Earnings Season: Fundamentally Flawed

It’s earnings season and once again, the new set of data allows us to evaluate the fundamentals. As I have written before, I used to love earnings season but I don’t anymore. I am sure it’s the media spin and the public reaction, but it really is sad for traditional investing. As far as I am concerned, earnings season and the way it is used is Fundamentally Flawed.

Yesterday was a perfect example. Here is the headline summary from Bloomberg: "U.S. Stocks Break Six-Week Slump as Citigroup Beats Estimates". Please read that, and then take a look at what I wrote last earnings season about the same stupid assumption.

From Analyzing Analysts on April 18, 2008:

Let’s look at C back then… What was the opening price per share of Citi on April 2nd, 2007? $51.31

What was the Forward PE if you bought into Citi on April 2nd, 2007? 11.4 - Sounds cheap! Doesn’t it?
What was the Expected Earnings Growth Rate? 9.6% - Wow, a PEG ratio of about 1.2. Sounds doubly cheap!
What was the Dividend Yield? 4.2% - Fantastic and besides, they’d never cut that dividend. Right? Wrong!

So one year later on April 1st 2008, the price was $22.61 and the trailing 12 month PE was 33.6. OOPS! That’s quite a bit off from the 11.4 projected last year. But don’t fear, today’s Forward PE based upon the analyst estimates is only about 8. Sounds cheap! Doesn’t it?

As a followup, I am going to pick on Citi’s ~~earnings~~ loss reported this quarter. It was a loss, not a profit. Revenues were down significantly from the year ago quarter. And if you can seriously buy into this notion that they beat estimates, please take another look.

90 days ago, average analyst estimates for Citi’s quarter just ended 6/30/08 was +$0.57 per share. Not a loss of 57 cents but a profit of 57 cents.
60 days ago, the average estimate for C was 36 cents per share and 30 days ago it was for a profit of 31 cents.
7 days before the report, suddenly analysts are down to a loss of 59 cents per share.

Is that impressive to you? Did Citi really beat estimates, as per the media’s claim? It depends which estimates you believe. And if you believe the estimates for next quarter, just for the record, it’s a 34 cent per share profit. 90 days ago, the same estimate was for 68 cents per share profit. I look forward to checking back on this 90 days from now.

Oh and by the way, the forward PE is 8. Magically, that’s the same “cheap” ratio that we had last quarter based upon the same group of incorrect estimates. Doesn’t it bug anyone that C has maintained positive 12-month forward earnings expectations each quarter since this whole thing began? Those are the fundamentals we were supposed to believe in? Excuse me, but they have lost more than a few billion the past 4 quarters.

So despite those quarters being losses and analysts had expected that the worst was over a long time ago, we now are supposed to buy into the current fundamentals being better than analyst expectations and future earnings that are going to be good. Okay, I got the message… .the worst is supposedly behind the financials.

Earnings season is a volatile time. Crap earnings are sensationalized as beats just because the analysts pump them up 90 days ago and then wipe them out before they are announced. And the media buys into it. And apparently, based upon the market reaction, so do investors relying on “fundamentally flawed” information. Fundamentals are being overrun by media hype and a belief in estimates that are chronically wrong. Then, when the historical data comes out, we are told that bad stuff is good and that the future stuff is more important anyway.

Now, in the last 3 days, we hear how Wells Fargo, JP Morgan and Citi have pushed the market higher based upon their “better than expected” reports. First, as I keep saying…”better than expected” is a pretty flawed concept and second, those are historical earnings. AHEM! I thought past earnings are not so important for all the fundamentalists who love to fantasize about discounting future earnings. And what about those future earnings or the health of the financial system is encouraging? Other than a bunch of analysts and media and executives putting a spin on the future - what fundamental info are you relying upon?

For the last several earnings seasons, we have repeatedly been told how great earnings are when you exclude financials. Suddenly ex-financial reports like GOOG and MSFT are not good and miss estimates and the market heads higher. Okay, I got it. Apparently, ex-financials are now not so important.

And suddenly financial losses and reduced revenues are looked at as a good thing. That is fundamentally flawed.

This article has 21 comments:

Jul 20 11:22 AM
Top ten ways to damage control your disappointing earnings report:

10. Instead of a normal press release, have it read from the corporate headquarters by the Penthouse Pet of the Month.
9. Convert the currency amounts from USD to Zimbabwe dollars to make it sound like you turned around the company quickly.
8. When describing mortgage backed securities losses, do so in Pig Latin.
7. Stage a hostage scenario during the earnings call and hope the analysts are so shaken that they forget to follow up.
6. Blame Al-Queda for lower returns.
5. Stress the fact that you were college roommates with Ben Bernanke and that you have photos of him in bed with a live boy and/or a dead girl.
4. Trot out the "dog ate my balance sheet" excuse

And the top three ways to minimize your nauseating losses

3. Remind your pals in the public sector that you have jobs for them when they get tired on sitting in Beltway traffic.
2. Threaten to yank advertising and business from industry analysts and news agencies.
1. Lie, lie and lie some more, then "restate" during a rally.
Jul 20 11:41 AM
There is something strange about this web site.
With 100 million Citigroup shares traded daily between willing sellers and willing buyers, there should be plenty of credible commentators on both the bull and bear side. Yet Seeking Alpha only seems to publish bearish writers, many with stated short positions.
Is this site just a short-sellers' propaganda vehicle?
My own take on how to evaluate Citi, in which I am long, is that we need to examine Pandit's stated integrated banking model (Mexico) to see if it works there, than decide if that model can really be globaliized. We need to evaluate whether Citi is driving their toxic exposure down. We need to see if Citi is on track cutting costs. We need to watch the disposal of non-core assets (right assets?, good price?, on schedule?). Finally we need to decide if Citi will survive until home prices stabilize and the economy turns up (I am sure of it).
I am bullish on Citi two years out, but it's going to be a wild ride.

Jul 20 12:49 PM
User 219640

I am sure this site would publish an article on pets.com resurgence if it was well written and could state some accurate and coherent arguments towards advancing that opinion. In the absence of intelligent opinions towards that scenario, is it right to declare that SA is now bearish?

It is not just a bunch of anonymous SA posters calling for the breakup of Citibank. You can pick up any financial newspaper and find experienced industry money managers and analysts stating that the retail section and the investment section should be split.

Sandy Weill had a dream to merge Travellers into Citigroup. He rammed a bill through Congress which repealed Glass-Steagall which had worked for many years and didn't need tinkering. He then set himself to the task of overthrowing the Citibank management, and installing his own board of cronies, including his cocaine addicted son who would fall asleep at briefings after all night binges. Citibank embarked on a voracious pattern of growth through acquisition, centering around an integrated market model of cross pollination of insurance, retail banking, mortgage lending, credit card lending and investment brokerage.

Meanwhile, what has all the work resulted in? If you are a Smith Barney customer, as I am, their business model is years behind the discount brokerages which involve better selection of securities, less fees, less selling of crummy products and better online platforms to trade and research. The credit cards are experiencing the pinch of the economy. The uptick in business on the insurance side is brought down from the costs of consolidation. Even Starbucks knows when it is time to close stores but Citibank refuses to address the possibility of downsizing. There is no silver bullet which will slay the werewolf at the bank's vault.

During all the turmoil of Citigroup stock, have you noticed a conspicuous absence of comments from the founder of the megabank? I wonder where Sandy Weill is these days? Oh that's right, he's counting your money and laughing on his yacht.
Jul 20 12:53 PM
Well it could just be that we are in the beginning of a bear market and most of the contributors here are calling it like they see it. Rising interest rates, rising inflation, horrible news coming from almost all sources every day, government trying to "fix" things and making things worse every time they open their mouths....

I think nearly everyone is bullish Citi two years out, but the money that would spend on Dramamine just isn't worth the long term hold.
Jul 20 12:57 PM
Great article! I'll go one step further though. A very small percentage of investors sell short, so the only way for analysts to make commisions and feed their families is to be bullish - even in a bear market. That way, they can convince their clients to pour more money into companies that are on their last legs. If you think the state of the financial sector is bad now - wait to see what the barren landscape will be in 1 year. The pain is only beginning. There's no doubt in my mind that analysts are manipulating the perennial bulls by creating estimates that are far below what the company will actually report. When people are willing to invest their hard earned money in a company that's lost $17.4 Billion in only 3 quarters, I am absolutely shocked. What is $17.4 Billion? It's 35% of the entire Federal Deposit Insurance Corporaton's asset base of $50 Billion. There's a reason why this site seems to be bearish. That's because we're in the beginning of a long bear market!
Jul 20 01:33 PM
"There is something strange about this web site."

Yes, strange and wonderful! The diversity of opinion presented at S.A. has helped me sort out the lies and propaganda pump machines of WSJ, Bloomberg, MSN...
S.A. provides a critical balance of opinion essential for long or short term trading and I think the establishment press will need to move to a similar balanced approach to regain their credibility. Are we talking about a free market here, or some government sponsored Ponzi scheme?

Jul 20 02:14 PM
I found out long ago don't listen to the ANALYSTS, do your own investigation then decide. If these people where so smart they would be running these companies, not trying to out guess them, on earning or lossses

Jul 20 02:43 PM
Very good article. I can't believe anyone can be bullish on the banks. When are they going to fess up about what is on their books? Chase bank just sent out letters to everyone in Arizona that their Home Equity lines have been frozen and the value of their home appraisal just dropped 25%. Does anyone smell a bomb going off soon?
Jul 20 02:53 PM
Well said Mr.Steinhardt..I've been yelling at the tv when these stooges in financial media repeat the better than expected routine.

If you read financial blogs all over the web,as I do,you will find mostly agreement with your position....my question is,who the hell is buying these broken financial stocks?I have bought a couple for a trade here and there...but not for an investment!Thats probably 3 yrs down the road..
Jul 20 02:58 PM
Time to short the banks again. Sure they may go up for a few more days but like the opposite of catching a falling knife, you can not pick exactly where the top of this bull run will be.

I said to a friend the other day, if I told you on Monday that you could short the banks at the price they traded for a month and a half ago would you do it? Well here we are, one week later you can short the banks at the same price they were trading at in early June. Has anything changed to make the banks better companies in the last week?

To top things off, banks like WFC and PNC actually raised their dividend. This is strictly a stock manipulation play. There is no doubt that cash in king at this point in time, so why in the world would a bank look to send more cash out to its shareholders? This is a horrible business decision. They are making dividend decisions based on stock price, not on sound economic principals. They are doing long term damage to their companies in order to prop the stock price up today.

C, MER, PFC, STI, COF and their cohorts will all be substantially lower in a month and a half than they are today.

The author is completely correct about earnings season. The last market rally started at the begining of last earnings season. This rally started at earnings season. All this tells me is that earnings are manipulated and to invest on them is idiotic at best.
Jul 20 02:58 PM
What about the....

"If you go back three decades"
"If you go back forty years"
"Over the last 50 years"

Thomas Lee of J.P. Morgan and his credibility are falling on the proverbial sword. Dimon's lap dog to sure.

No Mr. Lee. Let's just go ALL THE WAY back to 1930. Now tell me what you really see.

Blasphemy.
Jul 20 03:11 PM
I found this article fundamentally sound, unlike the bank reporting, which is not only fundamentally unsound, but corrupt, and possibly criminal. Analysts bullish on Citi in the short run are doing a disservice to the investing public. I agree, in the long run Citi investors will reap a fine harvest of profits. But now is not the time to sow those seeds. Wait a few months, or maybe even a year. Make sure the climate is favorable.
Jul 20 03:14 PM
Also,the banks are so far away from their traditional business model for the last 15yrs,backdate comparisons are of no value.I feel for the retirees with their trust rated stocks going into the tank and no chance to recover before they take a dirt nap.I am 57 yrs old and it looks like I'll be working to 70,if there is any work to do..
Jul 20 03:36 PM
You are one hundred percent right in your opinion of manipulation of the news media and how they report earnings. It is a branch of the NYSE spin machine. Along with the specialist system that controls individual stocks they can move an issue and or a market in any direction they wish with little resistance from the unknowing investor. To read more on how they manipulate both the market and the investor click on my site and read how it is done.

Richard
Jul 20 03:55 PM
Very revealing article. Also, take into account the feds role in restricting the short selling of 19 financials. In combination with the analysts providing assistance to the financials with their guidance, it is not certain to predict any sort of price action in these stocks. The mechanics in the price action of many of these stocks is beyond repair if you are looking for any kind of consistency for a trade. The only consistent thing that I can see is that the action in the financial stocks looks horrible and broken from being thrown around all over the place. I would have covered my short positions on the first day of the rally on the financials. However, I decided to hold my short positions the moment I found out that the SEC is restricting naked short selling on some of the financials. I was even ready to load up the truck on the short during the next couple days, but my broker did not have alloted shares to short, courtesy of the feds. Guys, this is a no-brainer. If the federal government is stepping in and restricting a certain price action, it probably means that being short puts you on the right side of the trade and that without the restriction you would be in for a hell of a good time. Kinda like driving your car as you please, as if you owned the road. That is what the shorts were to the feds.
Jul 20 04:04 PM
Mike;
Very good article! I too gave up on following S&P500 earnings, surprises and disappointments etc as I was unable to garner any way to accurately interpret them to make money. I instead follow earning changes reported weekly for the 4000+ companies tracked by WSJ and have found it a little more reliable.

As you can see from the chart as Q1-08 reporting season was ending, earnings broke down hard in Q3-07 (which we began to see a few weeks into Q4-07 - tradesystemguru.com/co... ).

As of the latest data as I write this (July 20/08) Q2-08 earnings dropped again falling 30% from Q2-07 after the second week of reporting season with 631 companies having reported so far. Earnings have shown a bearish tendency to continue to worsen as reporting season progresses...

It is harder to fudge results for the majority of companies reporting as a group than it is the cherry picked companies of an index like the SPX or DJIA... but I didn't realize just how bad it was till I read your article.

Cheers,
Matt Blackman
Host TradeSystemGuru.com

Jul 20 06:35 PM
An incomplete argument. You can't tell whether the recent jump in financial stocks in response to earnings "beats" is justified unless you also factor in the relationship between share price and expected earnings over the course of any recent changes in earnings expectations.

In other words, if the stock price has already plummeted in reaction to reductions in earnings expectations, then a bounce may be justified by a "beat" even if the beat is only against a reduced target.

Would be helpful if the article included this level of analysis to help determine which bounces are justified and which overdone.

Jul 20 06:38 PM
If it's any comfort, they'll stop massaging the data when they decide there is no more money to be made in doing so. By the way, the capital base of the United States is 0. This is what they are now trying to leverage.

However, soon enough the remaining powers will put a stop to it and withdraw the Federal Government from American society. Hope you're ready for that.
Jul 20 08:16 PM
fatcat: "who the hell is buying these broken financial stocks?"

Dark pools of public money, a few million here and there, enough to move the tape. The CIA have about $10 billion a year unallocated to play with. Saudis have considerably more petty cash.

I don't think it matters. Financial psyops and lapdog media spin are inherently feeble. Ballooning money supply, leverage, writedowns, job losses, peak oil and war risk can't be waved away by sell-side cheerleaders.
Jul 20 08:49 PM
It is all a giant con game orchestrated by the Fed, Treasury and the PPT. It is politically incorrect to state the truth and anyone who attempts to is branded a leper. Announcements by the Fed, Treasury and eg. FDIC are stage-managed so as to have a positive or least-negative impact. The US is no longer a free market. It is a stage-managed market. The C result was a loss, a big loss, $2.5b, but we expected worse, so it is positive news – how ludicrous as the projections show. The US economy is being ruined by bureaucrats and politicians who manipulate the economy and markets for short-term gain. The current-consumer is the insignificant and inconsequential pawn who is worth only slightly more than future consumers of future generations. A bubble in RE to pay for overpriced stocks to be paid for by current consumers and consumers of future generations who are considered mere serfs. What is the purpose? To protect those that put them where they are - the moneyed elite who think they own the earth. The US consumer is running out of steam, so their jobs have been off-shored and the emerging economies used to increase demand for multi-nationals. The strain on the limited resources of the earth creating yet another bubble. There are many, many problems with the US economy. The economy is being “run” (ruined) by bankers (Fed, Treasury), and they appear to think that more and more cheap money is the solution to everything. Trade deficit, budget deficit, USD decline, inflation, unemployment, corporate earnings, RE crash, bank failures. How many signals do these people need to tell them that they are ruining the US economy? Asset-inflation is not wealth-creation. Their answer to that is that it is up to the markets to decide asset values. When markets decide that asset-prices are overpriced, they drop rates and pump in more money. The markets don’t decide, they decide. When the markets say they are wrong, they provide the same solution that created the problem – more cheap money.
Jul 20 09:19 PM
<<Earnings season is a volatile time. Crap earnings are sensationalized as beats just because the analysts pump them up 90 days ago and then wipe them out before they are announced. And the media buys into it>>

Actually the media is in collusion with the analysts and Wall Street in general. Every single one of those banks that reported all "increased" dramatically and even stated that losses on all fronts "are" getting worse and will continue to get worse. This rally is typical Wall Street non sense. The big boys pump the market on the back of the shorts, and the media does its part by trying to convince mom and pop americans the bottom is in. Watch BAC on Monday. They too will say everything is OK, yet the smart money knows that it will be a few quarters before they start owning up to all the Countrywide problems they bought.

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