A stock market question: re "Missed estimates"

[KFC911]

I've got a question that's been bugging me. Why does the news media report that a company has "missed estimates", when from my perspective, it's the "professional analysts" who have "missed" in predicting the company's actual performance. Why doesn't the news media report that the analysts' have "missed reality" instead? I'm just curious as to when the analysts' "guesswork" became so newsworthy, and have they ever consistently gotten their predictions right?

[widebody911]

"Analysts" and their "estimates" are nothing more than institutionalized manipulation of the stock market.

[Mo_Gearhead]

What they are indeed saying is " the analysts MISSED THEIR estimates" of the companies' performance. While companies may have internal 'goals, earning targets', etc., you don't see many companies broadcasting those figures to outside sources. It's newsworthy only in the sense that when companies DO report quarterly earnings, you get to see which analysts had better inside sources!

But I get your point.

[widgeon13]

The analyst do not predict the company performance on a quarterly or annual basis, that is actually derived from company provided information (dividend, sales figures, EBITDA, whatever) and usually reported that way.

I worked for a Canadian company for 30 years and was an officer of the company (for what it's worth) now retired, we would meet with certain industry analysts and give them projected figures and report previous performance results. They would then report those figures to the financial community. This would lead to a level of expectation and obviously if the targets were not achieved the stock price would usually drop or their had to be some good explanation.

The sad thing is that even when companies achieve their target, in most cases the stock drops. It's only when company dramatically exceeds expectation that the stock seems to react in a positive manner.

[KFC911]

Originally Posted by widgeon13

The analyst do not predict the company performance on a quarterly or annual basis, that is actually derived from company provided information (dividend, sales figures, EBITDA, whatever) and usually reported that way.

...we would meet with certain industry analysts and give them projected figures and report previous performance results. They would then report those figures to the financial community....

If I understand what you're saying correctly, then when the analysts' really miss BIG on their estimates, then who has really miscalculated? Can a company really be that far off the mark on measuring their own performance, or do they mislead on purpose? I personally don't put much "stock" (pun intended) in what the analysts project, but since many stocks rise and fall based upon whether they meet/beat the street estimates, I was just curious.

ps: I don't doubt that Thom is correct, but I'm just curious as to which "institution" is doing the manipulation, the company in question or the brokerage house (or both )?

[widgeon13]

both the company and the analysts would like to have credibility, so it does no one any good long term to mislead the public or the shareholders. If the targets are set and not achieved, the stock reacts. Continued disappointment in the financial community leads institutional investors and analyst away from recommending the stock, which continues to contribute to a poor performance(decline in stock price). US markets and financial community are very much geared to quarterly results which can be very disappointing because companies chase short term results for the stock price rather than slower sustainable positive long term results.

Japanese companies are much the opposite as they are more content to allow longer term results impact stock price.

Manipulation has a negative connotation and illegal as well if it can be proven. A situation like Enron could have been viewed as manipulation since financial records and performance were misrepresented in an effort to continue the escalation of the stock price. Many executives are given options in large numbers that can prove to be very valuable short term if the price of the stock goes up from the option price.

[KFC911]

Originally Posted by widgeon13

both the company and the analysts would like to have credibility, so it does no one any good long term to mislead the public or the shareholders. If the targets are set and not achieved, the stock reacts....

I hear what you're saying, but I guess what prompted my thread was Apple's quarterly report yesterday. Obviously, they "blew away" the analysts' estimates, but then it was generally reported that Apple consistently "underprojected", so that makes me wonder "what's the point of it all"? I know, I know, ....the talking heads must have something to chat about. I guess I just don't get the prediction/projection aspect...why do it at all (since they consistently miss), just wait a few days until the REAL numbers come out and save some hot air .

[widgeon13]

Your point is valid. What it boils down to is "this is the way it's done", not necessarily right or wrong.

Apple is a good example because their performance has been so good over the last couple of years and stock price has gone up, no one in the company or the financial arena wants to say the end is here, once that happens the bottom drops out of the stock. Technical innovation and timely delivery to the market are what drive a company like Apple. A natural resource or more industrial company (paper industry) are more driven by actual supply/demand and pricing.

Once Apple is not seen as a leader in technological innovation (when they can no longer deliver new products) they will fall from glory and stock price will drop. Nothing lasts forever.

[KFC911]

Originally Posted by widgeon13

Your point is valid. What it boils down to is "this is the way it's done", not necessarily right or wrong....


Once Apple is not seen as a leader in technological innovation (when they can no longer deliver new products) they will fall from glory and stock price will drop. Nothing lasts forever.

Thanks for clarifying that first part...the second part is a given

[hytem]

I don't know if you can believe anything the media says about the stock market. Missed profits for one or two companies might be an excuse for some selling of those stocks, regardless of who is to blame. But it doesn't explain overall market behavior, as the media would like to have you believe.

For example, the last few days we have been seeing a market correction. Not once have I heard the obvious explanation for such a correction from the media: PROFITTAKING. Pure and simple. There has been a runup, and the big boys are taking profits. Sit tight. They'll be back.

No, it's not about real estate (a favorite whipping boy of the media lately--the market is just fine where I live--but it's been devastated in Florida, with false alarms from the media about hurricanes the past year or so, which have skyrocketed property insurance there).

[jyl]

The stock market has been taking a header for an unhappy combination of reasons.

First, losses from subprime debt became dramatic (crystallized by Bear Stearns admission that its two subprime debt hedge funds, managing what used to be $1.5 billion of investor money, had become worthless). This is making investors sharply pull back their willingness to buy speculative debt. That in turn jeopardizes numerous M&A deals and private equity buyouts, which depend on huge debt issuance. The market has been fueled partly by these deals. In general investors are becoming more risk averse.

Second, the news about the housing market keeps getting worse, and appears to be extending beyond simply subprime borrowers. Consumer spending is already weak, and investors fear the impact of tightening credit standards on everything from prime mortgages to home equity loans to credit cards to auto loans. On top of high energy costs.

Third, this has not been a good earnings season. In 1Q07 consensus estimates were for S&P500 earnings to grow +3% and they actually grew +8% (all these numbers are approximate, from memory). In 2Q consensus was for +3-4% and actuals are coming in around only +4-5%. Numerous bellwether companies are missing consensus estimates (XOM being an example) and many of the rest are guiding 3Q below consensus.

[EDIT: Earnings reports improved later in the earnings season and right now actuals are around +8-9%.]

Fourth, the market had run up so strongly since March that traders had a lot of recent profits to protect (profit-taking).

About analysts' estimates, the basic idea is that the value of a company is the dscounted value of its future cash flows, so investors try to estimate future earnings to determine what they are willing to pay for the stock. In most cases those estimates are based on company management's guidance (kc911 take note) When a company misses estimates, it means that something is going badly in the company's business and/or that management isn't telling investors the accurate facts about the business. Some investors extrapolate the bad news to future quarters and even future years, which brings down their valuation of the stock. That is the theory, anyway, the practice is a lot messier and more complicated and less rational.

[KFC911]

Originally Posted by jyl

...In most cases those estimates are based on company management's guidance (kc911 take note) When a company misses estimates, it means that something is going badly in the company's business and/or that management isn't telling investors the accurate facts about the business. Some investors extrapolate the bad news to future quarters and even future years, which brings down their valuation of the stock. That is the theory, anyway, the practice is a lot messier and more complicated and less rational.

Thanks everyone! John, this is what prompted this thread. I was watching the "Apple news", and the media was widely reporting that Apple seemed to "always" under project their guidance numbers, and then consistently beat the street estimates. Why would they do this...in order to always look good when they "beat the street" or ?. I'm just curious, as I realize that I'm just picking up the crumbs that the "big boys" leave behind, and I guess that's why I don't pay much attention to the media. In fact, I'm ready for another AnnaNicoleParisMartianbaby saga to get their attention once again

[jyl]

AAPL is good at playing the game via managing expectations. They regularly guide low so that they can beat the consensus estimate. However, investors aren't total dupes so there is a real expectations number out there (also called "whisper number") that they have to beat for stock to go up. This qtr I think the published expectation was $0.72 and they needed to beat by at least 15 cents or so, or the stock would have fallen.

Fundamentally, AAPL's business is doing very well so they are able to play the game. When their fundamentals begin to slow and then fall, managing expectations won't keep the stock from falling. But until there, managing expectations helps keep the stock moving up semi-smoothly rather than spiking and plunging as investor expectations get too high.

The difference between published consensus and the real expectations is one reason why you'll often see XYZ company beat consensus and stock goes down, or ABC company missed consensus and stock goes up.

[KFC911]

Originally Posted by jyl

...The difference between published consensus and the real expectations is one reason why you'll often see XYZ company beat consensus and stock goes down, or ABC company missed consensus and stock goes up....

Thanks John! I was just using AAPL as an example, but I've often seen what you describe played out. I'm not naive enough to think that a "little player" can beat the "big boys" in this "game", but like running from a bear in the woods, I'm just trying to be faster than "the lemmings", not the bear

[competentone]

Originally Posted by KC911

I'm not naive enough to think that a "little player" can beat the "big boys" in this "game", but like running from a bear in the woods, I'm just trying to be faster than "the lemmings", not the bear

The "big boys" don't necessarily have any advantage over a "little player" -- there are plenty of historical examples to demonstrate that. Consider, for instance, Enron; from: http://www.forbes.com/2002/02/27/0227analysts.html

Despite their independence and the variance in their techniques, nearly every sell-side analyst reached the same conclusions about Enron in 2001, right up to the brink of its bankruptcy on Dec. 2. As of Oct. 18, all 15 analysts tracked by Thomson Financial/First Call rated Enron a "buy"--12 of the 15 called it a "strong buy." Even as late as Nov. 8, the date of Enron's disclosure that nearly five years of earnings would have to be recalculated, 11 of the 15 recommended buying the stock. (There were three "holds" and one "strong sell.")

from the same article:

Howard Schilit, president of the Center for Financial Research & Analysis, an independent research house (which did not follow Enron) testified that in a one-hour review of Enron's public filings before the start of the collapse, he found several red flags: $1 billion in related party revenues: two thirds of company profits in one quarter coming from unconsolidated affiliates; and negative cash flow despite more than $1 billion in reported profits.

"For any analyst to say there were no warning signs in the public filings, they could not have been reading the same public filings as I did," Schilit said.

"Bigness" is not the equivalent of "competent."

[Don Plumley]

Before Sarbanes-Oxley and Reg FD, the estimates game was more of just that, a game. There were whisper estimates, analysts that had unequal access to management estimates, etc., etc. So Reg FD tries to equilibrate the playing field that making sure that when officers and employees discuss material financial information, including future estimates/projections, that they do so in a manner that any potential investor has open and equal access - such as by releasing on the internet or through previously announced conference calls.

So the question is asked why don't companies just sandbag their estimates so they can exceed them? A couple of reasons: Pressure to show that your company is beating your competitors in terms of earnings growth; Sandbagging becomes obvious after a short period of time, so then your projections lose credibility; and management making and meeting their estimates demonstrates the control they have over their business and knowledge of industry trends.

In good times, this is all fairly easy. But this pressure to provide consistent positive performance really shows up after a few bad quarters. The first time, there are usually enough reserves and room on the balance sheet to prop up the numbers. Increase inventory, reduce contingent reserves based on a "reassessment", stretch out payables, etc. But unless sales start picking back up, its very difficult to maintain this game, and numbers (and projections) start going south. A great manager at that point tells the analysts that a) unexpected things happened; b) here's what we are doing to fix it; and c) here's what it means short term to our results. The stock takes a hit, but over time, things should return to normal. But not all company executives have the backbone to do this.

Google has taken the angle of not providing any estimates, and cheers to them. But they are a lonely voice in a crowd of thousands, that are pressured by analysts to provide projections. Game on.

[KFC911]

Originally Posted by Don Plumley

...So the question is asked why don't companies just sandbag their estimates so they can exceed them? A couple of reasons: Pressure to show that your company is beating your competitors in terms of earnings growth; Sandbagging becomes obvious after a short period of time, so then your projections lose credibility; and management making and meeting their estimates demonstrates the control they have over their business and knowledge of industry trends....

...Google has taken the angle of not providing any estimates, and cheers to them. But they are a lonely voice in a crowd of thousands, that are pressured by analysts to provide projections. Game on.

Thanks Don, the first part is exactly what the media reports (that I saw) seemed to report on Apple...that they consistently "sandbagged". I'm with you (and Google)... I wish they'd forget all of the "epectations bs", just wait a few days/weeks for the REAL numbers to come out.

[competentone]

Originally Posted by Don Plumley

Google has taken the angle of not providing any estimates, and cheers to them. But they are a lonely voice in a crowd of thousands, that are pressured by analysts to provide projections. Game on.

I think you are letting yourself be "deceived" if you think Google is following their "no guidance" policy with the best interest of the public shareholders in mind.

Just look at their two-tiered stock system (the insiders' Class B shares have 10 votes for every one vote the public shareholders have with their Class A shares) -- I know Google tries to claim that this is for the "benefit" of the public shareholders ("they know better what is good for the company than the shareholders do, so they need to keep absolute control") but generally, anytime "power" it not given to the owners of the company proportional to their ownership capital risks, it's a "bad" thing.

As for the "lack of guidance" -- having listened to a good number of Google's conference calls, their policy sounds more like a way to avoid answering any "difficult" questions, than anything to "help" the company long-term. Essentially, their policy is used to avoid giving the public shareholders information which is critical for making investment decisions. Less information flowing from the company to the shareholders is generally a "bad" thing for the public shareholder.

Of course, if you argue that Google is somehow "not fixated" on meeting the (outside) analysts quarterly estimates because they don't give guidance -- you just have to look at some of the details in their SEC filings to see otherwise.

Look at how they "play" with things like their quarterly tax rates, or "adjust" their receivables numbers (currently standing at $1.6+ billion -- strange when their billing system is structured so that most advertisers pay "at the point of sale") to "meet" the outside analysts estimates.

I also monitor a number of forums with Google advertisers -- there is sort-of an "inside joke" about how the advertisers' budgets get "all used up" as the end of the quarter approaches. Google's system "mysteriously" becomes more aggressive in serving ads (and those ads seem to find more clicks) just in time for Google to book the revenue.

I've said it before, and will say it again, for anyone who wants to really start digging into the company -- I think you'll eventually reach the same conclusion I've drawn: There is some type of "culture of deception" within Google (perhaps, "self-deception" at its core) -- personally, I expect there to be some type of Enron-like collapse with the stock/company in the not to distant future.

[KFC911]

Originally Posted by competentone

....-- I think you'll eventually reach the same conclusion I've drawn: There is some type of "culture of deception" within Google (perhaps, "self-deception" at its core) -- personally, I expect there to be some type of Enron-like collapse with the stock/company in the not to distant future.

Interesting perspective. I'm not one to follow or listen to the conference calls (I know, I know ), but I have no doubt that almost every major corp. manipulates the numbers to some extent in order to meet "whatever" the management team desires. Do you really think Google is facing an eminent collapse? Granted, it's grossly overpriced now, but I don't see an "Enron" in the making. I was "lucky", and have known about Google since the very beginning (in 1999 - a music festival acquantance/friend was one of the very first employees), so I rode that rocket from the IPO until it's PE ratio exceeded what I'm comfortable with.

[competentone]

Originally Posted by KC911

Do you really think Google is facing an eminent collapse?

Yes, which explains why I've lost tens of thousands of dollars on the permanent PUT position I've been keeping on the company since last year. (Of course, since I've been losing money, it means I've been wrong so far.)

There are a lot of different angles where I can see problems -- like the receivables number I mention above (it is inconsistent with their billing system -- or means they've been extending credit very freely to some advertisers to grow revenue; the question is if those advertisers are good credit risks or not?).

One of the quickest ways to get an idea about the questionable things going on behind the scenes at Google, would be to read here (read all the links -- the experiences of Google's customers -- the advertisers buying the ads -- can say a lot):
http://www.apogee-web-consulting.com/blogger/2007/01/not-search-engine-spam.html

I've also spent time reading some of the legal briefs Google's lawyers have filed in different court cases. I can only describe some of their lawyers' argument as being an "out right attempt to deceive." (I had no interest in any of the legal disputes; I was just reading the briefs to try to understand the company better. I believe that the lawyers business people choose to handle their legal issues and the arguments they make can say a lot about their ethics.)

Right now, read the arguments Google makes when defending the copyright infringement rampant on YouTube. They try to hide behind the "Digital Millenium Copyright Act" saying that they comply with the law and take down infringing material when notified by the copyright holder of the infringement, but it is pretty clear that the Act wasn't intended to protect the sort of "willful blindness" about infringement YouTube/Google needs to engage in to operate a site like YouTube. (Cases are pending on this.)

There is no doubt that Google is "raking in large amounts of money," I think though, that they are not as "fantastically profitable" as they appear to be.

Advertising has a certain "slushiness" to it; advertisers are used to spending money and getting a gradual return for their spending. I think Google has been exploiting their advertisers -- or at least profiting by turning a "blind eye" to the exploitation occurring on their network. As the advertisers "get wise" to the activity, they will be pulling, or significantly reducing, their advertising with Google (we saw this with Ebay just a few weeks ago). The extent of "trust" that is lost will determine if (or how severely) Google crashes.

Remember that Enron, wasn't "all" fraud -- they were doing a lot of legitimate business, but when the elements of fraud were exposed, all the legitimate business was taken elsewhere and the company collapsed.

I see the same potential situation with Google; if advertisers lose their confidence in Google because of fraud Google is engaged in (or profiting from while they ignore their partners committing the fraud), and the company is not as profitable as it has been made to look, the stock will collapse severely. Shareholder and advertiser lawsuits, and possibly SEC or Justice Department action, could then force the company into bankruptcy.

Most people will probably think "I'm nuts" to mention "Google" and "bankruptcy" in the same paragraph, but I keep digging as I continually re-evaluate my market positions and I keep concluding that Google is a "house of cards" at risk of collapse.