Earnings Season–Fighting the Last War
The financial media has the effect of reinforcing some of the most counter-productive tendencies identified by the behavioral finance literature, described in prior posts. On a day like today, with the market down big time, CNBC brings in those who can "explain" what has happened. The selection bias gives the illusion that there are all of these wise heads who are figuring this stuff out in advance.
Here is the edge for the savvy investor. Most people are dramatically influenced by early occurrences in their lives or careers. Most hedge fund managers are pretty young, and perhaps unduly influenced by the "internet and tech bubble." They also have in their (brief) careers some experience with corporate accounting issues, deception, lying by sell-side research analysts to foster investment banking business, a myriad of one-time charges, and other elements that exaggerate earnings.
Like the Nobel Prize winning Pavlov‘s dogs, they have learned to be suspicious of any earnings forecast.
The problem? They are fighting the last war!
This one is over. The world has changed. (There is this child’s game played by pundits, where if you dare to say that "thing’s are different" you lose.) Well it is different to anyone who is not wearing blinders. At "A Dash" we read hundreds of analyst reports on the stocks we follow and the changes are apparent. Here is what has taken place:
- Companies are much cleaner in their earnings reports.
- Options expensing has been mandated by FASB.
- Companies are extremely careful in their forward- looking statements. This is not even close to the cheeleading days of 1999 and 2000. I followed interviews in 2003 very carefully, and CEO’s were all conservative in front of the Iraq war. Companies do not give encouraging guidance unless they can really see it.
- Sell-side analysts are more conservative — much more conservative. They have a higher number of "hold" and "sell" ratings, even though the coverage universe is smaller.
- Analysts try to guess the economoy to find some sell ratings. When the specific information from the company does not justify lowering earnings, they produce some authentic Wall Street Gibberish about how this is the peak of the cycle. That means that they have decided to predict the economy, instead of following their stock.
Pundits who are stretching the mileage from their "bubble era" analysis, continue to say that analyst estimates are exaggerated and "must come down" even though these estimates have already been normalized, discounted, and discounted again.
There are many pundits and hedge fund managers who harbor this view. For some time now, when the prediction has been incorrect, the PE multiple for stocks has just gone lower. Since "everyone" knows that earnings will move lower, it makes sense to "bake in" a lower multiple.
The next segment will see how that approach has worked…..