AN EARNINGS SURPRISE? MAYBE FOR THE “ANALYSTS”….
Markets soared yesterday on the back of “better than expected” earnings from JP Morgan and Intel. I am not sure who pays the analysts to do their work, but I’ve been warning of a great Q1 earnings season for well over three months now. Though early in earnings season the first few signs show that we couldn’t have been much more right. We said it would largely mirror last quarter’s earnings as analyst’s remain woefully shy in terms of ratcheting up expectations. On January 8th I wrote:
“For 2010 Q1 [analysts] are calling for just 1.9% sequential growth. In a nutshell, they expect earnings to be in-line with the last few quarters (which I believe is utterly naive and lacking in any real analysis worthy of paid employment). These estimates are almost certainly low.”
In addition, on Tuesday morning we highlighted 1 month old reports from Goldman Sachs and the Intel rumor mill about the high probability of “better than expected” earnings and bullish market action. Lo and behold, the data release was almost exactly as we expected and stocks soared over 1%.
Despite obviously low estimates, analyst’s were unbudged from the marvelously sandbagged levels that Intel’s executives pegged their earnings “guidance” at. Intel’s execs told them they would earn roughly $9.7B in revenues and their margin break-down implied about 37 cents in earnings. Not surprisingly, the analysts, without doing any original work, pegged their estimates at EXACTLY these levels. And not surprisingly, the results were “better than expected”. My personal favorite is always Apple who plays the analysts like they’re total and complete fools….
The analyst community has made a mockery of earnings season by consistently missing the target by a wide margin. On the way down we were able to sidestep the disastrous market crash largely because we noticed how wrong the analyst estimates were. In early 2009 we were confident of a mean reverting trade because the analysts had then swung to the opposite side of the boat. They couldn’t have been more wrong and the “upside surprise” helped spur the March rally.
Original thought clearly isn’t part of the job requirement at most research firms. What’s even more shocking is how market moving these estimates are. Investors literally buy and sell stocks entirely based on a company’s ability to beat these terrible guesstimates made by the consensus. Talk about the blind leading the blind….
How a “beat and raise” surprises these people is beyond my realm of expertise, but my work has been showing these “better than expected” figures long before they were posted. Nonetheless, market participants were utterly shocked by the data as stocks rallied broadly.
And for anyone looking for the earnings playbook I’ll hand it to you in abbreviated format:
- This earnings season will mirror last earnings season. I.e., it will be characterized by moderate revenue growth and robust margin expansion.
- 70%+ of companies will beat earnings.
- Revenues ex-financials will remain in the mid-single digits, but will go unnoticed by most analysts and TV commentators.
- The analysts will once again be proven oblivious to reality as our “expectation ratio” has consistently proven.
Goldman says this is all “priced in”, but yesterday’s market action shows they might be wrong. Investors were clearly shocked by the “news” and willing to snatch up shares based on the “better than expected” results….
The market won’t decline because there is no catalyst for downside. Until then it’s a race to get in….
As a former sell sider I can testify to the pressure one faces to ensure that they never model numbers too high for fear of looking silly to the buy-side community. Too low is quite fine and in fact, buy-siders and management love estimates that are too low. Model them too high though and be prepared to get calls from both of the latter groups in the weeks leading up to earnings to suggest “you might be a little aggressive with your modeling”. The sell-side remains, post global settlement, one of the areas within the financial oommunity most challenged by the omnipresent conflict of interests that are created by attempting to thread the needle to satisfy so many disparate parties (i.e., clients, sales force, director of research, management teams and buy-side)….there’s just too much pull from too many directions for most analysts to be comfortable with doing “original work”. It’s sad, but it’s the structure and will always be.
great post ferro.
the cfo/analyst dance is such that there is no incentive for the sell side to be truly upfront and accurate (as best as one can be about matters such as accounting treatment and judgment that often don’t get decided until late), but also for the buy side to be really proactive. remember, one person’s hard digging is another person’s inside information, given the SEC rule prohibiting individual material disclosures. ray dirks (if you are old enough to remember him) was the best insurance analyst around, and all of his hard work only got him into trouble with the SEC.
It just blows my mind how influential these guys are on price action though. Anyone familiar with the game knows it’s a big joke, yet CNBC and Bloomberg report this “better than expected” crap like it’s actual news.
You want to know what 85% of the companies in the S&P will ACTUALLY report this quarter? I’ll give you tomorrow’s news today….
I hear you but it has historically been the case that analysts under-estimate the strength of earnings coming out of recessions….nothing new this time around…
However, it’s a touch misleading to generalize that analysts are systematically always way too pessimistic…
Statistically, history actually shows that analysts persistently have to revise annual estimates DOWN, not up…on the flip side though, they often times are too low on the current and next forward quarter…
Again, it comes down to conservatism and original thought…nobody is going to penalize you for being 10% too high on an annual number and having to reduce it; you just won’t look silly for making that mistake…however, there’s much more credibility risk to doing the same thing for the current quarter estimate…
Lastly, know this whole convo cuts both ways – they’re always way too optimistic heading into recession
But, if it were just sell-side stupidity that was so ubiquitous, why were so many smart buy-siders so wrong through all of 2008-2009? Truth be told, the very fact that so few can generate risk adjusted superior returns vs. the market over time or can upgrade/downgrade a stock correctly and get EPS est. on the ball highlights the fact that the finance industry in general is vasty too big for its societal contribution…lots of dead weight!
That’s my whole point. I am not only shocked at how wrong they are during bull markets, but also shocked at how wrong they are during bears.
What value do they offer? More importantly, why do they influence price action so much….
same can be said about ratings agencies…also RE appraisers, come to think of it…sorry if i offend anyone
I don’t think that analyst ratings and the actual stated performance has as much impact as you think – other than perhaps being the time when volume really hits the stock.
There’s a lot more to earnings than EPS and Revenues vs Expectations. Changes to Income Statement, Balance Sheet and Cash flows are very important for value investors and many scenarios are simulated before earnings are released. This has become even more fun when computers get involved. However, its still a marketplace and there are many other “forces” involved that can drastically alter what one would perceive as the correct direction following a report….
TPC – I think the sell-side is as big of a joke as you do. I commonly stated this belief when I was there and continue to. I would say 20% of analysts at my firm added value (hopefully I did). Value add to me is the ability to call out a material catalyst on a stock prior to it happening. That’s how I set up my franchise at least – it was all about proprietary contact development!
In the end, while the vast majority of sell-siders can’t get it right and don’t add value on the EPS estimate thing, they still offer buy-siders a crap ton of industry expertise and historical context. That is huge if you’re a buy-sider who has to get ramped up super quickly on a company or industry that you have no experience with.
And lastly, before I forget…why do they influence price?
If we assume the market is reasonably efficient on a daily basis (fair bet I’d say), then the only way stocks can continue to go up is if reality exceeds expectations…
If, as I stated previously, sell-side analysts have the greatest amount of industry background and thus, company specific background within each industry, then they will be the aribters of expectations vis a vis their written research…
While buy-siders might complain, the vast majority are generalists, and lack the company insight to appropriately model EPS themselves…
And there you have it…sell-siders set expectations given their industry background (some have 20 years experience with a list of stocks!!)…
And yes, they will be devilishly wrong at each and every turning point the market will ever make in a major way – I would have been called an a$$hole by my sales force had I ever gone out and started downgrading stocks wholesale because my macro thesis was turning bearish…you’re just not allowed to make macro calls like that- they’ll crucify you!
“…Original thought clearly isn’t part of the job requirement at most research firms. What’s even more shocking is how market moving these estimates are…”
like i wrote before:
this game is being played for generations now.
analysts aren´t dumb by nature. they´re forced to lowball their numbers.
the system is based on rising equity prices, which keeps companies and institutional/retail clients happy and business strong.
next to liquidity and interest rates the main catalyst for rising stock prises are “upside surprises”.
if you wanna keep your job you do everything to keep this game going.
you make sure that 60% or more of the reports will beat.
and for the market moving part:
it´s the dumb money that moves.
i don´t get why pension/mutual funds that manage trillions of dollars still rely on third party research instead of doing their own due diligence.
there’s just too much pull from too many directions for most analysts to be comfortable with doing “original work”.
Peter Lynch makes this point in one of his books, namely that it’s usually better for one’s career to make “safe” choices than it is to aspire to make very good ones but then screw up. They’re managing for their downside, more than anything else.
First of all, virtually every bit of content in this article is so blatantly obvious to any market professional, that it hardly merits comment.
Patting yourself on the back for these observations/predictions is like thumping your chest because you knew the sun was going to rise this morning…
Second of all, if you knew all this, and you’re such a market genius, why have you been so unremittingly bearish the last several months?
I love the argument that this is “all priced in” after we see the stocks move over 20% into the earnings and then another 5% on the news. That makes no sense.
I also love the accusations that I have been “unremittingly bearish” because I said I was building my first short positions in over two years. I have received dozens of emails asking me why I am a permabear. If I am such a permabear then why did I predict the market would be up 18% in 2009? Why did I say the economic recovery was for real in my 2010 outlook and that stocks would rise in H1?
Have I been short for the last month and wrong? Absolutely. But please don’t skew reality with this hogwash about me being some permabear. This site is more balanced than any out there.
Regardless, I’d love to see other people put their picks out there so freely as I do….No one seemed to complain in 2008 when I called the crash or on March 8th when I called the bottom or throughout 2009 when I said shorting was out of the question….We all make mistakes. If you’re so much better at investing and believe that no one makes mistakes then I invite you to put your picks out in public for everyone to view?
I don’t think 1 million people are coming here each month because I’m some brain dead moron who puts out useless content each and every day….
“I’d love to see other people put their picks out there so freely as I do”
i have and i have been skewered like st. stephen for it…i have had to be brash and brazen to defend myself against onslaughts, even as my picks have been proven correct (so far)
feels better now that i got that off my chest
as for the site’s content, my go to sites are tpc and scott grannis; very dependable, mostly balanced (scott is skewed a bit bullish, tpc is, well you know), provide content not normally or easily accessible
then there is ZH, which is usually a waste, but sometimes just golden
And I have sung your praises of late….You’ve nailed it. Would I tear you down if you were wrong? No. What is the point?
People trashed me when I turned bullish. Now they trash me when I turn bearish. Welcome to the world of investing people….If you think you’ve found some holy grail here then move on. I provide the content and even throw out a few ideas of my own some times. I’ve been pretty clear that you shouldn’t follow the anonymous picks of a stranger and that global macro is not my bread and butter (though I appear to be better at it than most).
Use the site and decipher the info as you please. If you don’t like the content or my personal posts then just stick to the other content (of which there is tons) and/or ignore the site altogether.
My main point would be that it is considered crass in this business to go on about how “we could not have been more right,” especially when it is about a subject as banal as the shortcomings of Street research- that’s considered very old news at this point, just to let you know.
I do put my picks out there everyday, to market professionals only, and if I ever made comments like the ones in your article, they would stop picking up the phone.
On the other hand, humility about your wrong calls and introspection thereof is considered perfectly acceptable behavior.
Meanwhile, I do find your site useful.
Hope that helps.
I think it’s rubbish to say that the investment community understands the flaws of the analyst community. If that were true no one would care about the “consensus estimate” or “better than expected” earnings. CNBC would not report it and investors would not cheer when the numbers were released. These people move markets. Plain and simple.
Me pointing that out may sound “crass”, but it is the reality. I’m obviously generalizing here – there are plenty of excellent Wall Street analysts, but for the most part they are robots. Robots who have a huge influence.
I think it’s insane to imply that their estimates don’t matter. After all, one of the only reasons I was bullish in March 2009 was due to the extremely low guesstimates. And my research has been calling for that same environment for the entire last year.
Larry Kudlow is dead right when he says profits are the mother’s milk of the stock market. How those profits are viewed is extremely important in understanding where the market is going….Implying otherwise is foolish.
As for humility, I have certainly sung the praises of anyone who has been long over the last month. I have been very wrong. It’s part of the game….
virtually every bit of content in this article is so blatantly obvious to any market professional, that it hardly merits comment.
If it was as obvious as that, then stocks wouldn’t tend to rally on positive surprises or fall on negative surprises, as they do.
I improved my game once I figured out that the market isn’t as intelligent or efficient as I had once believed. Even “surprises” that shouldn’t be often are.
I would agree that it should be obvious. I would disagree that it is.