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Conference Calls: The Good, the Bad, the Misunderstood

Scott Rothbort

Now, in this installment of The Finance Professor, let's focus on some recent conference calls and provide insight and commentary into the earnings results, the actual calls and the subsequent reaction. In the process, you will get a sense of how to distinguish between good, bad and misunderstood conference calls.

Bad: Merrill Lynch, Third Quarter of 2007

Oct. 24, 2007: In anticipation of the release of its quarterly results, Merrill Lynch MER was expected to take a large writedown related to its credit markets portfolio. Expectations were for Merrill to take a $4.5 billion hit. Instead, Merrill took a $7.9 billion writedown.

When the news first broke, the stock actually did not look too bad. However, things got worse from that point on. Prior to the morning conference call, Merrill received a downgrade from its ratings agencies , and the stock began to crumble. Then the conference call began.

From the outset of the call, Stan O'Neal, Merrill's chief executive officer (at the time), took the microphone. (This was a departure from Merrill's normal procedure, which usually has its calls conducted by the company's chief financial officer.) Immediately, danger signs flashed that matters at Merrill were worse than imagined. O'Neal tried to use the forum atmosphere of the conference call as an opportunity to convey a mea culpa. However, what unfolded on the call was O'Neal's disclosure that Merrill had taken too much subprime risk and that its risk management systems failed.

This was perhaps one of the worst conference calls that I have ever heard.

Merrill dropped nearly 6% that day, and except for some brief countertrend rallies , Merrill has been in a downtrend ever since. The postscript to this conference call was the firing of O'Neal and his subsequent replacement by John Thain.

You can listen to an archive of the call on Merrill's Web site -- click here (registration required).

Misunderstood: Costco, First Quarter of 2008

Dec. 13, 2007: Costco COST had a very good run going into its quarterly earnings report, with the stock breaking out to an all-time high. This was going against the grain of other retailers, which were feeling the impact of extended warm weather conditions and a slowing consumer who was being set back by higher energy costs.

Despite those conditions, Costco was reporting strong same-store sales month after month (see "A Checklist for Profiting from Retail and Restaurant Stocks"). This resulted in analysts raising their consensus estimates for several weeks prior to the earnings release.

As it turned out, Costco reported its quarterly results, and they were right in line with the latest round of marked-up analysts' estimates. This was an excellent quarter for Costco. However, the stock sank like a brick in David Letterman's "Will It Float?" segment.

Why did this occur?

To the uninitiated, it looked like some profit-taking . Yet the 7% premarket selloff was more than just profit-taking. It was an implosion. But what caused it?

To begin with, Costco made its new highs and broke out technically in the days leading up to its earnings release. This attracted momentum investors to the stock.

However, momentum investors will flee at the first sign of trouble. All that's usually needed is a little push. Thanks to the ever-pervasive hedge fund community, Costco got that push. Rumors of disappointing gross margins were being spread rapidly. But this negativity did not align with reality. All that a Costco investor needed to have was some patience to wait a few hours to listen to management on the conference call.

On the Dec. 13 call, Costco management provided a detailed analysis of gross margins by product, department and reporting periods. Looking forward, the company provided a positive outlook (or "guidance") for future gross margin growth.

However, Costco's naysayers shot first and asked questions later (i.e., they sold immediately). And that was a mistake. Costco closed at $70.19 the day before the earnings release, traded as low as $65.10 early the day of the earnings release, and closed at $68.54 that day. Subsequent to that day, shares of Costco have traded higher. (See No. 1 in "Five Missteps to Avoid During Season.")

You can listen to an archive of this call on TheStreet.com -- click here.

Good: Apple, Research In Motion and Dick's Sporting Goods

It's hard to say which one of last quarter's good conference calls can be regarded as the best (because there are several really good ones). However, three calls do stand out in my mind: Apple AAPL, Research In Motion RIMM and Dick's Sporting Goods DKS. All of these companies' quarterly reports and earnings conference calls delivered affirmation to the bulls .

Here a few characteristics that each of these calls shared:

• Reported better-than-expected results for the most recent quarter.
• Provided robust guidance for the upcoming quarter.
• Quelled any concerns regarding issues that may have lingered with the naysayers, particularly that these companies would be adversely affected by a slowing consumer or economy.
• Demonstrated opportunities for continued future growth.
• Caught the short-sellers off guard, with stocks spiking significantly the day after the earnings announcements.