Commentary: Bad Quarter? Don't Keep Shareholders GuessingAmey Stone
Investors used to just have earnings season to worry about. Now there's also pre-earnings season to sweat over. The number of companies publicly announcing that first-quarter earnings won't meet Wall Street's expectations has been steadily increasing over the past few years. Investors benefit from these "pre-announcements," since they are getting new information earlier. But the way in which some companies handle the announcements leaves much to be desired.
As of Mar. 25, First Call Corp., a Boston firm that tracks earnings estimates, tallied 203 pre-announcements for this quarter, with about 54% reflecting lower expectations. March brought bad news, first from such tech leaders as Intel, Motorola, and Compaq Computer and then from Kimberly-Clark, Sunbeam, and Cummins Engine. Despite the positive news from Microsoft on March 24, "what really stands out about this quarter is that there have been so many significantly negative announcements from major companies," says Charles L. Hill, First Call's director of research.
SHOCK ABSORBERS. The public releases are a vast improvement over the days when companies might just tip off a few favored analysts to lower their numbers. That allowed some well connected investors to bail out of a stock before most others realized anything had gone awry. To be sure, the warnings can cause sharp sell-offs, but they seem to help smooth things over by the time the actual earnings number is released.
To disseminate disappointing earnings forecasts this quarter, companies have used a range of methods that in some cases can be improved upon. Some, such as Intel and Cummins Engine, issued press releases. Others, including Compaq Computer Corp., followed the press release with a conference call but restricted it to analysts and big investors. Walt Disney Co. didn't issue a release at all but guided a few analysts to lower their expectations for the fiscal second quarter, prompting a 2.8% slide in the share price on Mar. 4. The company says that it just responded to analysts' questions and did not consider it had "material" news to report, which would have necessitated a public release.
Disney may be right, according to the letter of the law. Learning that the box-office take was weaker than expected did not prompt analysts to lower their earnings forecasts by much. However, the spirit of the law would call for Disney to have issued a press release, giving all analysts and investors the same information at the same time.
This gap between spirit and letter is something the Securities & Exchange Commission has taken note of recently. "Legally, you can split hairs all you want," said SEC Chairman Arthur Levitt Jr. in a Feb. 27 speech warning analysts not to trade on material information prior to its public release. "But ethically, it's very clear." Levitt noted "a great deal of unusual trading" can occur before announcements.
Leaving legal gray areas aside, there are some simple things companies should do to improve the flow of information. For openers, companies should pre-announce earnings only after the market closes, granting the public ample opportunity to learn the news before trading resumes the next day. This is increasingly the practice, but it should be the rule.
ALL EARS. If companies are going to hold a conference call to provide more detail about the news release, they should open it up so the public can listen in. This can be done by broadcasting Q&A sessions live over the Internet. Microsoft recently started doing this with its quarterly earnings announcements, and Intel will do so with its next announcement. For those companies with Web sites in place, this is neither an expensive nor complicated proposition. Companies can also open up their conference call to the public by announcing the number in their press release. Technology now allows thousands of listeners in on a single call.
Pre-announcements may only smooth the overall effect of a company failing to meet earnings expectations. Ultimately, the stock price will settle at its real economic value. Still, with many investors looking for signs it may be time to take profits, companies should provide Wall Street and the general public with the same information at the same time.