EC Beats & Misses, Seen & Unseen

Wall Street glorifies companies that beat quarterly estimates by arguing that the long term comprises a lot of short-terms. But beating earnings estimates for a few consecutive quarters doesn’t necessarily lead to long-term greatness. It assumes that significant changes to the business are visible in the reported numbers.

This is likely what General Electric (GE) executives rationalized as they destroyed the company’s protective shareholder “moat” and its respected corporate culture. Their short-term thinking focused on “beating earnings” on a quarterly basis, thereby insuring seemingly endless analyst upgrades. Except GE’s short-term success that was seen by the market came at the expense of unseen damage to its moat, balance sheet, and corporate culture.

Conversely, consider Apple reporting what analysts considered “disappointing” numbers for eight sequential quarters (three lifetimes on Wall Street) leading up to 2007. During that time, Apple (AAPL) is pouring every ounce of its resources into R&D and coming up with the iPhone. It cannot hire the right engineers fast enough and thus must pull in engineers who had been working on the Macintosh (then Apple’s bread and butter), which results in delaying the introduction of new computers by a few quarters (this did happen). Did those negative short-term results subtract from the value of the company, or were they instrumental in adding trillions of dollars of revenue to Apple?

Quarterly misses and beats show only what is seen, but true investors are able to see the unseen.

With the luxury of hindsight, I picked two examples, GE and Apple, that seem to prove that earnings misses are great and beats are bad — but they are neither. They are part of the vocabulary of the semi-staged reality game show on business TV — which I choose not to participate in. Facebook for example, was recently accused of using casino gaming psychology to get their users to keep coming back to see if their posts or family pictures were “liked.” Quarterly “beats” and “misses” are not much different; they add casino excitement to investing and turn unsuspecting investors into gamblers.

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