The earnings-beat game for corporations
- Felix Salmon, author of Axios Markets
Did you know I take requests? Lobbyist Bruce Mehlman writes in to ask: "If more than 70% of firms regularly beat Wall Street quarterly earnings expectations, doesn't that suggest the experts setting expectations are not so good at their jobs?"
It's a good question. In the second quarter of this year, the earnings-beat ratio actually reached 81%.
James Bianco, of Bianco Research, has two answers for Bruce.
Reg FD is the easy answer. Before 2000, companies would whisper earnings forecasts into the ears of favored analysts, who would then be rewarded for their accuracy. The SEC made such behavior illegal in 2000, saying that all earnings guidance has to be given to everybody in the market simultaneously. At that point, corporate incentives changed.
- Companies receive a predictable spike in press attention when their earnings are released, and those stories nearly always mention the stock-market reaction. The easy way to engineer a short-term stock rise is to lowball your official earnings guidance. It doesn't help the stock price in the long term, but it does improve your PR.
- That game might finally be coming to an end. In the third quarter of this year, the stocks of companies that beat earnings expectations actually fell by 1.5%.
If you want a non-engineered forecast, look at revenues, not earnings. Revenue beats are about as common as revenue misses, mainly because companies rarely game their revenue estimates.
The bottom line: The "experts" setting expectations are, ultimately, the companies themselves, rather than the sell-side analysts. Because earnings can be gamed, there's little point in analysts trying to second-guess them. Insofar as analysts add value, it's from long-term structural insights rather than short-term trading opportunities.
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