Making sense of the numbers game
As companies begin posting their quarterly earnings this month, investors will be focused on whether they meet their estimated numbers.
Missing the numbers--the per-share earnings that a company is expected to post--can cause a large swing in a company's stock price. But investors may be dismayed to learn that the way analysts determine earnings estimates is equal parts science and art.
And even if a company meets the official estimate, the mysterious "whisper" number can still ambush the shares.
Some recent examples of the power of the number include the following:
• Lucent Technologies was expected to earn 54 cents a share during its first quarter. When the company warned two weeks ago that its profits would be closer to 39 cents, its shares plummeted 28 percent.
• Similarly, BMC Software and Baan delivered warnings earlier this month and their stocks tanked by more than 30 percent.
• Conversely, Adobe recently posted better-than-expected results and its shares jumped 13 percent.
Analysts and research directors acknowledge numbers are often high or low of the actual results because setting earnings is far from an exact science. In addition to hard figures such as the cost of materials or labor, analysts often rely on interviews with the company executives, competitors, suppliers and customers. A dash of intuition also is part of the mix.
The problem in this process is that none of the sources of information is infallible--starting with information that comes straight from the horse's mouth.
"The great myth about earnings projections is that even the companies are sometimes clueless," said Bruce Lupatkin, former research director for Hambrecht & Quist who now runs technology hedge fund North Bay Technology Partners. "They give guidance to the analysts, but it's garbage in, garbage out."
Sometimes a company will try to intentionally lower the estimate to ensure it will be surpassed, Lupatkin said.
This often results in forecasts starting high at the beginning of the fiscal year but gradually ratcheting downward in subsequent quarters, said Chuck Hill, a spokesman for First Call, a research firm that complies analysts estimates.
| The numbers game These are some of the tech companies that are scheduled to release quarterly earnings in the next two weeks and analysts' expectations. | |
| Company | Per-share earnings estimate |
| America Online (AOL) | $0.08 |
| Apple Computer (AAPL) | 0.89 |
| Gateway (GTW) | 0.42 |
| Iomega (IOM) | 0.04 |
| Lucent Technologies (LU) | 0.37 |
| Microsoft (MSFT) | 0.42 |
| Motorola (MOT) | 0.81 |
| Rambus (RMBS) | 0.10 |
| Scient (SCNT) | (0.02) |
| Sun Microsystems (SUNW) | 0.20 |
| Source: First Call | |
As a result, each analyst must learn the nuances of the companies they follow--more art than science.
"(Applied Materials) gives explicit guidance, 'We expect 9 cents a share,' that sort of thing," said Ashok Kumar, an analyst with US Bancorp Piper Jaffray. "Intel, on the other end of the spectrum, is more qualitative. That's how we can justify our existence."
Andy Bryant, Intel's chief financial officer, is known for giving relatively vague, elliptical statements about the chip giant's future sales, analysts said. Generally, if Bryant says Intel expects to see "growth," analysts construe that to mean an increase of anywhere from 1 percent to 5 percent, while "substantial growth" is interpreted as 5 percent to 10 percent, said A.A. "Tad" LaFountain, an analyst with Needham & Co.
While there are many legitimate reasons for analysts to be off, some say laziness has also crept into the profession.
"A good analyst will do a bottoms-up forecast," said Lupatkin of Hambrecht & Quist. "They will try to dissect revenue by product line if appropriate, look at the margin contributions by product, study the overall market, talk to competitors and suppliers and then run it by the company management to get their take and input.
"Unfortunately, what tends to happen is analysts will just solicit some input from the company and won't gather other input. That makes it a less valuable projection."
Dan Niles, managing director at Robertson Stephens and an analyst of PC and semiconductor companies, agreed that most analysts mainly rely on the company's guidance and operate on a herd mentality.
"Most analysts take what a company says because it's the easiest thing to do and less risky. Most do that because they'd rather be wrong with the crowd, rather than out there on their own," Niles said.
There has been another recent development that further confuses investors' ability to react to earnings statements.
Analysts typically publish their earnings forecasts and research firms such as First Call then tally the numbers to arrive at a consensus estimate.
However, another estimate, called the whisper number, has become a controversial but important barometer.
"The whisper numbers are suppose to be some inside information that analysts whisper to their top clients. We think they're a crock. These whisper numbers are usually based on how a company has done on previous earnings expectations," Hill said.
Crock or not, the fact is that whisper numbers drive stock prices.
Yahoo, for example, beat analysts' fourth quarter estimates of 15 cents a share last week, but its stock fell 10 percent after it missed its whisper number.
Last quarter, eBay reported earnings of 2 cents per share, surpassing analyst estimates of 1 cent. But the whisper number was 4 cents and eBay's stock took a hit of about 8 percent.
News.com's Michael Kanellos contributed to this report.