ANALYSIS (Q1 2007 Earnings Season): Internet companies are playing a game of stump the analysts. And they’re winning.
For the second straight quarter, the research desks on Wall Street have significantly and pretty consistently fallen short in their earnings estimates.
This is no small matter for analysts. Their job is to query the company, talk to its customers and crunch its numbers to distill it all into a single number: an EPS forecast that, if short by a penny or two is no big deal. But a forecast off by 23 cents, as happened with Apple this quarter – well, that can cost clients money. And clients hate to lose money.
Take a look at the graph below. With the exception of Yahoo – whose earnings were among the few tech giants to disappoint Wall Street this quarter – all of their net profits came in at least 9% ahead of the consensus of analyst estimates.
The biggest surprise of all – in every sense of the word – belonged to Amazon, whose 26 cents a share profit was 11 cents, or 69%, above the 15 cents the Street had been forecasting. Most analysts had given up hope that Amazon’s profit margins would ever rebound, with some arguing the company was no different from an old-fashioned bookseller.
Boy were they wrong. Amazon’s net profit more than doubled while its ever-scrutinized operating margin expanded thanks to some spending discipline. Piper Jaffray downgraded Amazon’s stock a day before its blowout earnings. Amazon’s stock rallied 40% in the next two days.
Even Microsoft, which many had assumed was aging into a steady machine of predictable profits, took the Street by surprise Thursday. All of the 34 analyst forecasts were calling for EPS in a narrow range from 45 cents to 47 cents. Microsoft’s number came in three cents ahead the highest of all those forecasts.
Nor is this parade of surprises a one-quarter aberration. In January, when the same companies were reporting earnings for the fourth-quarter of 2006, it was Yahoo who had the biggest surprise. Apple followed closely behind. All of the others had surprises that were at least 9% above the consensus.
What’s going on? Most of these companies were easier to predict a year ago, when the surprises were much more modest. Did they suddenly become harder to read?
Part of the disconnect is due to analysts, who were probably inclined to paint the tech sector with a broad brush, one that foresaw a market slowdown. A slumping housing market was expected to spill over into the economy at large. Overall profit growth this year was expected to be half the 14% rate of 2006.
Within that mindset, most analyst expected some tech giants to come up short: One or two might surprise to the upside, but surely not all of them. But companies like Amazon, Microsoft and eBay, under pressure for years to rein in spending while ensuring past spending would translate into present growth, were starting to deliver.
All of this is good for contrarians and for spectators like us in the press. Aside from Yahoo, these companies have in aggregate several tens of billions of new dollars in their stocks that weren’t there a couple of weeks ago.
But it makes life tough for analysts. Having resuscitated their reputations after the excessive antics of Blodget, Grubman et al, they are now facing a new crisis: Relevancy. If they don’t get a better handle on earnings of the biggest tech names, it won’t be hard to forecast the impact on their own income.
lol – so much for that.
goes to show, that’s all analyst are – analyst.
if anyone is going to make an educated decision about what stocks to buy – it’ll be me…atleast i won’t be kicking myself as hard if i lost money on my own, as opposed to letting someone else do it – and losing it.
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Very interesting article, it’s rare to find good financial analysis of tech companies from people who know what they’re talking about.
start a tab – gigafin
I have two words to say about this post.. Elastic Cloud.. heh..
Its only just begun. Productivity increases will continue to drive profits up as engineers replace accountants.
In my experience Fundamental Analysts are never good at predicting big changes in earnings. They are good when things are steady, so whats the use?
I am just worried that based on these results I hope we don’t start seeing the inflationary forecasts from analysts like the previous bubble.
Great article. thanks
if you think analysts are only valued for and paid for their ability to accurately predict earnings estimates on a quarterly basis you have little idea of how wall st works today. another point i’d make is…why dont you try estimating earnings, post your predictions on your blog, and then we’ll track how well you do compared to the analysts. but like i said, it still wouldnt matter too much if you topped them because their valued and paid for many other, frankly more valuable, things.
Mark, just wondering, what those other “more valuable” things are. Pray throw some light.
Well. Mark – what exactly are they paid for? What’s more important on the Wall Street than predicting the value of a company you cover? How else does one make money on your Wall street? Fraud? Commissions?
Om – Mark has a bit of a point and it is difficult to predict BUT
Mark – Analysts tend to be more accurate in other industries and rarely do companies with such large market caps consistently beat expectations.
What this can mean is:
a) Standard inustry analyses are not well suited to companies with low marginal cost (then again, that would imply that they do poorly with pharma stocks where the analysts are pretty accurate)
b) The analysts covering the tech industry have not done a good job of adjusting to growth in these companies’ earnings and may need to re-do their models.
Jay, actually the post is by Kevin so perhaps it should be addressed to him.
Mark,
I am sorry – but I don’t make estimates and I don’t post them on my blog. That is part of the analyst gig. While I understand it is tough to be spot on, the variance data in this quarter is just too glaring.
Having said that, if you don’t think estimates and numbers are part of an analyst’s job, why include them in the research reports.
That would mean no debate on whether the estimates were met or not.
Forgive me but this post is both ignorant and misleading. To suggest, for example, that there is any justification for AMZN current price based on the % surprise ignores even the most basic knowledge of valuation metrics. Yes, AMZN profit was twice expectations- $115 million vs 70 million. But this is on $3 billion in sales. Its PE is >120. For comparison, GOOG earned over $1 billion on similar rev. GOOGs earnings “surprise” was greater than AMZN entire net. GOOG revenue increased by more than 30% but unlike AMZN, they have double digit margins and a PE under 50. There is little question that GOOG revenue will increase next quarter (as it always has). AMZN rev will fall (as it always has because of the seasonality of their business). Don’t get me wrong. I like AMAZON as a company…it is a well run internet retailer. I buy stuff from them all the time. But as a business they have no significant competitive advantage (unlike Ebay, GOOG or MSFT) – their margins are thin, they are facing growing competition in their space. To growth into their PE would take an astronomical increase in revenue and market share. The analysts have AMZN right. A good business but overvalued. Any rational person would sell into this short squeeze driven run up.
Om, Thanks for jumping in.
Mark, I try not to make a habit of responding to anonymous, petulant comments but I’ll make an exception because of the discussion it generated.
Of course, there is more to an analyst’s job than an EPS forecast (including the kind of under-the-table footrubbing that got many of them into trouble several years back.) But downplaying the importance of their ability to forecast earnings is like saying a pitcher’s ERA doesn’t tell the story. It may not tell the whole story, but everyone focuses on it anyway.
ref, my post was about EPS numbers and not absolute profits. And I didn’t bring up valuation, although you do raise some good points. AMZN is up on a squeeze, certainly, and its stock overvalued. Yet it is evolving back into a cutting-edge tech company, and we’re only starting to see that in its numbers. I wouldn’t underestimate it.
One point I should have made earlier: I singled out Piper Jaffray because of the unlucky timing of their downgrade, which was a little unfair because they should get points for making a gutsy call. They are usually prescient in their Internet coverage.