'Whispers' That Roar: Exposing the Analysts' Estimates Game
Jackson, Missouri, June 30 (Bloomberg) -- Shannon Puls is an unlikely mover
of markets. The balding 29-year-old holes up in a basement in Jackson,
Missouri (pop.9,256), 1,000 miles from the New York Stock Exchange, riding
a sagging couch and hammering away on a laptop. It's not even his
basement; it belongs to his brother, and he shares it with a deer's head, an
exercise bike and a 130-pound Rottweiler named ''Dozer.''
But Puls (pronounced Pulse) also commands an array of eight
server-computers and he gets stock quotes from a satellite feed. So armed,
the former accountant produces quarterly estimates on fast-moving
companies that he publishes on his EarningsWhispers.com Internet site.
This is no futile exercise in ego. A Bloomberg study shows that
EarningsWhispers and a competitor, streetIQ.com in Carmel, California, give
investors far better estimates of per-share earnings than they get from the
published figures of securities analysts. And they're free.
These rookies on the Internet aren't actually beating the pros as much as
they are exposing the earnings estimates game the analysts play. Analysts'
published estimates are often outdated, misguided and just plain wrong. The
true estimates are their oral updates of the published numbers, which they
pass along to big customers -- the so-called whisper numbers. Analysts in
effect are keeping two sets of books, one for the public and the other for
favored clients. ''I define the whisper number as the analysts' real earnings
estimate,'' said Puls.
Moving Markets
The whisper numbers emerge at the end of each quarter, just in advance of
published earnings reports, and they have been roiling stocks for the past
three years. ''Some appear to come from brokers or analysts and some
appear to come from investor relations departments of the (companies)
themselves,'' said Susan G. Watts, a professor at Purdue University who with
two colleagues conducted a two-year study of the whisper phenomenon.
These days the whispers don't stay quiet for long. Updated estimates quickly
become public on Internet message boards such as Silicon Investor, where
Web surfers exchange what they've heard about expected earnings,
especially for computer, Internet, biotechnology and airline companies.
While the term whisper numbers implies inside information -- indeed, that
undoubtedly contributes to their popularity -- these unofficial estimates have
actually become more like a roar, amplified by the Net. EarningsWhispers,
streetIQ.com and other similar sites now act as electronic tip sheets. Shares
of companies like Yahoo! Inc., Intel Corp. and Dell Computer Corp. make
huge moves when companies report quarterly earnings, depending on how
reported profits compare with the widely broadcast whisper numbers.
Internet Ride
Yahoo, the leading Internet search engine, for example, rose 39 3/8, or 22
percent, to 219 1/8 two days before it reported first-quarter earnings. It then
dropped to 206 11/16 in the next three days. Some 25 million Yahoo shares,
more than triple the average daily volume, traded the day before the report.
Yahoo's wild ride was due at least in part to the disparity between the whisper
numbers on the Internet and the analysts' published estimates. The whispers
predicted 10 cents to 11 cents a share, the analysts only 8 cents. Yahoo
earnings came in at 11 cents.
The whisper number is the latest refinement in how investors look at earnings.
Up until the mid-1980s, stocks moved in reaction to how reported earnings
compared with those of previous quarters. Then the analysts took over, and
shares rose or fell depending on how profits compared with analysts'
predictions. Now the whisper estimate is the thing. 'Nonsense'
Not necessarily for the good, in the minds of some investors. ''The
psychology around the earnings report has been completely poisoned by this
whisper nonsense,'' said Philip Orlando, chief investment officer for Value Line
Asset Management. Orlando says the market may become distorted by
rumors about earnings -- like the children's game of ''Telephone'' -- rather than
the real earnings.
Stock prices often rise on heavy volume just before the company's earnings
reporting date. Then, when earnings are announced, they plunge. On the
surface, this is puzzling because in most cases earnings exceed the average
estimates of analysts surveyed by First Call Corp. and the other reporting
services.
What happens, though, is that profits fall short of the whisper number, which
is several cents higher than the published estimate. Intel Corp., which
dominates the market for personal computer microprocessors, is a classic
case.
As far back as the first quarter of 1997, Intel's earnings of 55 cents a share,
adjusted for splits, beat the analysts' average estimate of 52 cents. But
whisper estimates had created the expectation that Intel might report as
much as 57.5 cents -- prompting Intel shares to fall 2 percent the next day.
Report Performance
Things hadn't changed much in this year's first quarter. Intel's profit beat the
average prediction of analysts polled by First Call by 2 cents a share, coming
in at 57 cents a share. However, they didn't beat the whisper, which was 58
cents. Result: the stock price fell 6 percent.
The study by Watts and two other professors -- Mark Bagnoli of the University
of Michigan and Messod Beneish of Indiana University -- compared 943
whisper estimates posted on the Internet with 3,546 analysts' forecasts for
the same stocks. It found 78 percent of the whisper numbers exceeded the
average analyst forecast on First Call. The Internet numbers came in a bit
higher than the actual earnings but were a lot closer to the real numbers than
the analysts' estimates.
Similarly, a study of 101 high-tech companies' earnings reports by Bloomberg
showed that estimates on Puls' EarningsWhispers.com and streetIQ.com
were off by 21 percent, while the analysts missed by 44 percent.
Pipeline
Puls, who started his Internet site last August, says he gets help with his
whisper estimates directly from the companies, although not always from
people in investor relations. He declines to be too candid in naming
companies and giving examples of what they tell him. He says he doesn't
want to lose his sources.
But he says that a company official will direct him to an analyst who has, for
example, an 11 cents per share estimate for the company's earnings rather
than another who predicts 6 cents. That tells him to expect at least 11 cents,
and probably more.
Earlier this year, an investor relations person called him wanting to know why
he didn't have a whisper estimate for that company. The IR person then gave
Puls a list of analysts following the company -- in order of which had the best
estimates. Puls says he compares the information he gets this way with what
appears on the Internet chat lines and produces his numbers.
EarningsWhispers.com attracted attention after its coup on Apple Computer
Inc. earnings. Puls said a friend at Apple, where he once worked as an
accounting consultant, tipped him that earnings for the quarter ended last
Sept. 30 were going to be much higher than analysts' average estimate.
Analysts who followed Apple were predicting 49 cents a share. About three
weeks before the report, Puls estimated 74 cents. Puls was closer; the
actual number turned out to be 68 cents.
Hits Parade
With his reputation growing, Puls says EarningsWhispers and his other Web
sites with investment tips now get more than 6 million hits a month and take
in $35,000 in monthly advertising revenue.
StreetIQ.com, which started last October, says it now gets almost 3.6 million
page-views a month. Scott Moss, 26, an editor there, won't discuss ad
revenue, but says the operation is profitable.
The history of whisper estimates is rooted in the stock market's mania for
short-term performance, the desire of companies to feed that frenzy by
beating earnings expectations, and the willingness of analysts to play along
with companies as they manipulate the estimates.
Investors today -- particularly mutual funds looking for companies with
fast-growing earnings and share prices -- say they seek out those they think
will have ''earnings surprises,'' that is, profits that beat analysts' predictions.
Even a ''value- oriented'' money manager like David Dreman, founder of the
Kemper- Dreman High Return Fund, agrees that stocks of companies that
report earnings above analysts' expectations produce market- beating returns.
The Key
Beating the analysts' estimate is the first step toward pushing a stock to the
top of popularity polls -- just as a nasty surprise of less than the analysts'
forecast is almost a sure trip to the bottom, says Merrill Lynch & Co. market
strategist Richard Bernstein.
With big investors placing such emphasis on earnings surprises, it's no
wonder that company CEOs do too.
Companies increasingly are manipulating their earnings, fearful that any
shortcomings will trigger sell-offs in their stocks, Arthur Levitt, chairman of the
Securities and Exchange Commission, told the Financial Executives Institute
last November. ''For many, this pressure has become all too hard to resist,''
the stock market's chief regulator said.
Companies usually create the surprise by poor-mouthing the next quarter's
earnings. Last December, J.P. Morgan & Co. said its fourth-quarter profit
would be less than 58 cents a share. Analysts reduced their estimates for the
quarter's earnings to a range of 25 cents a share to 50 cents. In January, the
banking and securities company reported a profit of 86 cents a share. ''All is
fair in love and war and earnings estimates,'' Lehman Brothers Inc. analyst
Diane Glossman said at the time.
Cooperation
By and large, analysts cooperate with the companies by keeping their
forecasts low. A study by New York's IBES International Inc. reveals what
has become a ritual mating dance. Analysts often start out overly bullish,
then bring their estimates down during a ''confession period'' as the
companies talk down the predictions either in public or private. The analysts'
estimates reach bottom just before the actual earnings come out.
''Companies have done a very good job of managing expectations,'' said
Robert Froehlich, chief market strategist at Scudder Kemper Investments. By
suggesting that earnings will be 40 cents when they expect 50 cents,
companies produce the surprise that Wall Street wants to see -- and the
stock price goes up.
Low-Balling
This manipulation by companies and analysts is close to perfect. In the
Bloomberg study of first-quarter earnings, analysts' published estimates were
less than reported earnings almost three-quarters of the time, and more than
actual earnings in only 7 percent of the cases. By contrast, the whisper
estimates of Puls and Moss were both closer and more balanced. They were
too low 52 percent of the time and too high 30 percent of the time. ''It's a
simple game,'' said Moss. ''When you lower the bar, you can easily hurdle
it.'' Puls said companies now even try to get him to keep his estimates too
low, in effect doing the thing they do to the analysts. ''Some of them are very
persistent in trying to talk me down.''
A separate Bloomberg study last November identified 92 companies,
including Lucent Technologies Inc., Dell and Tyco International Ltd., that
produce ''earnings surprises'' with impeccable regularity.
IBES, one of the three major providers of analysts' estimates, even publishes
a category of companies that will have ''expected earnings surprises.'' IBES
sells its ''Earnings Surprise Indicator'' as a premium product for $15,000 a
year. ''It sounds like an oxymoron,'' IBES says in its sales literature. ''What
is predictable can't surprise. But recent studies have shown that earnings
surprise does have a predictable component.''
Keep Door Open
But if analysts know that companies deliberately misguide them and
investors, why don't they adjust the estimates they publish on First Call and
other services? For several reasons. First, analysts fear that if they challenge
the ''guidance'' given by companies, they will be shut out of corporate
meetings and ignored on conference calls.
But a bigger reason for an analyst to toe the company's line is that an
increasing portion of his paycheck is coming from the company's investment
banking business -- underwriting and corporate merger advice -- with his
brokerage house. ''As the financial business becomes more concentrated, it
is becoming harder and harder to find an analyst whose firm does not have an
investment banking relationship with the companies the analyst follows,''
complains the SEC's Levitt.
In the recent takeover battle between Deutsche Telekom AG and Olivetti SpA
for Telecom Italia SpA -- which Olivetti won --a total of 14 brokerage firms
were enlisted to give advice or lend money to one of the parties involved.
Deals and Dollars ''The reality is, that's the most profitable part of our
business today, so people who bring in significant deals will be more
generously compensated,'' said analyst Steven Garmaise, director of
research at Merrill Lynch Canada. Garmaise said the link between deals and
dollars is less direct at his current firm than what he's seen in previous jobs.
Whisper estimates come about in part because most analysts make their
last earnings revisions long before the quarter ends. The
Bagnoli-Beneish-Watts study of whispers showed that almost half of all
analysts' estimates were made as far back as the beginning of the quarter.
Only 1 percent were made within five days of the earnings announcements.
''Whispers may be correcting 'stale' analysts' forecasts,'' the researchers
said.
Analysts who receive timely information at the end of the quarter about
earnings typically relay the message orally to favored clients rather than
putting it in their printed reports. ''An analyst who is forecasting that a
company will earn 39 cents a share will tell investors, 'I've been talking to a
few guys and just between you and me 42 is the number,''' says money
manager Orlando.
Privilege
This smacks of insider information, because only a few people are learning
what the analysts know. ''Big institutions are the only customers they care
about,'' says Marshall Front, managing director of Trees Front Associates in
Chicago. ''They don't care about the retail investors.''
What may start out as inside information doesn't stay that way long. ''These
whispers get out real quick on the Internet,'' said Alexander Cheung, a money
manager for Monument Funds Group.
At any point, is illegal inside information being disseminated? There are no
legal cases to answer the question. ''This area of the law is in such infancy,''
said Darrin Robbins, a San Diego-based attorney for Milberg Weiss, a New
York firm that specializes in shareholder suits.
Companies won't even discuss the subject. ''Whisper estimates and
analysts' estimates are both Wall Street's business -- not ours,'' said Dell
spokeswoman Libba Letton. ''We wouldn't comment on rumors and that's
what they are,'' said Chuck Mulloy of Intel. ''It falls below the category of
analysis.'' A spokeswoman at Microsoft, a past master at beating its own
earnings estimates, was even more blunt: ''We'll pass on this.''
No, Thanks
Analysts are even less communicative. Most of them declined to discuss
whisper estimates or their role in creating them. But Michael Flanagan, who
covers the brokerage industry as head of Financial Service Analytics, said
that as a group these folks tend to be conservative. ''Analysts would rather
be low than over with their estimates because when you're over, you're
marked as wrong,'' he said.
Silence can't hide the fact that manipulation of earnings estimates is so
widespread that quick-witted people like Puls and Moss can undo the bias of
published estimates largely on their own. ''Our chief reference tool is prior
earnings histories,'' said Moss. His staff focuses on a narrow list of 150
companies and compiles a history of previous earnings surprises, company
announcements in advance of earnings reports and, to a lesser extent,
''rumors that traders post on (Internet) message boards.'' After that, it's
simple, Moss said. If a company's estimates to analysts are traditionally too
low by 10 percent, you add that back and get your whisper number.
Aberration
Puls tries to provide a whisper number based on what he sees on the
message boards though, like Moss, he uses what the company has done in
the past as a guideline when there are conflicting estimates. ''If we have a
good source, we use it,'' said the Missouri native. ''But if someone tells us
that Cisco Systems will beat analysts' estimates by 5 cents a share, we'll
ignore that, because they've always beaten earnings estimates by 1 cent in
the past.''
Traders have various strategies for profiting off the whisper. If that number is
higher than the average published estimate, as it usually is, they can buy the
stock in the weeks before the earnings report and watch it rise to meet the
whisper. Or if they think the actual earnings won't meet the whisper estimate,
they can sell the stock short the day the report is due, hoping that it will
plummet the next day and they can buy it back after disappointed investors
sell out.
Candor
Clearly the whisper number is on investor agendas. Analysts are now being
more open with their own whisper estimates --during television interviews, for
instance, and even in print.
BancBoston Robertson Stephens analyst Alex Mou recently told clients in a
report that Lexmark International Group Inc., a computer printer maker, ''will
beat our earnings per share estimate by 2 cents.'' Asked later why he did that
rather than raise his estimate by 2 cents, Mou chuckled and said, ''I want
them to beat my number.''
Companies are also trying to provide better guidance to the public, without, of
course, setting themselves up for the kind of earnings shortfall that can lead
to a plunge in their stock. In June, Best Buy Co., an electronics retailer, told
everyone that it expected to earn 20 cents in the fiscal first quarter, almost
than double the analysts' forecast on First Call of 12 cents. Of course, Best
Buy still managed to ''surprise'' later that month by producing 22 cents a
share in real earnings.
In other words, everyone is still playing games with earnings -- and earnings
estimates. With the whisper number now common talk, it may only be a
matter of time before the guessing game rises to yet a new level. Ominously,
traders now talk about trying to get a company official to tell them if the
whisper is correct. What's next? A whisper on the whisper? |
