Hiltmon

On walkabout in life and technology

Analyst Expectations

Lets take a look at the Widget market. It’s maturing but still expanding, with sales growing to about 2 million a quarter.

An experienced investor, looking at fundamentals, history and buyer preferences, will expect Peach to sell 1 million Widgets and Pear to sell about 250 thousand, with the remaining Widgets being sold by others.

But lets assume the presence of an Analyst that wants to drive Peach’s stock down, and wants to promote Pear. They want to do this because that Analyst’s firm makes more money when Pear shares, securities and derivatives trade.

The Analyst cannot say Peach will sell 2 million widgets this quarter, that’s the whole market and will seem like an unreasonably large and implausible number to their clients. They also cannot say the correct number they expect based on fundamentals, because if Peach achieves that number (very likely it will) then the Peach stock price will go up, not what their employer wants. So the Analyst picks a number that sounds reasonable, but is made up, that will achieve their goal.

Lets say the Analyst picks 1.25 million sales. On the surface it seems a reasonable, if high, expectation. A long pass if you will.

On the other hand, the Analyst calls 150 thousand sales for Pear, also not unreasonable, a 2 yard rush, especially if Peach is growing quickly.

Then Peach announces its earnings. Revenue is up, profits are up, cash is up, debt is nonexistent and market share is up on great sales of 1.1 million Widgets. It is, in fact, Peach’s best quarter ever. Fundamentally, Peach just proved itself to be a more valuable company and it’s share price should rise.

The press and the Analyst report the Peach earnings as a miss, because Peach reported fewer Widgets sold than the Analyst made-up number claimed was expected, and the Peach stock price tanks. The Analyst’s company wins.

Later that week, Pear announces its earnings. Revenue is down, profits are negative, margins are down, market share is down, and debt is up on sales of 200 thousand Widgets. All in all, a shitty quarter by all measures for Pear. Fundamentally, this company looks worse, the prognosis is that it’s getting worse and it’s share price should drop.

The press and the Analyst report that Pear beat expectations and the Pear share price rises instead. It seems that Pear did better than the intentionally low-ball figure chosen. The Analyst’s company wins again.

It makes no sense. Fundamentally, economically, and return-wise, Peach is a good, sustainable business and Pear is a money-burning disaster heading over a cliff. Yet Pear shares go up and Peach shares go down.

Now replace Peach with Apple and Pear with, well, anyone else in the same space (or use Amazon if you wish).

It makes no sense. It’s wrong. Yet this is how it really works on Wall Street these days. And it’s perfectly legal.

I am expecting this scenario to play out tonight at the Apple earnings call, and at the next, and the next. Just like the last one and the one before. And there is nothing we can do about it.

Follow the author as @hiltmon on Twitter and @hiltmon on App.Net. Mute #xpost on one.

Comments