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….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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