When Wall Street analysts raised their bows and arrows to target Apple's second-quarter earnings, NationsBanc Montgomery Securities' Kurt King came the closest to hitting a bull's-eye with his estimate while others missed by a long shot.
"I wasn't surprised that my numbers were so close, but I was surprised that the [analyst consensus ] was so low," King said today.
King set his earnings estimate at 32 cents a share for the second quarter, while the consensus of analysts' estimates was 16 a share, according to First Call. Apple ended up reporting net income of 38 cents a share.
How did an analyst who doesn't use a Macintosh but has followed Apple for three years come so close compared with other analysts? King, who also follows Hewlett-Packard , among others, discussed the art of setting earnings estimates:
"Sometimes there's an element of luck," he said. "I'm really speculating [on Apple] because I wasn't looking at [other analysts'] models [and didn't] receive much guidance from management. But one reason may be the way I took into account tax loss carry-forwards, and another reason may be that some portion of the [analysts'] coverage was not maintaining their models very carefully."
Tax loss carry-forwards, in essence, allow a company to take a loss from previous periods and apply any tax benefit derived from being in the red to future periods when the company posts a profit.
King said he may have applied a greater
Other ingredients in his earnings estimate mix: the recent success by Apple's management to control expenses and the company's new product line, such as the G3 systems. Apple said the G3 played a major role in pumping up its profits, since the new product carries higher profit margins.
Apple's performance prompted King to raise his third-quarter earnings estimate to 41 cents a share from 32 cents, and his fiscal year outlook on the company to $1.60 a share from $1.31.
But it wasn't enough to change his "hold" recommendation on Apple's shares--a clear sign of the PC maker's struggles ahead.
"Apple has a chance to deliver earnings above published Street estimates as long as the company executes well. But, more importantly, is whether they can grow their [revenue] on a sustained basis," he noted. "It will take more than execution to do this. Apple, I believe, has already lost the platform war, and it may not be possible for [the company] to grow revenue in today's PC market."
Still, he said, Apple should be able to meet its goal of generating an increase in year-over-year revenue growth in its first fiscal quarter because of the weak performance it will be compared against. In addition, new products will help propel revenue.
Setting earnings estimates is tricky when a company offers little guidance on its financial performance, or when it lacks consistency in its revenues and profits--as Apple has. But when a company's management keeps Wall Street informed and has a more predictable financial performance, the range in estimates typically is narrower.
"When companies have a tight grouping of analysts, that's when you get a very clear 'whisper number' that's going to be either above or below the consensus," King said. A whisper number is an earnings estimate that is offered up by analysts but is not reflected in their formal estimates that they report.
King, who earned an M.B.A. from Columbia University and a bachelor's degree from UCLA, said it's untrue that analysts are always looking to be the one who comes closest to hitting a company's earnings number.
"For companies we are enthusiastic about, we actually want our estimates to be below their number so we can say they beat our estimate," King said. "Often, our focus is on the long-term--the next year--rather than the next quarter. So most of our important clients are looking at where a stock will be in six months to a year, more than where will it be tomorrow or next week."