Kass: Earnings Likely to Trend Lower

This blog post originally appeared on RealMoney Silver on Oct. 27 at 7:27 a.m. EDT.

This morning I wanted to expand on last Wednesday's "The Earnings Season Racket," in which I questioned the business media's preoccupation with third-quarter earnings beats. My conclusion in that column was that third-quarter 2009 beats are overhyped as they are the outgrowth from lowered guidance.

Underpromising and overdelivering is the oldest game in the investor relations handbook, as earnings expectations are often cagily crafted by corporate managements. In turn, many Wall Street analysts, emulating Ralph Wanger's zebras, follow that company guidance in adopting a herd mentality that morphs into a Wall Street consensus.

To be sure, I am being somewhat hyperbolic. Not all Wall Street analysts are lemmings or are simply providing maintenance research. There are still (and always will be) research stars. But, in the main, a variant view from the sell-side consensus is relatively rare, as the middle of the Wanger's herd of zebras seems to provide a security blanket to most analysts.

This helps to explain why on average over the past decade, over 60% of reporting companies beat consensus, with a range through thick (economic expansion) and thin (economic contraction) of between 45% and 80% beats. So amazingly, even through the very thin (recession), there has never been a single quarter in 40 quarterly periods in which under 45% of reporting companies didn't beat consensus!

Admittedly, the improving trend in recent earnings beats (from the low in fourth quarter 2008 of 54% to the current beat rate of over 75%) is important, but it could be argued that the most recent quarter's historically large earnings beat rate might have been favorably impacted by the lowered guidance and reduced expectations made during and immediately after the credit crisis. Even though the percentage beat rate is now at the highest level since third quarter 2006, which had a beat rate of 72%, the fact that over 75% of reporting companies in third quarter 2009 exceeded consensus expectations may be less impressive than has been evinced in this month's endless media celebrations.