17 Oct 2003 Guidance Falls Short of Earnings Expectations

Last night, EBay reported a 69% increase in earnings for the fourth quarter and a 55% in the number of active users.  But it was their more conservative year-ahead guidance that sent the stock and the market lower in trading this morning.  The company suggested that 2004 earnings would likely come in around 98 cents a share, less than the $1.05 analysts’ profit estimate of analysts surveyed by Thompson Financial.  Money manager Paul Cook of Munder Capital suggested that Ebay “may make more investments than expected in growth opportunities, or may be leaving room to exceed the guidance.”

EBay is just an example of how meaningless management guidance has become in the latest several quarters.  Vincent Farrell of Victory Capital Management, the guest host on CNBC this morning opined that companies might as well not offer guidance because it was so conservative and it rarely reflected the ultimate results of the company.

As indicated in previous Briefs, the causes for conservative or no guidance stem from SEC Regulation Full Disclosure which required companies to disclose fully and publicly all significant information they plan to disclose.  The Sarbanes-Oxley Act of 2002 makes CEO’s and CFO’s more culpable than ever for what they say.  The several false starts of economic recovery over the past several years have also left many managers over promising results for the future.

So if management projections are no longer useful, where does that leave us?  It leaves us where we should focus in the first place – reality, not hyperbole.  It likely means that investors will once again rein in their expectations horizons.  Typical markets anticipate results rather than react to them.  The numbers of months or quarters ahead they anticipate is a factor of economic health and stability.  When the economy grew so consistently throughout the mid-nineties and even more rapidly toward the end of the decade, investors’ time horizons extended to years.  In many cases, they were willing to wait for years for profitability.

Today, that horizon is much shorter.  Confidence in the sustainability of the economic recovery keeps both managers’ projections cautious and investors’ expectations low.  These are two primary factors that explain why this economic recovery is so tenuous.  The economic stimuli from both the Administration and the Federal Reserve have had a significant impact on the consumer, but the response from businesses in the form of investment and hiring has been sluggish.  But recent signs show promise.

The third quarter earnings reports began coming in this week and the period of earnings pre-announcements draws to a close.  Remarkable this time though is the lack of warnings coming from companies.  More importantly, the actual results released this week have been quite good.  For example, Motorola came out a day ahead with the release of their earnings in response to a Moody’s downgrade of their bonds.  They reported earnings 82% ahead of analysts’ expectations.  Bank of America increased earnings by 33% over last year and 13% ahead of analysts’ expectations.  Intel’s earnings were 136% ahead of last year and 13% ahead of expectations.  Apple Computer earnings increased a full 300%, 21% over expectations.  Johnson & Johnson’s profits increased by 21%, well ahead of their historical growth rate.  Merrill Lynch surprised analysts by 18% with their growth rate of 69%.

As you can see, companies over a broad spectrum of industries have shown rather remarkable earnings results for the third quarter.  Government reports released this week were on balance quite positive as well.  According to the Federal Reserve in New York manufacturing in that state showed a dramatic pick up this month.  An index above zero means the number of manufacturers who said business improved was that much greater than the number who said it deteriorated.  Manufacturing in thePhiladelphiaarea expanded this month by the most in seven years and a gauge of hiring plans rose to the highest in almost twenty years according to the Philadelphia Fed.

Hiring may be starting to rebound as the Labor Department reported that first-time jobless claims fell to the lowest level in the last eight months during the week ended Saturday.

We expect markets to be a bit bumpy as we navigate through the earnings season and digest the upcoming news.  But the trend continues to be positive for the economy and for investors.  While the broad market likely reflects these prospects, opportunities continue to exist among outstanding individual companies.   We will work hard to make sure we own as many of these outstanding performers as possible.