Corporate earnings season has already been a doozy before it even got started. It’s supposed to be a well-scripted song and dance designed to pull a bag over investors’ heads. Works marvelously: stalling revenues and earnings propel the stock market ever higher. And any flops are soon overcome.
Take mattress maker Select Comfort. It sent investors tossing and turning on Monday when it lowered its earnings guidance for the fourth quarter, citing a “sales slowdown” after Black Friday and “a tepid retail holiday shopping season.” The company expected “this challenging environment” to drag on in 2014. Not exactly brimming with optimism. Earnings for the fourth quarter would be “below the low end” of its guidance range of $0.18 to $0.26 per share. The stock plunged 19% to close at $17.28.
Analysts scrambled furiously to redo their earnings expectations so that the company, when it actually reports earnings, could beat them. No research required. Just fix the numbers.
Like so many of our corporate heroes, Select Comfort is a serial offender that relies on investors’ short memories. On July 17, it missed on earnings. Stock skidded 24% over the next month, from over $27 before the announcement to $21 in August, only to creep back up to $26 by October 16, when it re-missed earnings estimates and lowered guidance. Stock plummeted 34%, to $18, only to creep back up to $21.35 by late last week. When the debacle re-happened on Monday, the stock plunged again. No doubt, the stock will creep back up until it gets knocked down by the next announcement. That’s the game.
Hundreds of billions of dollars spread across the stock market are at stake. A “disappointment” is what you get when analysts fall asleep behind their computers and don’t cut their earnings estimates low enough fast enough. It can temporarily induce a bout of reality into the equation and wipe out billions of dollars in market cap. But a “beat,” even if it’s just a less catastrophic loss than analysts had “expected,” can create billions of dollars in wealth, out of nothing. The company might still be losing money, but just less than it had given analysts to understand.
This is haymaking time for traders. The good thing: in a blind and relentless bull market that just keeps going up regardless of what happens, many of these post-disappointment losses disappear as the stocks start creeping higher again, though there is no reason for them to creep higher. “Beats,” however illusory, drive stock prices to new highs. This is the game of creating wealth out of nothing. And everyone from the President and the Fed on down does their darnedest to keep that game going.
But it’s getting harder and harder to keep it going. Turns out, America’s corporate heroes have been lowering their Q4 earnings outlook in record numbers. According to FactSet, of the 107 S&P 500 companies that have given an outlook for Q4 so far, 94 have guided way below analysts’ expectations. That’s 88%!
It was the worst ever in the universe of the FactSet data series that started in 2006. And it was the 14th quarter in a row of negative guidance exceeding positive guidance, with the gap widening nearly every quarter (disconcerting chart via MarketWatch).
“The most negative guidance sentiment on record,” is what Thomson Reuters analyst Greg Harrison called the phenomenon. They found that of the 130 companies in the S&P 500 that have given outlooks so far, only 11 guided above analysts’ “consensus,” and 11 guided in line. But 108 cut their outlooks below consensus. That’s a chilling negative-positive ratio of 91%.
Clearly, earnings growth is in trouble. Sales have barely kept up with inflation over the last couple of years. With top-line growth missing, earnings have to be goosed in other ways. Rampant cost cutting has been in full swing for years, and the low-hanging fruit has been harvested. This is supplemented by accounting tricks, such as dumping large chunks of costs into “non-cash” and very regular “one-time” write-offs that are then totally ignored by the market. And perhaps the most effective: financial engineering, such as borrowing loads of money to buy back shares, dolls up per-share earnings, while quietly hallowing out stockholder equity. If wayward analysts paid attention to these methods, they’d be fired or ridiculed.
But even those methods are now reaching their limit in generating “earnings growth.” Leaves the last measure to drive up stock prices: manipulating the “beats” during earnings season.
A year ago, analysts pegged earnings growth for Q4 2013 at 17.6%, according to Thomson Reuters. That phenomenal number was used to rationalize soaring stock prices. Only the sky would be the limit for forward earnings per share. Alas, over the course of the year, companies gave analysts to understand that they’d never be able to meet these ridiculous earnings growth figures. So down they went – while the stock market continued to soar. Thomson Reuters now pegs Q4 earnings growth at 7.6% and S&P Capital IQ at a measly 5.7%. Quarter after quarter, it’s the same goofiness.
But in a stock market bubble, the warts and bad breath of reality don’t matter. The finely tuned Wall-Street hype machine has rationalized last year’s 32% total return of the S&P 500 with fake and disappearing “earnings growth.” It worked marvelously. And there is hope that lots of hay will be made when our corporate heroes once again “beat” their ground-down earnings estimates with their well-engineered “adjusted” earnings-per-share constructs.
Nothing could have been a more pungent metaphor for the current investment climate than the headline, “Macau gambling revenue hits record $45 bn in 2013.” Read… Fizzing Optimism For Wild Financial Engineering In 2014