Wednesday, February 22, 2006

How to “Beat the Quarter”


Ms. Rieker, who joined Enron in 1990, clarified testimony from Mr. Koenig that as far back as January 2000, Mr. Skilling had directed last-minute changes to earnings results to put them in line with analysts' expectations.—New York Times


Thanks to Paula Rieker, the former board secretary of the former Wall Street Favorite known as Enron, the world now knows how certain large, complex, multinational companies manage to “beat the number” by a penny or two, quarter after quarter after quarter, until they don’t.

When the consensus expectation of analysts suddenly rose by 1 cent a share, to 31 cents, she said she "panicked." But a day later, when she was told that Enron would report 31 cents a share, Mr. Koenig explained that Mr. Skilling and the chief accounting officer, Richard A. Causey, had decided that the numbers should be changed. She modified the news release that went out that day.

Anybody who has ever worked at a real company—as opposed to the bright bean-counters who move straight from grad school into the ranks of Wall Street’s Finest—knows that companies are inherently messy affairs, what with people to manage and budgets to meet and judgment calls to make and accounting rules to bend...not to mention currency swings and interest rate movements and hurricanes, droughts, wars and government policy changes.

But to Wall Street’s Finest, who view nearly everything through the prism of a quarterly earnings-per-share number that is almost as meaningless as the paper on which it is printed, the messiness vanishes, its place taken by a "Number" that becomes the all-encompassing target, almost regardless of how that "Number" is reached or exceeded.

Take Dell, for example: Dell “made the number” last week thanks entirely to a lower-than-expected tax rate. Wall Street's Finest, as reported here, liked "the number" but not Dell's forward guidance, which seemed light to the so-called analysts whose job it is, presumably, to divine trends before they are glaringly evident and already priced into their stocks.

Where, the readers of this blog who have experienced terrible service problems at the hands of that once-great company might ask, have those analysts been for the last year? How can they be surprised at Dell's weak revenue growth, the declining earnings growth rate, and the lack of a full year forecast?

They’ve been spending too much time on useless models and not enough time talking to customers, that’s how.

Every investor should read carefully the account in today's New York Times of how one complex multi-national corporation “beat the number,” according to Enron’s Ms. Rieker in yesterday’s testimony:

Then in June 2000, with Enron prepared to meet analysts' earnings expectations of 32 cents a share, Ms. Rieker recalled that Mr. Koenig came into her office and said he had "just come back from a meeting with Skilling where he had said he wanted to beat earnings by 2 or 3 cents."

Four days later, Enron reported 34 cents a share. Analysts were never told about the sudden change.

The next time a company “beats the quarter” by a penny or two, think about how Enron used to "beat the number."

And ignore the analysts who actually care about it.


Jeff Matthews
I Am Not Making This Up



© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

17 comments:

Chris Fischer said...

One of your best posts that I've read. I couldn't agree more.

Its_strange said...

So scams continue. Got any names you would like to share ?

Its_strange said...

Bin Laden kills 3,000 on 9/11 and we go after his enemy . Our leaders were given blind support . Even the "liberal" press folded. Now i know nothing about this group that Bush gave the OK to run these ports but i can't help but think the countries responce is wrong, again. ... Once again, to much TV

rvb1977 said...

Great post. I love your reference about people who have actually spent time in real companies know they're messy. You couldn't be more accurate about that, and I spent 5 years at one of the "best" ones...

It amazes me that people lose sight of simple things sometimes. The best investments don't need a DCF model, they make sense because they're easy! Hopefully during my career changing process I'll be able to show a few of those "bright bean counters" that real corporate experience matters.

OR-Kiter said...

your blog is great....i used to be a sellside salesman for 7years so i can definitely relate to your comments about useless sell-side ratings and models,etc...especially since i knew how horrible some of the analysts were personally.nd how they cut their ratings after the news at the bottom

quints said...

It is really messy in the corporate world. Enron - yeah one guy at the top is fudging based on the times article. But anywhere you have worked, you know there are officers who are compensated on quarterly and annual performance and right down to the sales guy, they fudge dates, receivables, etc to make a quarter. Then, since they took money this quarter for last quarter's performance, they have to again steal from next quarter, etc. When the music stops, they make sure to change jobs before a bad quarter. All levels of many organizations. Add it all up and the numbers are vaporous.

leewhee said...

The earnings charade is even more bogus today than it was in the Enron daze, thanks to Sarbanes-Oxley and the like.

Now companies lowball expectations, get analysts to lower estimates, then...voila...they magically "beat the number."

Most traders and investors know this scam for what it is. Yet it still is galling to read reports about how bullish it is that so many companies are "beating analysts' estimates."

Of course they are. The entire process is stage-managed.

Captain Obvious said...

Being a sell side analyst in my past life, I can definitely say I agree with Jeff's sentiments regarding the ridiculous game, known as "beat the number". If I had a nickel for every time a company produced a solid quarter, but disappointed on the headline number, and sold off hard immediately thereafter...I'd have a lot of nickels. If I had another nickel for every time a company I covered beat the headline number in a less than confidence inspiring manner (e.g. lower tax rate, Other Income, etc.) and rallied...I'd have even more nickels.

Unfortunately for me, although I am no longer a talking head whose sole purpose is to handicap and comment on the inanity of the Beat the Number game, I find myself in the business of trying to collect nickels. While I would love to claim that I am a longer term investor who can rise above the noise and volatility created by the earnings season merry-go-round, unfortunately I am accountable for my mark-to-market P&L to those that provide me capital.

So while I know the Beat the Number game is a charade and is not the cornerstone of a solid investment process, I do have to think about the violence that others can inflict on my P&L based on their, often uninformed, reaction to headline earnings numbers. So I remain trapped, to a degree, into caring about this stuff...however meaningless it may be in the real world.

Its_strange said...

What will be the analysts role if they don't provide a number the company beats ?

Its_strange said...

It looks like OSTK is getting help from FFH and BVF with its stalking of Gradient and others. It looks like more nonsense that wouldn't take place if the SEC didn't stink at what it does.

awestruck said...

to be fair, the whole "beat the number" is really fostered by CNBC and its ilk. The financial press found out that the way to make a profit from business journalism was to cover it as a sporting event, complete with scores and statistics. I've been in the investment business for over 20 years, and the "street estimate" was never really a factor until CNBC found a need to have a real time metric to use in declaring each quarterly earnings report as a "winner" or a "loser".

whydibuy said...

Jeff's insight is a little tardy, for Warren Buffett (in his 2002 annual report I believe )mentioned the suspect accounting that seemed to allow so many co's to " hit the number" to the penny. While discussing how he was glad to get "lumpy" growth due to the fact that business ebbs & flows from qtr to qtr, he talks about what a red flag it is to him when he sees some co, qtr after qtr hit the analyst est. No way was reality so accomodating to allow that to occur so when you see that, watch out for the ol accounting tricks.

Its_strange said...

My letter to the SEC

Sir, I'm a small retail investor and have been a reader of Herb Greenberg for 8-9 years now. He is among the best in the business and you at the SEC know it. Yes, you know it. He has often warned the public about funny / fishy accounting and practices long before anyone else. Certainly long before you people at the SEC have. Once again, you know it. Once again if i were to subpoena your records it would show you at the SEC have been reading him as well. The record would show his reporting has often prompted you to take a look or investigate...to investigate long after the horse has left the barn . He wears the white hat and you know it. The subpoena you issued him is a outrage. You should be ashamed..I'm embarrassed for you.

I sign it with my real name Phil

emough is enough...Its time YOU pros at this site acted...Get off the rear end and start writing .

The Irrational Investor said...

Thanks for once again driving home an "Agressive Conservative" rule.

Richard Zeckhauser studied earnings management (early revenue recognition, moving COGS to inventory, ...) and found that CEOs have three incentives, ranked by importance as 1) posting a number higher than the year ago quarter, 2) not posting a loss, and 3) meeting or beating the consensus estimate. Surveys have shown that CEOs will cut projects in order to better the chances of meeting estimates (I don't have the reference for this at my fingertips).

Why is it that you never see a grey haired analyst on TV?

Its_strange said...

Man--------O--man do i love this internet ...I just did a "reverse phone" search of Alliance Distributors ( ADTR ) phone number on Whitepages.com and "Corner Distributors " came up . It showed ADTR address in College Point NY. Corner Distributors was named in the TTWO parking scam. ...

There is more but i'm having a hard time putting it all together..

Jeff Matthews said...

This is not a Take Two blog. If your TTWO scoop relates to Enron and Jeff Skilling and how companies can make the number, please elaborate.

But don't keep posting stuff that makes no sense on its own--put it on the TTWO message board.

Thanks.

Chiamus said...

She "panicked" because expectations rose 1 cent a share? Please. Not believable. Any Fortune 500 accounting dept can ALWAYS find an extra penny. If you miss expectations by a penny, everyone knows you got nothing left in the tank so the stock is taken out and shot.