Analysts' Forward-Looking Estimates: Just Plain Nuts 6 comments
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One of the reasons sell-side analysts on Wall Street are usually pretty bad at picking stocks is because they are reactionary, not anticipatory. Remember, the market is forward-looking, so what already happened is irrelevant.
Here we are, in a recession, and by most accounts the economy will stay bad well into 2009. And yet, the consensus estimate for 2009 S&P 500 operating earnings stood at $100.90 as of 10/14. That compares with a 2008 estimate of $75.94, which means the sell-side is projecting earnings growth next year of 33%. Absolutely nuts, right?
The problem is that analysts won't ratchet down their numbers until the companies actually come out and give specific 2009 guidance (they wait to be spoon-fed it, rather than anticipating it ahead of time like the market does). In such an uncertain economic environment, firms are uneasy about projecting earnings for this quarter, let alone next year. As a result, we have everyone on Wall Street well aware that 2009 earnings for the S&P 500 will be nowhere near $101 (hence the market has tanked), except the analysts won't tweak their official forecasts ahead of time.
Look, how long the bear market lasts will likely depend on how long the economy stays weak, but how far the market ultimately falls during the bear market will depend, in large part, on how far earnings fall. As you can see below, S&P 500 operating earnings peaked way back in 2006 before oil prices spiked and hurt many companies who have oil as a major input cost.
S&P 500 Operating Earnings:
2005A: $76.45
2006A: $87.72
2007A: $82.54
2008E: $75.94
2009E: $100.90
Obviously the 2009 number is crazy, but how far will earnings drop? The headwind is the recession we are facing, but with that we are seeing commodity prices come crashing down. That will help profit margins at most companies because their expenses will drop alongside their revenues.
Even if we see a recession during most of 2009, earnings might hold up better than some pessimists think. If that is the case, it should put a floor under stock prices next year, even if we hover along that floor for a while. So, the thing to watch is not whether $101 of S&P 500 earnings is doable in 2009 (it isn't), but rather if we can manage $70 to $75, which would make some of the more dire predictions of $50 or $60 overly pessimistic.
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This article has 6 comments:
(OK. The Red Queen didn't acutally say that, but she would have in this market.)
We can thank Sarbanes-Oxley for the current bizarro flow of information. Punishing 'forward looking statement' issuers tends to limit the number of 'forward looking statements' that companies are willing to provide to analysts. Without the 'inside' information analysts are just as clueless as the rest of us for predicting. Our guess is roughly as good as theirs.
Here post an example to solidate your case.
Today, SONY just haves its earnings outlook, mainly because of the Yen appreciation, the price war and the diminishing demands on its flat TV lines and digital cameras.
In other words, almost all sell-side analysts lost their reputation on such a famous firm of the very stable cash flow, and most of whom are from GS et al.
And the question is, over the downturn, the stock pricing model based on DCF is extremely qestionable for the following reasons:
1. the growth rate, may be negative or just like in the SONY case was cut in half, then the stock price will goes deep deep under water, totally not based on their past outdated estimated forward p/e for S&P at around 10 now. If you factor in this growth rate, current p/e for S&P 500 may be 20, or even higher in the SONY case.
2. Analysts got all the financial info mostly from the firm CEO/CFO, so, they have accepted their assumptions for the most part. In the SONY case, when SONY issue its new balance sheet, they made an assumption that marketable securities(mark-to-mar... issue) is based on Sep 30 number, or the market will not change too much based on this number, yet we all know that so far from Sep 30, the Neikki has sheded by almost 25%, which in financial institutions this balalce sheet should be marked to market on a daily basis for the monitoring purpose, yet in a business like SONY, they don't have to unless SEC asked them to post their quarterly statements in time.
3. Most princing models have a D/E(Debt/Equity in market value) ratio built in. If every stock shed like IBM in the past couple of weeks by 30%, then your bollowing cost - credit spread on risk-free rate will widen significantly, which will also eat into their profits by a very big slice.
Sure, we have a lot of macroeconomic factors that need to be considered.
Add all them together, you'll see over the huge downturn, you better be prepared for a 6~8 forward-looking p/e, which in reality after you have discount all these negative factors may stay at 15~20.
Another way you can predict the market move is for a huge downturn like this, every quarter tons of bad news will push down the whole market by at least 10%, then at the bottom (still 3~5 quarters away), we will see S&P at 600 or so.
And another example is SAMSUNG, which just posted 44 decline in net profit and is planning on its future capital investment in some area like LCD display. This cutback will further lead to economic downturn on a macroeconomic level.
SSMSUNG is an extreme case because compared to SONY, SAMSUNG has a huge advatage on currency WON's depliciation. Even with this advantage, its profit remained almost halved.
Just don't read into sell-side analysts' estimate too much. In an environment of high volatility, most analysts' estimates have been wrong with a statistical significance.
Even if the analysts were spot on for earnings the next quarter, basing prices on forward P/E is risky in a recession given they are most likely decelerating or declining. Cash flow and cost of capital become the major concern. Unfortunately, many companies were high on the hog with cheap corporate bonds and lot's of convertible 0 coupon bonds that made them feel money was free.
Don't expect things to go back to those days of loose capital and terrible margins where earnings were based on massive leverage.
Does the well-respected Prof. Shiller use the "as reported" number? (google: irrationalexuberance.c...