Dan Ferris: Why earnings "above analysts' expectations" are actually crap
By Dan Ferris in the S&A Digest:
If I ran the Wall Street Journal, I'd shut it down for a week and fumigate the place... At the very least, I'd ban the phrase "above analysts' expectations." This phrase is such an obvious and well-known scam, I'm shocked it's still allowed in print. I would call Wall Street analysts a bunch of whores, just like our senators and congressmen... but that does real whores a disservice. Then again, a whore's expectations are about as low as a Wall Street analyst's these days, so maybe it's a good fit after all.
Take Home Depot, for example...
Home Depot, the world's largest home improvement retailer - and a bellwether for both the retail and housing sectors - announced "better than expected" earnings of $1.1 billion for the second quarter. Of course, the most prominent feature of its earnings is that they were below last year's second-quarter earnings of $1.2 billion... just like almost every other company that has beat analysts' expectations. (Wall Street analysts' perennially low expectations must make them wonderful marriage partners.)
But as we pointed out last week, headlines - in this case, Home Depot 2Q Profit Beats Expectations - can be misleading. The headline doesn't tell you a huge chunk of Home Depot's earnings came from one-time cuts. About $410 million of total earnings (37.3%) came from cutting costs and tax settlements.
And of course, like so many other companies, Home Depot's sales fell 9.1% to $19.1 billion. Sales from stores open more than one year (comp sales, a key retail measure) dropped 8.5%.
So in reality, Home Depot's sales are down a lot, profits are down a little (buoyed by cost cutting and tax settlements), and comp sales are down a lot...
If Home Depot keeps turning in "above expectations" performances like this one, it should be completely out of business in about 10 years. Mr. Market reads the daily news and swears by every word, bidding Home Depot shares up more than 3%.
Target's second-quarter earnings report was - you guessed it - "above analysts' expectations," even though revenue declined 2.06% (ouch) and earnings fell 6.4% (ouch, ouch).
At Target, the wonderful "above expected" earnings were the result of the same cutting everyone else is doing... In this case, staff reductions, salary freezes, tighter underwriting standards at the credit-card division, and fewer store openings all helped Target increase its gross margin to 31.9% from 31.2%.
Target's credit-card operation is still deteriorating. Profits fell 15%. Expenses for bad debt jumped 19%, and delinquent accounts are soaring. Accounts at least 60 days late increased to 5.8% from 4.5% a year earlier. The 90-day delinquency rate rose to 4.1% from 3.1%.
Mr. Market, of course, reads the Wall Street Journal like a good little apparatchik and swears by every word. He sent Target's stock up almost 7%.
Just so we're clear on what really happened at Home Depot and Target: Less money came in the door. Period. They sold less. They earned less. And this ain't poetry or painting: Less isn't more in finance. In finance, less is less. Why does the Wall Street Journal do such a miserable job of telling you this? It's not even trying to hide its attempts to slip more happy pills into Mr. Market's morning coffee.
You may also recall Goldman Sachs' record earnings report this quarter - the result of government subsidies and fancy accounting... These numbers will come back to reality soon enough. In the meantime, Mr. Market's taste for ailing businesses seems insatiable...