Winning Investors Over. Baruch Lev

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СКАЧАТЬ earnings? A postmortem by market mavens suggested that the earnings disappointment was aggravated by eBay’s lukewarm outlook for the rest of 2005: an annual EPS range of $1.48 to $1.52 against analysts’ estimate of $1.50 to $1.72. But this could hardly justify a 22 percent price drop lasting three months until the subsequent earnings announcement. The real culprit, corroborated by the research I present in the next section, was the 80 percent price rise of eBay’s stock over the ten months preceding the January 2005 earnings announcement (the S&P 500 index over the corres ponding period increased by a mere 5 percent). What gets a stock clobbered upon a consensus miss is not so much the severity of the earnings shortfall, but rather the shattering of investors’ erstwhile growth dreams—the more enticing the dream, reflected by the price rise, the larger the disappointment upon wake-up. This, we will see, has important implications for proactive management.

       WALMART ALSO MISSES BY A PENNY. On May 12, 2005, Walmart Stores—the world’s largest retailer—released first-quarter 2005 EPS (excluding one-time items) of $.55 against a consensus forecast of $.56. Once more—a one-penny miss. However, in contrast to eBay, Walmart also slightly missed the sales target, $71.7 billion versus an estimate of $72.0 billion, and, like eBay, issued a gloomy guidance for the following quarter: an EPS range estimate of $.03 to $.07 below the analysts’ estimate. Surely, an all-around disappointing quarter, yet, the hit to Walmart’s stock was rather mild: a 3 percent drop (S&P 500 dropped 1.5 percent). Why the different reaction by investors to a penny miss between eBay and Walmart? Once more, the clue lies in investors’ expectations prior to the earnings announcement. Over the year preceding Walmart’s earnings release, its stock decreased by 12.6 percent.9 Disappointment in the wake of disillusionment apparently is easier to bear.

       A SHOCKER—CATERPILLAR’S $.12 DISAPPOINTMENT. On October 21, 2005, Caterpillar—a large earthmoving and farm machinery producer—reported third-quarter 2005 EPS of $.94 against a consensus estimate of $1.06. No longer a penny, rather a serious $.12 shortfall. Investors clearly vented their disapproval. Caterpillar’s stock price dropped 6.9 percent (S&P 500 increased 1.8 percent) on the earnings announcement. However, and this is important, within a couple of days, Caterpillar’s price started rising, gaining all the lost ground in ten days, and continued its ascent thereafter. The reasons for this were solid business conditions and sustained efficiency improvements. The increased demand for Caterpillar’s products post-Hurricane Katrina didn’t hurt either. The lesson is that even a serious consensus miss is a nonevent (except to panicky investors) when the business fundamentals are solid.

       GOOGLE’S FIRST DISAPPOINTMENT. Since its 2004 IPO at $80 a share, Google released an uninterrupted stream of good news and received investors’ adulation, catapulting its stock price to $470 in early 2006. Then, on February 1, 2006, came the first reality check. Google released a fourth-quarter 2005 EPS of $1.54 against the consensus estimate of $1.76. Google’s price dropped 8.5 percent (S&P 500 decreased by less than 1 percent) and stayed flat throughout February and March 2006. The intriguing feature here is that Google may have avoided the sharp price drop with an earnings guidance, which the company declines to give, on principle. In a repeat performance, Google announced a January 31, 2008, fourth-quarter EPS of $4.43, a penny short of the consensus estimate, and its price dropped 8.6 percent (S&P 500 rose 1.2 percent).

       GOOD NEWS FOR A CHANGE—WILLIAMS-SONOMA’S ONE-PENNY BEAT. Enough with the gloom and on to the rewards of making the numbers, such as this home furnishing retailer that released, on August 23, 2005, a second-quarter EPS of $.26, beating the consensus estimate by a penny. These earnings, moreover, increased by 11.6 percent from a year earlier. Surely good news, although not for shareholders, who reacted with a yawn—a price drop of 1.2 percent (S&P 500 decreased 1.0 percent). The presumed reason was that revenues, which increased 13 percent to $776 million from a year earlier, fell short of analysts’ forecasts of $783 million. The lesson is that it’s obviously not just “the earnings consensus, stupid”; revenue hits or misses matter too.10

       GENERAL MOTORS ROARS TO … A PRICE DROP. On October 25, 2006, GM announced, for a change, a profit of $.93 a share (excluding one-time items) against a $.49 consensus estimate. Revenues also topped the forecast. Delirious investors drove the price down 5.1 percent (S&P 500 was up almost 1.0 percent). While never at a loss for “Monday morning” explanations, analysts interviewed by CNN appeared puzzled. The best they could offer was that the CFO’s answer to a question about GM’s profit outlook was: “I can’t promise anything.”11 Investors’ reaction to earnings surprises sometimes surprises even expert analysts.

       H&R BLOCK’S $.04 BEAT—THINGS AS USUAL. On June 29, 2009, the tax adviser announced a fourth-quarter EPS of $2.09, beating the consensus by $.04. Revenue, at $2.47 billion, however, fell a little short of analysts’ expectation ($2.52 billion). Investors nevertheless reacted to the bright side. H&R Block’s stock price advanced 11.7 percent on the announcement (the S&P 500 was virtually unchanged). The takeaway is that anything is relative; in the depressed market from 2008 to 2009, any positive news looms large.

      These seven cases of consensus hits and misses with their consequences clearly indicate that there is much more to investors’ reactions than a mechanical response to the earnings surprise. Context is crucial, in particular, the stock price pattern prior to the earnings release, to which I turn next.

      Riding a Tiger

      Why are some earnings disappointments punished severely, while others escape unscathed? The long answer is that there are many reasons. A sales, cash flow, or gross margin disappointment jointly disclosed with the earnings miss obviously paints a particularly bleak picture of things to come. So is an earnings miss coupled with a downcast management outlook of the future. But there is an equally important, although less appreciated, determinant of the reaction to an earnings miss and, importantly, one that managers can proactively alleviate: investors’ pre-miss growth expectations.

      In a comprehensive study of the consequences of missing, meeting, or beating consensus quarterly estimates, published in 2002, accounting researchers Doug Skinner and Richard Sloan documented that the stocks of companies that missed the consensus dropped by 5 percent, on average, whereas those that beat the consensus increased 5.5 percent (prices of companies that exactly met the forecast rose by 1.6 percent), over the three months ending with the earnings release (thereby reflecting investors’ aggregate reaction to managers’ guidance and analysts’ forecast revisions made prior to the final earnings announcement).¹² The important insight of Skinner and Sloan came from ranking the disappointing companies by investors’ growth expectations prior to the earnings release, as measured by the market-to-book ratio (the ratio of the forward-looking stock price to the historical-based book or equity value per share). Whereas the disappointers with low prior growth expectations saw their stock prices decrease by 3.6 percent, the earnings disappointers with high prior growth expectations experienced a double price whammy: a 7.3 percent drop.¹³

      Even more surprising, the price hit to an earnings miss is only slightly affected by the magnitude of the disappointment, and even small shortfalls of a penny or two by erstwhile highfliers result in sharp price declines, as in eBay and Google. Moreover, whereas for all stocks, investor reaction to positive and negative surprises is roughly symmetrical, for high-growth stocks, the negative reaction to an earnings disappointment is substantially more severe than the reward for a similar positive surprise. Paraphrasing Willing Congreve in The Mourning Bride, hell hath no fury like a shareholder scorned. The price hit to disappointing highfliers is accentuated by “momentum investors,” that breed of market players riding the growth tiger, who are quick to bail out on the first sign of the end of growth—often an earnings disappointment. This helps explain why the magnitude of the consensus miss matters little. Any miss signals the end of the dream.

      There are two important lessons for managers here. The first is reflected in the familiar adage, there is no free lunch. Investors’ growth expectations and the consequent СКАЧАТЬ