Alert: Analysts Getting Dumber
Wednesday, May 2, 2007 | Wayne MulliganRating:
Question: What happens when a company’s earnings fall short of analysts’ estimates?Answer: The stock price drops!
And not just by a little – it usually gets hit HARD! And not only that, but the analyst gets a big, fat quote in the paper that day, and people begin to think things like, “Wow, this analyst is pretty smart. He thought this company would do great, but instead they did terribly, and he knows why.”
Meanwhile, no one stops to think, “How did this guy come up with his estimate in the first place? Why was he wrong?”
For some reason, people tend to ignore the messenger and focus on the message when it comes to this sort of stuff. But, the truth of the matter is, in this case the messenger created the message!
But more on that in a minute ...
First, I have another question:
What happens when a company’s earnings exceed analysts’ estimates?
Answer: Well, the stock goes higher, and we don’t really hear much from the analysts.
And still, nobody seems to ask how these estimates were concocted, and since they seem to be consistently wrong on both the downside and the upside, an even more important question emerges:
Why are we listening to these guys in the first place?
Answer: I have no idea!
And that’s precisely why I don’t listen to them and why I don’t follow quarterly earnings estimates when deciding whether or not to buy a stock.
But let’s go back to how these “professionals” come up with earnings estimates to begin with ...
Their first step is usually a super-secret, proprietary mathematical algorithm – just kidding.
The first step is that they call the company up and ask them what they “think” they’ll earn that quarter. Actually, they don’t usually need to call the company – the company will usually have a conference call and TELL EVERYBODY what they think their earnings will be.
Wow, somebody actually pays these guys (analysts, that is) to regurgitate information!?
Then these super-smart analysts perform a number of other super-secret mathematical inquiries like asking the company’s customer if they’re still buying products from the company and seeing if other companies in the same sector are performing in a similar fashion.
I still don’t see what justifies 6 – 7 figure salaries for these analysts, but maybe I’m missing something here.
And after they’re done talking to all of these people and coming up with all of these deep, insightful equations, they then come up with a final number – usually a tight range of numbers – for what that company will likely earn that quarter.
And guess what?
The company usually surprises everybody and either comes in above or below estimates! So what was the use of those estimates to begin with?
Not much, if you ask me.
I recently came upon a great article over at a technology blog I frequent: Wall Street Stumped, Surprised by Internet Companies
It talks about how analysts became especially “dumber” during the most recent earnings season.
On average, analysts came in short on their estimates by about 9% - more so on some of the companies in question.
For instance, they missed Amazon’s (Nasdaq: AMZN) number by almost 69% and were off by 23 cents on Apple’s (Nasdaq: AAPL) earnings.
That’s why I could never figure out why a stock would rally so hard or get hurt so badly based on the fact that a guy with a crystal ball in some Wall Street office made a bad prediction.
Does that seem right to you?
What investors need to do is tune out of the media, tune in to a company’s fundamentals and make a decision based on fact, not hype.
Have a great week!
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Wayne Mulligan
Contributing Editor
The Tycoon Report
