'Whispers' That Roar: Exposing the Analysts' Estimates Game
Bloomberg News
July 6, 1999, 3:01 p.m. PT
'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 Analysts' published estimates are often outdated,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?
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