Beating the Street to drive up stock prices

In an earnings season preceded by a flood of warnings, everything seems to be coming up roses.More than half of the Standard & Poor’s 5...

In an earnings season preceded by a flood of warnings, everything seems to be coming up roses.

More than half of the Standard & Poor’s 500 companies reporting earnings in the last two weeks topped Wall Street’s expectations — most by just a penny or so. Is it a case of happy surprises? Or are companies playing the old game of guiding expectations to ensure that no one goes home disappointed?

Managing expectations isn’t a problem if companies are merely conveying as much information as possible to help Wall Street estimate their earnings, said Thomson

First Call research director Chuck Hill. The practice becomes a problem, he said, if a company purposely lowballs the guidance so it can boast of ‘beating the Street’ and possibly drive up its stock price. Unfortunately, he added, it’s nearly impossible to tell the difference.

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In the past five years, an average of 81 companies in the Standard & Poor’s 500—or 16 per cent of the index—beat analysts’ quarterly estimates by just a penny, according to Thomson First Call. Astute investors track these patterns and factor them into their decisions, but research suggests that the less sophisticated may be at a disadvantage, said Beverly Walther, an accounting professor at Northwestern University’s Kellogg School of Management.

Companies that manipulate the expectations game merit additional scrutiny, she added.

There’s a difference between exercising caution and misleading analysts and investors, Hill said.

“Honest conservatism” is when a company guides analysts to the low end of its own estimates to make sure it won’t disappoint investors, he said. On the other hand, if the accountants say earnings will come in at 27 cents a share, but the company provides guidance of 26 cents, ‘that’s purposely lowballing it’. This occurs less frequently than the honest conservatism, hesaid.

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In the last two weeks, 60 per cent of the companies reporting higher than expected results beat the Street by a mere penny or two.

Among them were the 3M Co and Citigroup Inc. Both have surpassed estimates to that extent in five of the last seven quarters, according to research firm Multex, as has Cisco Systems Inc, which experts said is known for consistently exceeding analyst estimates by the barest margin. In rare cases, Hill said, he has heard of companies actually pressuring analysts to keep their forecasts low.

What has changed, he said, is that fewer companies are missing or beating forecasts by significant margins. Hill attributed the change to Regulation Fair Disclosure, which has prompted companies to broadcast their expectations in preannouncements and mid-quarter updates. (Reuters)