Conference Calls: The Good, the Bad, the Misunderstood

Earnings season is almost here. To help you get ready, my "Beginner's Guide to Earnings Call" walks you through a step-by-step approach for how to listen to and analyze a public company's quarterly earnings report. Then "Five Missteps to Avoid in Earnings Season" shows you how to avoid the biggest investor blunders when listening to earnings conference calls (widely referred to as simply conference calls).

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?