BOSTON (TheStreet) -- General Electric (GE) - Get Report, Bank of America (BAC) - Get Report and Citigroup (C) - Get Report will release first-quarter earnings over the next week, which means investors will want to know if profits beat, met or trailed analysts' expectations.
Investors should instead look at accruals ratios and other pieces of information to determine the success or failure of the companies.
Companies such as GE, Bank of America and Citigroup have a great deal of influence over analysts' estimates. That's why it's called earnings "guidance" -- companies guide expectations. As a result, exceeding analysts' forecasts is sometimes a meaningless event. If investing success were as simple as buying shares of companies with so-called earnings beats, everyone would be a millionaire.
Analysts have been too pessimistic about earnings over the past few quarters, which makes performance appear better than it is. They're suffering from anchoring bias. Now that the economy is starting to show signs of life again, earnings estimates should be increased. However, General Electric and Bank of America have estimated earnings far below last year's levels. Analysts seem to be gun shy, hoping to be regarded as cautious, as opposed to irrationally exuberant.
Over the past four quarters, General Electric has beaten earnings estimates by an average of 3 cents a share, with a range of 2 cents to 5 cents. With does that tell us about the company and its prospects? Not much. After GE exceeded estimates by 5 cents in the first quarter of 2009, the company's stock fell 6% in the following three-month period. Second-quarter results beat expectations by 3 cents, and the stock surged 38% in the third quarter.
There are complicating factors that make earnings numbers largely irrelevant. Astonishingly bad or phenomenally good results tend to move stocks, though smart-money investors look at more esoteric metrics when assessing quarterly performance. The accrual ratio can help investors sniff out true
. Beyond that, trends are important, but year-over-year changes are too short of a timespan.
Bank of America and Citigroup, for instance, are likely to publish strange year-over-year increases due to volatile 2009 earnings. Those comparisons are tied to a single quarter, making them dependent on a small sample of the previous year's performance. Taking a trailing 12-month average can help smooth out earnings, giving a more meaningful comparison.
Last year at this time, Bank of America had a trailing 12-month earnings level of about 63 cents a share. To match that, first-quarter earnings would have to come in at 23 cents a share, which is unlikely, given that estimates are calling for 10 cents a share. Anything higher than 14 cents a share will reveal that the Bank of America maintained the recent increase in 12-month earnings.
The hard numbers are just one part of an earnings release. Accompanying the financials is a spiel by the company regarding the quarter that just ended and an outlook. These statements offer real value. Since earnings information is based on stuff that already happened, there's limited value in it. The forward-looking statements shed light on the quarters yet to come and can help investors develop expectations and areas of concern.
For instance, if on the Bank of America call the CFO makes a comment about spreads widening in the lending business, investors may get a bullish signal since the company is taking in more than it's paying out.
As with most things, context is everything. A simple "beat" or "miss" is nothing by itself. Don't be fooled by the headline number. Read the earnings-call transcript or listen to the call, which are usually available for streaming online. The nuggets of information are abundant and far more telling than performance relative to a capricious consensus estimate.
-- Reported by David MacDougall in Boston.
Prior to joining TheStreet Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.