At the end of the classic Western, “Rio Bravo,” when the bad guys came running out of a blown-up house holding up their hands in surrender, John Wayne’s sidekick couldn’t help but exclaim “Look at ’em quit!”. These days, I’m reminded of that scene whenever a company announces or warns of disappointing earnings. It’s like a stick of dynamite exploding, sending investors and analysts running for the exits faster than ever before.
These days, it seems that investors and analysts expect companies to know what their upcoming earnings will be, down to the last cent. In the U.S., companies unable to “massage” their quarterly earnings results to match those they’ve led analysts to expect are said to have lost “credibility.” After such an indiscretion, large companies often get dropped to “hold” and smaller companies are likely to get “removed from coverage.”
A prime example of this phenomenon came in January 2000 with Lucent’s warning that their profits would not meet expectations. The next day, as much as $60 billion in market capitalization disappeared. What really grated me was that I’d lost money on Lucent put options when their previous quarterly result suggested a rosy, trouble-free future.
But the drama surrounding earnings bombs is not restricted either to the largest tech companies or to the U.S. market. One industry I’ve been following globally this past year has been the entertainment software (video game) industry – generating over $11 billion in annual sales. While I think the industry has good long-term potential, investors seem ignorant of the transition period resulting from the gradual phase-out of the current generation of Sony and Nintendo machines. Because of this, disappointing earnings and sales announcements have been hitting the industry like sticks of dynamite, and investors have been “quitting” the stocks with equal ferocity. The U.S. was bombed first, triggered by Electronics Arts in mid-December, when an analyst cut sales forecasts almost -10%, after which the stock fell as much as -35%. In January, the game maker Acclaim announced that its quarterly profits fell -96%, rather than rising as expected, and saw its stock fall over -50%.
In the U.K., the trend of disappointment continued. Last week, Eidos P.L.C. announced that sales, and thus profits, would not meet earlier expectations, leading its stock to plunge over 58% from its December highs. Analysts in Europe and America claimed that they had already been anticipating a slowdown, however few had bothered to cut their forecasts. When the news came out, therefore, what shouldn’t have been a total surprise seemed like one, and analysts rushed to cut estimates, or if they were too lazy to make that effort, simply dropped coverage of the company, alleging that it was too volatile and unpredictable to analyze.
What a load of bull. Analysts are supposed to add value to the market by attempting to forecast what may be difficult to forecast. That’s how one gains knowledge everyone else doesn’t already know – and that’s how you make money in the market. Unfortunately, for companies not able to spoon feed analysts and the public with accurate predictions – investors and analysts just give up, running for the doors with their hands up.
As a postscript, its surprising to note that the share prices of several other large European game makers have continued to gain over the past month, with continental analysts seemingly happy to leave their earnings expectations high. I can’t help thinking that, based on what’s happened lately, there’s going to be another load of dynamite hitting these companies in the future as well. (And the worst thing about that is, they’re difficult to short).
