Financial Analysts — We Love the “Beat”

In an era of financial shenanigans, crisis, and perpetual hype it would be nice if someone in this industry called it straight. Granted, the quarterly earnings game is made for television, at the nexus of news and entertainment, with increasing emphasis on the latter. Even so, we should be careful not to allow the entertainment factor to turn earnings season into some new reality television show. Boo-Yah, Jim Cramer.

Look no farther than our current Q-2 earnings party as evidence of this phenomenon. The story really begins at the end of last quarter. As is typically the case, a well-tutored CEO begins the quarterly earning conference call with a slap on the back for beating all expectations. This is usually from the company’s favorite-son analyst, someone who goes along with all the earnings spin and serves as the company’s lap dog. In return, this analyst always gets through to the CEO, enjoying special access to the company. Not inside, preferential information mind you — just complete access, with one caveat: that analyst will consistently tout the company and its stock. The minute she stops, phone numbers get changed. You get the idea.

Now, back to the CEO … he is elated, he is a rock star, and he gives the corps of analysts on the conference call his “expectations” and earnings guidance for the next quarter, farm fresh and spoon fed. Wouldn’t it be nice, he thinks to himself, if everyone is surprised next time when the company yet again exceeds expectations? Meanwhile, the company’s stock enjoys a party of its own, rushing higher on an earnings “beat.” Heaven forbid the CEO has to deliver a message of failed expectations — the market is never kind to a CEO or a stock in the case of an earnings miss.

For Q-2 2011, the market and economy are confronted by declining economic growth, devastating unemployment, weak demand, poor credit, record deficits, high energy costs, and, on top of all that, a highly skeptical investor. Who knows what’s in store for Q-3, but it is not looking any rosier. The curious thing is that nearly 80 percent of the S&P 500 firms reporting Q-2 earnings thus far have trumpeted an earnings beat!  Seriously, that is downright paranormal. Yet, given the company’s incentives, completely understandable. For any analyst worth his or her salt, enjoy the party but at least have an honest appreciation for what is at work.

Check out our work on short-termism and earnings guidance. And remember, a CEO who’s constantly fixated on “the next 3 months” is seldom paying enough attention to the long-term-value drivers of a company. There is no time like the present for both CEOs and analysts to wean themselves from the quarterly nonsense. After all, being a professional analyst requires diligence and plenty of professional skepticism, as outlined in the CFA Institute Code of Ethics and Standards of Professional Conduct.