Are Companies Really Doing Better?

By Dave Carpenter, AP Personal Finance Writer

CHICAGO (AP) — More than 80% of major companies reporting third-quarter results this month have beaten Wall Street expectations. So is business that good? No. Are companies gaming the system? Yes.

Corporate America has a habit of low-balling the earnings forecasts used by analysts to determine their estimates. That way, the bar is lower, and companies can easily jump over when the quarter's results are announced — even if profits and revenues have fallen off a cliff.

"Over the last decade, there's been a distinctive tendency for companies to underpromise and overdeliver," says Dirk van Dijk, chief equity strategist of Zacks Investment Research. "Lately companies are being even more cautious. They realize investors can very harshly punish any company that disappoints."

Beating expectations generally gives share prices a quick lift, but the news can mislead investors about the real state of the business — and just how far this economic recovery has to go. In fact, of the companies reporting third-quarter results so far, 60% have posted lower net income compared with a year ago.

Still, the recession has, if anything, accelerated the flow of positive earnings "surprises" as companies play it safe and issue more conservative earnings forecasts. Over the past two years, 65% of earnings reports have beaten estimates. Even after last fall's financial crisis, the following two quarters produced nearly twice as many beats as misses.

And this quarter, 81% of the first 199 companies listed on the Standard & Poor's 500 index that reported earnings came in above expectations.

The expectations game works like this.

Corporation X announces weeks or months ahead of time that it expects to earn, say, 55 to 60 cents per share. Analysts look at various measures of the company's financial and operating performance while compiling forecasts, but rely heavily on guidance from management.

The resulting consensus forecast might be around 57 cents a share.

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