Analysts Continue to Boggle the Mind

There are 3,400 sell-side research analysts in the United States. No matter what they do, they’re not going to get too many flattering comments from me on this blog. First off, don’t get me wrong, there are some good analysts out there. They are tough to find, and likely only number in the dozens, but they do exist. But for the vast majority, they baffle me. Let me explain two extremes.

First, we have Sears Holdings (SHLD), one of the largest retailers in the country with more than 3,000 stores and $50 billion in annual sales. Guess how many analysts cover SHLD? (Hint: take the “under”). The answer is 6. That compares with 23 for Target (TGT), 24 for Wal-Mart (WMT), 28 for Bed Bath & Beyond (BBBY), and 29 for Best Buy (BBY). How can this be? The sell-side is not shy about telling you that it’s because Sears doesn’t give guidance.

Without guidance, how can they possibly know how to project sales and earnings on a quarterly basis! It’s ludicrous, really. After all, a research analyst’s job is to research, analyze, and make projections. Heaven forbid should they actually be forced to do their job! So what we have on Wall Street are people who take numbers companies give out on conference calls and plug them into their own Excel spreadsheets. Not exactly quality due diligence.

But then we have the other end of the spectrum. It occurs a lot less frequently, but it does happen, as Wednesday’s trading action in Cigna (CI) stock shows. Cigna shares fell $15 after reporting first quarter earnings. What happened, you ask? They missed estimates, right? Nope, they reported EPS of $2.11 on $4.1 billion in revenue. Consensus estimates were $1.89 and $4.1 billion.

Oh, well then they lowered guidance for 2006, right? Wrong again. Cigna actually raised 2006 EPS guidance from $7.25-$7.70 to $7.50-$8.00 per share. Well then why on earth did the stock drop $15? Amazingly, it was because analysts had been projecting 2006 earnings of $8.07 per share (estimates ranged from $7.50 to $9.10). Why would the average Wall Street projection be for EPS of more than $8.00 when the company ‘s management thinks they are going to earn less than $7.50?

As stated before, I’m all for analysts doing extra work on their own outside of conference calls and press releases from companies. However, when a stock drops $15 after the company raises their guidance for the year, something isn’t right. Such a huge discrepancy between what management teams project and what analysts project should be a red flag. If the analysts are more accurate, then they are doing their job well, but such instances are rare. After all, CEO’s and CFO’s should certainly know more about their company than the analysts who cover them.

Now for the only really important question with respect to all of this: is Cigna a buy at $90 after the $15 drop?

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4 Thoughts on “Analysts Continue to Boggle the Mind

  1. Anshu on May 4, 2006 at 2:37 PM said:

    Great post Chad. Couldn’t agree with you more — as this was ALWAYS a problem that we encountered at my old job, where analysts simply would not listen to the company given guidance. We would hit or exceed our number, but the stock would tank due to analyst expectations. Just to play Devil’s Advocate — do you think the higher forward analyst estimates are priced into the stock? If so, you could argue that when Cigna reported higher guidance (but lower compared to analyst estimates), the stock price would correct. This is clearly not an efficient market if the analysts are driving it, but is that what is happening intuitively?

  2. Chad Brand on May 4, 2006 at 2:54 PM said:

    That is absolutely what happened. The market was pricing in $8+ and the company said they would only do $7.75 for 2006. The funny thing is, the company had guided the year to $7.50 three months ago, and investors still believed the analysts who were above that, so clearly nobody cared about Cigna’s own guidance. But now, all of the sudden, investors do care what they think they will earn? As usual, it makes little sense, but traders are short term oriented, so if a company guides below estimates, they simply run for the exits and move on to something else.

    To your point about efficient markets, I always like to compare the stock’s price reaction to the severity of the projected earnings shortfall. If we are now going with Cigna’s $7.75 number, versus the sell-side estimate of $8.07, that is 4% less than expected. And yet the stock fell 15%. Efficient markets? I think not.

  3. Jay Walker on May 4, 2006 at 6:57 PM said:

    The fact that stocks are tanking after beating expectations and raising guidance , reminds me very much of the atmosphere in the NASDAQ-rocket era.

    This is another reason I think that the market may be well and good primed for a fall, something I talk about in my blog. Stress test your portfolios, folks.

    Jay Walker
    The Confused Capitalist

  4. Chad Brand on May 4, 2006 at 7:08 PM said:

    I haven’t seen many stocks that meet those criteria. In fact, the stocks that do beat numbers and raise guidance have done very well. In the last week or so we saw that with Garmin and Terex, to name a couple. It’s when guidance is reduced, or kept constant despite a better-than-expected Q1 (which implies caution going forward), that has kept a lid on stock prices this earnings season.

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