations were beating estimates.
They hurdled a bar set so low that it would be nearly impossible to trip. Is that really the sign of a recovery?
The stock market and trading is all based on BS. There isn't a true market fundamental left. Since that is the case the only solution is to get rid of the market altogether. It is as corrupted if not more than the halls of Washington DC. If reality does ever truly set in the lows of March will look like good times.
Reply
10-26-2009 @ 2:54PM
Bob said...
Over valued and due for a 2000 point correction!
Reply