Earnings forecast: How companies set low expectations to create a “surprise” growth

With the second quarter of 2013 well under way  companies are beginning to put out their first quarter earnings.  271 companies of the Fortune 500 which make up the S&P 500, have reported a earnings growth at 3.9 percent, 2.4 percent higher than the forecast of 1.5 percent. “Some 69 percent of the S&P 500 have beaten forecasts, once again conforming to the pattern of lowering expectations enough to “surprise” by beating them. The 69 percent figure exceeds the long-term average of 63 percent. This has been the pattern for the last 15 quarters, with growth estimates at the beginning of earnings ultimately being beaten by at least a full percentage point.” According to the article, companies are purposely low-balling their estimates only to beat those forecasts at the end of the quarter. This has held true for the past 15 quarters and seems to be the trend going forward. Investors and stakeholders will continue to be surprised and will be looking at positive earnings growth at the end of the quarters. It seems to me as if investors don’t really mind the idea of that since these earnings reports has caused the S&P 500 to rise 1.2 percent since the first company released its earning back on April 8th.

Photo credit: stockopedia.co.uk

Though the companies that have posted earnings have had a good growth, the companies that are yet to report are expected to have a 0.4 percent decline in earnings. Among these companies could be Walmart and Home Depot since they have not posted their earnings yet. First quarter revenue was projected to have 1 percent growth but instead is expected to fall 0.3 percent. Even though, companies have had a success when it comes to profits, revenue forecasts have declined, which goes to show that many companies still have a decline in sales. “’It does concern me. It’s not sustainable over the medium or the long term. There’s only so much companies can do to sustain growth without increasing sales,’ said Paul Zemsky.” They are able to get higher earnings through cutting costs and expenses but not through an increase in sales. This poses a threat to the economy in coming quarters because it will mean that companies will be hiring very less now since they will try their best to cut cost.

After reading this article, I felt that companies have to better forecast their earnings since there is such a gap between the forecast and the actual amount. They may have to use a different forecasting technique to come up with their earnings projections so that there isn’t a “surprise” when the actual numbers come out.

Do you think that companies are doing the right thing by setting low forecasts of earnings? Does this fairly present the true position of a company?  Also, as I mentioned before, many companies are doing good with profits and yet the revenue is going down. Do you think these companies can survive through cost-cutting measures or will they have to do something to increase sales?

 

 

“Earnings beating forecasts but jury’s out on rest of season” by Caroline Valetkevitch and Ben Berkowitz

http://finance.yahoo.com/news/earnings-beating-forecasts-jurys-rest-211325797.html

 

 

10 thoughts on “Earnings forecast: How companies set low expectations to create a “surprise” growth

  1. I think that companies are doing the right thing by setting low forecasts of earnings because if you have set forecasts that would not be able to meet in the future, and we generally choose the lowest forecast error. And that why companies only can set forecast in short-range, not in medium or long-term. I think that these companies are doing good with profits and yet the revenue is going down, one of reason is expense more than profits, there are too much on expenditure. Therefore, cost-cutting will affect employees and employees motivation, or do something to increase sales, it will affect customers demand of purchases. So that company should concern and depend on what companies needs and burden to decide which ways they can go on and survive.

  2. I cannot say if they are doing the right thing just by looking at these numbers. I would have to see the forecast of the previous quarters and by how much the actual has been higher. It might look suspicious though, that all the time their forecasts are too low with respect to the actual. Probably, they should revise their forecast techniques. Also, I am kind of confused about the fact that profits are good when revenue is going down. I do not understand how this would happen by having higher expenses than profits, as the previous comment mentioned.

  3. I think that companies forecasting low on purpose loses the real value of why companies started to forecast in the first place. If a company continuously forecasts low, there is no value in that data. I agree with the first comment that forecast is a way for companies to figure out what aspect the company should focus on to survive the competition.

  4. I enjoyed reading this post and absolutely agree with the comment above stating that continuously low forecasts yield no value especially if done on purpose. If a forecast is not going to provide accurate information and be of poor quality, companies are misrepresenting themselves. In the long-term this is going to catch up with them.

  5. Setting low forecasts of earnings may not be a good a good idea to carry out altogether because as one of the comments mentioned above already states that revenues are down but profits are up. This means that operating costs are being lowered, which result in labor cost being reduced as well. The company cannot keep cutting their operating costs for long because once the company hits the lowest possible level then the profits will fall along with the stock price.

  6. I think companies are smart to make a decision to under forecast their numbers. A common rule is to under promise and over perform it’s a win-win situation. In the big picture, I think this will affect the credibility of a company but with an unstable economy, you need to cover yourself and make sure you don’t fall short. You need to make your company look good in order to attract investors.

  7. Great post! It really is hard to say if this is the so called right thing to do for a company but we cannot forget the fact that a financial managers, CEO’s,and many other employees are all responsible if the forecast do not meet. We live in a financial world that puts pressure to produce and meet expectations so I am not surprised that we have this kind of activity happening. Is this the correct way of conducting business? That is debatable but again it is a numbers game in the financial world and everyone is relying on those quarterly, yearly forecasts.

  8. Companies may not always be purposely setting “low” forecasts; they may think of it as a conservative strategy. The majority of companies will not release forecasts that are very high because if these goals are not met then the stock price will plummet. If a company is conservative and sets a modest goal, it releases pressure from the management staff and employees to generate more revenue. Today, the majority of companies strive to generate more profit than their competitors and secure a favorable market share. Some small strategies, such as low forecasts, will allow the company to be regarded more highly than the competition if their forecasts are met. I believe that a company can only survive short term through cost-cutting measures. Ultimately, the company will reach a point where they can no longer cut and must generate profit. In a shaky economy fewer companies will try risky strategies to generate more profit and will favor cost-cutting measures.

  9. Lowering estimates in order to beat them during earnings season is an age-old practice that companies have been doing for decades. If you think about it, these companies would be stupid not to do it. When a company reports earnings, the headline either reads “Company X beats earnings, stock price soars”, or it reads “Company misses earnings, stock prices plummets”.It doesn’t even seem to matter much if the company misses or beats estimates by a matter of pennies in either direction.

    To a large degree, market participants hold true the notion that securities are efficiently priced, meaning fairly priced according to all available information. When information comes out that is better than the information that is supposedly priced into this efficiently-priced market, prices rise. I have no problem with companies doing this. They are conveying conservative expectations in regards to their financials, and they are helping shareholders when stock prices rise with the release of “better-than-expected” data.

    As far as companies beating estimates with cost cutting as opposed to revenue growth, the idea that these companies can continue to beat earnings without top-line growth is a fantasy. A company can only cut expenses so far. Sooner or later, the economy will need to pick up and support sales volume. This may be hard, however, as companies are laying off employees to cut costs.

  10. You got to shoot for something. Most people think that shooting high will always lead to optimal result; however, this isn’t always the case. Shooting to high can discourage people or bring stress. Shooting low may relax employees or lead them to push the barrier and over achieve. It is an interesting way to do business but this is the age for innovation and new thinking.

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