In the video above, Hewitt Packard’s CEO Leo Apotheker said the following:

Carl:  Before we let you go, Leo, I don’t know if there’s been a quarter since you joined where the company beat, if you will, I wonder you’ve got to be looking forward to that day.

Leo Apotheker: We’ve beat this quarter.

Carl:  But with accompanied by guidance that was very disappointing.  Every quarter has had some level of disappointment. Are you looking forward to one where there is none?

Leo: Of course. But I just want to make sure we get the facts right. We beat expectations in Q2 both on a revenue and margin side and EPS side. Let’s get the facts straight.

Becky: But the stock market is showing your stock down 5% this morning because of disappointment about the outlook for the third and fourth quarters. That’s a concern.

Apotheker:  I can easily understand that. We will walk our investors through our guidance for the rest of the year and explain the reasons. But I would like to make sure that we get the verbiage right and the facts right. You did beat for this quarter you beat both on the bottom and top line. That’s good news.

The transcript cannot convey the frustration in Apotheker’s voice when he was accused of missing expectations for the current quarter.  He can understand the stock falling, he can understand the outlook being poor, but do not accuse him of missing on the quarter.  Apotheker stressed this point multiple times.

Gamed Earnings

As the next two charts show, beating earnings and revenues expectations is nothing new.  Aggregate S&P 500 earnings have beaten expectations for 50 straight quarters, including the current quarter.  As we explained last July:

The chart below highlights the inception of SEC regulation “FD” (aka, Fair Disclosure). Before FD roughly 50% of companies beat expectations, as would be the case if analysts were trying to get it right. Now that companies have to disclose to all at the same time, we believe their investor relations departments are masters at “guiding” analysts just below actual earnings.

This way the companies “beat” expectations and get the positive press and accolades that come with it. Further, it seems that everyone is happy with this apparent gaming of the system. This is why we believe the percentage of companies that beat expectations is a meaningless statistic. The game is designed for this to happen, even when earnings are collapsing (during 2008′s epic collapse in earnings more than 50% of companies still beat expectations).

Note that the percentage of companies beating estimates has been falling in recent quarters, from 75%  in the first quarter of 2010 to 67% in the first quarter of 2011.  By this metric, earnings are not doing that well.

Click on chart for a larger image

In recent quarters investors have caught on that earnings are gamed and have greatly discounted these results. So they are now turning their attention to revenues. The next chart shows the percentage of S&P 500 companies that beat revenues estimates. This data series only started in 2006.

Click on chart for a larger image

At first blush revenues appear to offer a more honest view of companies’ financial outlooks than earnings. If analysts were actually trying to get it right, the number of companies beating the benchmark should vacillate around 50%. Revenues estimates did exactly this.

In recent quarters, however, revenues are showing an upside bias. Is this because companies are genuinely reporting good numbers or are the investor relations departments now gaming these numbers as well? It’s hard to tell. But we can say in our unscientific review of earnings releases that companies are highlighting revenue beats more now than ever. This is a red flag that these numbers are also being gamed.

Earnings Estimates

In the next video Robert Keiser, vice-president of S&P’s valuation and risk management strategies team, applauds the earnings numbers and suggests they are the most important driver of higher stock prices.

Melissa:  Does it simply tell us that Wall Street got it wrong when it came to the first quarter, that the expectations were too low?

Robert Keiser:  There were double digit earnings growth where the S&P outperformed expectations and the economy is growing 2 to 3% and consistently. In terms of the second floor, based on the company’s guidance, they give guidance and beyond, obviously we have a much better sense in terms of the reaction themselves. The analysts said estimates for S&P earnings are now up to $99.90 and the bar has been raised.

Later Keiser said:

Keiser:  The S&P estimate is right now going to earn $112 a share. Every quarter that the market either meets or beats expectations, there’s a little bit more confidence and it’s going to take about 1400 and sometime in 2012.

Keiser’s assumption is that earnings estimates are stable and even somewhat accurate.  However, as the next two charts show, the 12-month forward earnings estimates as calculated by Bloomberg are $122.44 for the S&P 500, essentially the same as S&P’s estimates.  However, the second chart shows, the error rate between forward earnings estimates and actual earnings is growing.  The worst miss occurred in 2008, which exceeded the record set in 2001. In other words, earnings estimates are becoming less accurate, not more accurate.

So before Keiser tells us that the forward P/E ratio on an estimate of $112 is cheap, why should we believe this will happen?  Forward estimates were also that high in 2009.  How did that work out?

Click on chart for a larger image

Click on chart for a larger image


Current quarter earnings estimates are gamed and 12-month forward earnings estimates are getting worse over time.  Use them in valuation estimates of the market at your peril.

Category: Earnings, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

10 Responses to “Understandings Earnings Estimates”

  1. Leigh Drogen says:

    It’s time that we take this game out of the hands of analysts who don’t have the incentive to make accurate earnings estimates and put it in the hands of the traders and analysts from the buy side and social finance crowd who do. When the sell side gets shamed by the social finance crowd for being down right less accurate, their incentive structure will change in order to preserve their jobs. We’re building the platform to make that a reality at

  2. [...] Barry Ritholtz, “In other words, earnings estimates are becoming less accurate, not more accurate.”  (Big Picture) [...]

  3. [...] Run-don’t-walk to see Jim Bianco’s fascinating discussion on Understandings Earnings Estimates. [...]

  4. noahmckinnon says:

    So how is a regular joe like me supposed to even start to get a realistic handle on a company’s worth?

  5. socaljoe says:

    I would also encourage investors to look at as reported GAAP earnings, not operating earnings.

  6. AHodge says:

    If you are looking for “unbiased” estimators in the statistical sense
    dont look at earnings forecasts, they are almost always low in total
    somebody smart has pointed out the older est from month or so earlier are better
    then all the companies whisper lowball to analysts to get them down and beat
    even worse why would anyone even look at TBTF financial sector reporting
    exceopt maybe JPM and goldman?
    the companies themselves dont know how they are doin

  7. Mike M says:

    “So how is a regular joe like me supposed to even start to get a realistic handle on a company’s worth?”

    Easy, you smooth earnings by taking an average over a reasonable period. And you use only reported earnings. Of course, no one wants to do that today because the result is that stocks are overpriced.

  8. icm63 says:

    ,,”So how is a regular joe like me supposed to even start to get a realistic handle on a company’s worth?”..

    Richard Wyckoff method
    Jim Hurst methods

    Earnings, EPS, PEs etc are Wall Streets marketing tools, reading the cycles of the future and watching the Wyckoff composite man is the true way to read the tape of the market.

  9. blackjaquekerouac says:

    “my earnings are better than yours no matter the estimate.”

  10. [...] week, we highlighted how earnings estimates were being gamed and have become more inaccurate in recent [...]