More on corporate earnings and analyst error
The handy little EA function, remember, lets us look at earnings surprises (and sales, too, if we’re interested in that). And it breaks the data down by geography—you can drill down to the individual country level, or keep it at regions, which is what we’re doing here. And if we compare EPS earnings surprises by region, and exclude the current quarter, we see a sharp difference between Western European companies and North American companies (US, Canada, and, um, Bermuda—don’t ask). For Western European companies, it’s pretty evenly split between positive and negative earnings surprises—in some quarters there are more positive surprises, and in some quarters there are more negative ones. Over the entire period (again, not including the current quarter), the positive/negative ratio is about as flat as flat can be—1.01 times. Here’s what the data look like (note that the Average does NOT include the data for the current quarter, since it’s not yet finished, and that the data is as of 1 March):
Now, this is really what you would more or less expect—all the percentages remain roughly the same over the entire period, except for the current one, where the total % of earnings surprises (both positive and negative) appears meaningfully higher than average. Now, it may be that this will regress to the mean as the rest of earnings come through—we still have lots of companies to report. So we’ll just have to wait and see. But if analysts are doing their jobs, then companies are doing what you would expect—some are a bit higher than expected, some are a bit lower, and it’s roughly comparable over time.
If we look at North America (which, let’s face it, is mostly US companies), a different pattern emerges:
In fact, several differences are apparent. First, there is no quarter when negative earnings surprises exceeded positive earnings surprises. In fact, the average positive/negative ratio is 1.33—there was only one quarter of Western European earnings that exceeded this ratio at all, and most quarters didn’t even approach this level. So North American data seem to be positively biased relative to Western Europe. Second, while negative surprises are a bit higher in North America than in Western Europe (20.73% versus 18.64%) this doesn’t look that material–it could be, I suppose, but I’m not sure there’s enough data here to say. However, positive surprises are a whole lot higher—27.06% versus 18.78%. Even for a data set this small, this looks pretty compelling. And this pattern has been pretty consistent over this entire period. Third, it’s this difference in positive surprises that accounts for the overall result of there being considerably more earnings surprises in North America than in Western Europe (47.43% versus 37.42%). Lastly, nothing in any of this so far in any way explains the sharp escalation in positive earnings surprises in 4Q09, where positive surprises account for 42% of ALL earnings monitored by Bloomberg so far this period, and total surprises are nearly two-thirds of all reported earnings.
Again, let’s be clear—we could still regress to the mean in the balance of this reporting season. But that would still leave unexplained the fact that North American companies routinely generate positive surprises at what appears to be a higher rate than Western European companies. Or, as we mentioned last time, North American analysts do a considerably poorer job of predicting earnings than do their European counterparts.
OK, now, this is all good fun for the statheads among us, but there are some needed caveats. First, this isn’t a real longitudinal survey—for that, you would need a decade or two of data, and we don’t have that through Bloomberg (maybe Thomson Reuters does, but I don’t subscribe to them). Did a similar pattern emerge in the 2001 recession, for example? We don’t know. Second, we have no way of knowing at this point whether the relative size of the data sets has any impact—the North American data set is about four times the size of the Western European one. It may be that there is a higher number of small cap names in the North American set that produces some excess variability—but that still doesn’t explain the directionality of the data. But it is a potential concern.
So we’re back to the conundrum we mentioned last time—why do North American analysts consistently under-predict earnings in a way that their European counterparts don’t? Well, European managements could be feeding more interesting data and commentary to analysts than their North American counterparts. That’s something I would have entertained as a possibility fifteen or even ten years ago, when that sort of interaction was pretty routine, but it’s hard to see it occurring now, frankly. Second, maybe North American analysts have gotten more burned than their European counterparts, and are therefore more conservative in their predictions. The problem with this is that up to, say, the second quarter of 2009, there’s no evidence that North American analysts were burned at all—positive and negative surprises held pretty constant. But there is one interesting aspect of the North American data prior to this past quarter, and that’s the steady rise in the positive/negative surprise ratio during 2009—it’s higher each quarter. But that’s the only thing that really changes, and if anything it seems to derive from a decline in negative surprises during this period that mirrors an increase in positive surprises. But even if the current quarter is a continuation of a previous trend, what accounts for that trend?
Why do we care? Well, as is the case for anyone who works in the financial sector, I’m interested in a number of things, one of the key ones being sentiment. And we’ve had several quarters now of positive earnings surprises which get touted by the likes of CNBC as being meaningful of, well, something. We’re booming into a recovery, earnings show. Look how much better companies are doing. Well, leaving aside the fact that in general many companies are still doing worse than they were a year or two ago, and the fact that one fundamental reason for decent earnings at all is the pace of restructurings (ie, layoffs), what this might really show is that sentiment is possibly being distorted. North American (read Wall Street) analysts are doing an even poorer job of predicting the future than they usually do, but the spin is that companies are doing better than expected, so party on, dude. Given how much credence the business media in particular, and the investment community in general, places on these predictions, you would think that there might be some questions about whether this credence is properly placed. As the old saying goes, prediction is very difficult, especially of the future. If the current pattern holds, prediction is even more difficult that it was a year ago. Such sensitive souls. Perhaps we should pay less attention to these predictions—or, at the very least, less attention to the media spin-meisters and talking heads who still take them seriously. Maybe it’s time to remind people of that other old saying about Wall Street—“Often wrong, never in doubt.”
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