For the last few months we have been citing a statistic regarding the accuracy of company forecasting; namely, that nearly 25% of all public companies miss their expected or forecasted earnings every quarter. This statistic is on our website, in our webinar, and in our eBook.
Well, we were wrong. Turns out, we underestimated by 100%.
It seems that fully HALF of public companies miss their expected of forecast earnings each quarter.
Let me back up a bit.
On August 4th, I got a note from Manish, Trefis’ CEO, about an article The Wall Street Journal entitled, “Companies Routinely Steer Analysts to Deliver Earnings Surprises”. He pointed out the 50%-missed figure. I clicked through to the article, searching for it, but I couldn’t find it. Huh?
I sent Manish a response.
Me: Be glad to write something. Lots of rich stuff here. But, I think I’m missing something. The piece corroborates our 25% stat:
Quarter after quarter, about 75% of companies in the S&P 500 index meet or exceed analysts’ earnings forecasts, a statistic that has held up in good times and bad.
I don’t see a “50% missed number” anywhere in the article.
Manish: It says that another 25 percent would miss if it weren’t for these IR interventions in weeks leading to earnings
And he was right.
Here’s the thing: Forecasting is at once incredibly important and difficult to get right. Companies invest a lot of resources (people and tools and solutions) to build accurate forecasts so they can report to the “Street”, namely to the equity analyst community who pays attention to this guidance.
But when a company misses—particularly publicly traded firms whose every move provides content for the financial press—value disappears. Earnings are restated. Confidence in management weakens. People get fired.
Or as we say, “Missed forecasts kill profits.”
As soon as a firm puts a stake in the ground about the upcoming quarter’s earnings, however, changes in a dynamic business world make the forecast moot. Enter the Investor Relations team (the “IR” Manish mentioned in his response).
The IR team stays connected to the analyst community and–among its many jobs–manages the company narrative so it accurately reflects the true intent and capability of their firm. Many industry analyses will reflect their story, but some may offer negative narratives that could spell trouble for the stock price.
Makes sense, right? No one wants an inaccurate story making the rounds that will negatively—and perhaps falsely—color the analyst community’s perception of a firm’s prospects. In this capacity, an IR team acts as a kind of cheerleader.
But what happens when, say, halfway through the quarter, it looks like the firm will MISS the upcoming earnings estimate? Specifically, during the 40 trading days preceding an earnings announcement, what does the IR team do when the analyst community paints too rosy a picture of quarterly earnings?
Simple. They point things the other way.
Instead of cheerleading and pumping up the company, they contact the analyst community and talk the company down, as it were. This chatter causes the prevailing estimates to decrease. The firm then has a chance to “beat” the sufficiently lowered forecast. One commenter on the WSJ story describes the dynamic this way:
1. Contact analysts to cause lower stock price due to downgraded estimate
2. Stock price declines. Time to buy.
3. When the REAL results come out, surprise! It “beats” the estimate.
4. Stock price goes up. Time to sell.
Odd isn’t it? The IR department, in talking down its own firm’s forecasts, may find itself contradicting previous announcements made by the CFO or CEO.
(Incidentally, the discussion board drips with cynicism about this “elaborate dance [that] occurs between analysts and companies.” Click through if you are interested).
This strategy seems to work. According to analysis conducted by the Journal,
Nearly 2,000 times from the start of 2013 through this year’s first quarter, companies would have missed the average earnings estimate if analysts hadn’t changed their numbers in the 40 trading days before the company’s quarterly earnings report.
In one-fourth of those cases, the revised estimates fell enough that the company “wound up meeting or beating analysts’ expectations.”
That’s where the other 25% comes from.
That’s why it’s worse than we thought.
For us, this entire elaborate dance feels like so much wasted effort. Why not, instead, try a better planning and forecasting process in the first place? By leveraging technology, it is possible to see the key operating drivers at the core of your forecast so you can engage stakeholders in meaningful discussions on the assumptions that matter most. These discussions are critical, deceptively simple and often less understood part of a successful approach.
Based on data we’re seeing, we believe that a technology-driven solution can make a real difference towards solving this serious problem. Trefis technology transforms complex, static analyses-such as Excel-based data models-into easy-to-use, visual interactive experiences that let executives and analysts collaboratively develop “what-if” scenarios, and assess the risk and reward of any decision.
Never happen to you right? Why not be sure. Take our assessment and find out.