Aug. 3–What does it mean when companies miss their numbers?

If you own a diversified portfolio, you may be sitting bolt upright and saying to yourself, “What do you mean they missed their number, and what have you done to my stock?” Companies whose final results do not match analyst expectations are often severely punished, and with regulation FD (fair disclosure), it is likely to get worse.

Actually, I am getting a little tired of stocks with no particular problem being crucified because they have “missed their quarterly number.”

Whose number is this anyway? Actually, it is a gaggle of “follow the leader” analysts who send their numbers off to Zack’s or First Call, or some other keeper of the number. This often-whispered number becomes the measure against which the management performance is going to be measured. Sounds reasonable on the surface, but how does this come about, particularly now that the regulation FD has virtually cut off any ability to talk with company personnel beforehand and develop some sense of “How’s it going?”

The crucifications I am talking about are not companies that have had a major short-fall in earnings or major problem or unexpected piece of news, a la Enron. I am talking about good quality companies that report 69 cents for the quarter instead of 70 cents a share and whose stock is hammered by 10 percent or 15 percent. Traders and hedge funds can erase tens of millions of dollars of shareholder value in a heartbeat. I may be naive, but why is it that the company should be punished if these numbers do not match? Did it occur to anyone that the problem may be the analyst?

We are treating volatile guesstimates as if they had far more credence than they deserve. You only have to listen to three days of CNBC to see research analysts lower their number after something unexpected has happened, or raise their number after a good series of events. This is not research, this is group CYA for the old institutional research all-star team. We have taken what should be good indications of a company’s earning momentum into some sort of iron bar hurdle which will hurt you if you miss.

The best analysts in each industry are undoubtedly competent, are often very tuned into the companies they cover and their industries, and are an excellent source for trends within the industry.

However, especially now that regulation FD prevents inside knowledge, they are not subject to reams of inside information that used to allow them to reach deeply into chief financial officer functions and have a pretty accurate idea of what decisions have been made in each decision, what products are on the horizon, what divisions may be subject to being sold off and the other kinds of things that impact these quarterly announcements. This lack of data or reinforcement from corporate investment contacts can sometimes be devastating.

Let us take a company like Mattel. The analyst has no knowledge of how many parents are going to buy a kid a magic box for Christmas. They simply go to the trade show and deal in the same barroom banter as all the other suppliers as they guess what next season looks like.

I am not knocking research. I do research. Most of it’s good. Sometimes I blow it by not realizing a critical aspect. The same is true for many, if not all others. But, if I say that Constellation Brands is going to earn 48 cents and it earns 47 cents, it does not mean that Constellation Brands is a sell, particularly if its price earnings ratio is 10 or 11, and its growth rate is 15 percent per year.

That is why Warren Buffet and others counsel that it is better to concentrate on the fundamental growth engine of what produces those earnings, and not spend so much time beating yourself up if earnings are up 2 cents or down two. That is ultimately not how you make money, and the mutual funds digitally inflamed managers who punch the sell button every time one of these things happen are not only helping to create additional instability in the market, they are also creating a significant tax problem for many of their shareholders with their constant short-term trading.

Having an earnings consensus is a good thing. Making the consensus the dominant determinant of the stock’s movement for the quarter is ludicrous, wrong and will ultimately be seen for what it is: Analyst who need to be fired; not companies that need to be sold.

Brian Presley is a registered investment adviser and money manager who publishes the Presley Advisory Letter from Punta Gorda. E-mail: brian@presleyadvisoryinc.com

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