Back in the days when CEOs were mostly concerned with running their companies, as opposed to the stock prices, quarterly earning reports were a chance to catch up with our investments much as one would with our kid's report card. As with the latter, surprises were negatively correlated to our relative involvement (the closer you are the lower a chance for a surprise). In addition, by definition, the chance of a negative surprise was equal to that of a positive surprise. After all, if Johnny gets an "A" every time we expect a "B," logic dictates we should correct our estimate and expect an "A." Simple enough.
It seems, however, that in the super-sophisticated world of Wall Street research departments this simple logic has been lost as they keep getting surprised by company earnings. Consider the case of Google, a well followed company, which reported 4Q09 earnings last Thursday. The following was the headline on my Bloomberg:
*GOOGLE 4Q REVENUE, EX-TAC, $4.95 BLN, EST. $4.91 BLN :GOOG US
2010-01-21 21:02:22.337 GMT
According to the Wall Street Journal
So the results were better than expected (again). So I ask myself, aren't Google's results almost always better than expected? Fortunately, Bloomberg has a function to check this ( GOOG <Equity> ERN <Go> ) which yields the following screen:Even though results topped analysts' expectations, shares fell 4.8% to $550.94 in after-hours trading. The stock has nearly doubled over the past year....
By my count, contrary to popular belief, GOOG has a running streak of 14 quarters of negative surprises. The discrepancy, of course, is in the treatment of items, which is Wall Street parlance for whatever I did not want to include in the earnings number.
Without going into the details of what they exclude or getting into a discussion on the recurrence of non-recurring items I believe it is fair to ask the analysts what their game is. I mean, if my full time job was to follow this company, I think I would have figured out by now that my estimates are always too low and would adjust them accordingly. Even if the source of my estimates is the company itself.
Isn't the job the analyst to provide an estimate for the benefit of the investment community? I don't think we need them to parrot management's estimates, a simple press release can do that.
In my opinion, this is yet another example of how distorted the market has become over the past few years. Analysts are not rewarded for critical reports so they produce bullish reports instead. In turn, management's priority is showing better than expected quarterly results in order to drive their stock (the one they own) higher. The big loser? Credibility. Although you may fool most people most of the time, eventually they either catch on or run out money. Eventually, people who feel deceived become reluctant to invest which makes everyone (except maybe those who recommend Google while investing their own money in t-bills) worse off.
So long as we are clamoring for transparency I think Congress should consider recognizing that most investors do not have the time or knowledge to sift through company reports. What to do? Simple, mandate GAAP reporting. If companies want to provide alternative accounting measures they can do that in a 5-pt footnote on page 76. The idea that regular people can tell the difference is just an exercise on self-deception.
Disclosure: No positions