A New Era of Uncertain Expectations


By Amey Stone There was a time in the not-so-distant past when Intel's stock -- as well as the entire technology sector -- would have suffered major damage if the chip giant had told investors that it wasn't likely to meet the most optimistic forecasts. Not this year. On Mar. 5, the day after Intel (INTC) said first-quarter revenues were likely to come in a bit worse than expected, the stock fell just 60 cents, or 2%, to $28.95. The rest of the market hardly took note.

It's true that Intel's adjustment wasn't an earth-shaking disappointment -- to between $8 billion and $8.2 billion in sales for the first quarter, vs. the $7.9 billion to $8.5 billion predicted when the quarter began. But it's just one of a growing number of cases where investors seem to look the other way when companies lower expectations.

Consider insurance company StanCorp Financial Group (SFG): On Jan. 29, it told investors that instead of growing earnings 12% to 15% in 2004, growth would come in at just 4% to 6%. The stock dipped only slightly on the news -- and then bounced right back. Analysts didn't even bring their estimates all the way down, currently predicting that earnings will rise 6.25% this year.

"CAUTION IS IN." Call this the new era of diminished expectations. It's one where, as many companies ratchet back expectations, investors seem to be shrugging off negative news. The new dynamic is creating a tug of war between optimistic investors and cautious CEOs, who don't want to see their stock prices yanked downward because they couldn't deliver what they promised. The result so far this year: a flat stock market.

On the bright side, there are lots of not-so-worrisome reasons why companies and analysts, still licking their wounds from the economic slowdown and long bear market of the early '00s, might err on the side of caution this year. "CEOs have learned that there isn't a lot of upside to be gained by making an aggressive forecast and achieving it," says Richard Moroney, editor of investment newsletter Dow Theory Forecasts. But there is a lot of downside for missing an aggressive target, he says.

In the current environment, the primary goal seems to be to start out conservative, and beat the estimate in the future. On the part of companies and the analysts who cover them, "caution is in," says Lincoln Anderson, chief investment officer at LPL Financial Services. "From analysts to chief financial officers, a lot are saying it's better to keep your head down and be cautious."

NEW FOUNDATION? Are investors buying into this game? "We're sort of rolling our eyes at some of the guidance," Anderson says. With company costs so low and sales rising, "the good news is that it means profits will be up a fair amount in the first quarter," he believes. First Call consensus estimates are for earnings to rise 14.7%, a bar that Anderson expects actual results will far exceed.

Fact is, many investors and economists believe the foundation has been laid for earnings to boom, even without the more robust pick-up in demand for which CEOs yearn. "It's coming," says Mark Foster, chief investment officer at Kirr Marbach Partners in Columbus, Ind. "It will be here at some point."

Foster believes companies suffered through such serious cost-cutting during the downturn that they're reluctant to expand employment and capital spending until the expansion has persisted a few more quarters. That's keeping current economic growth restrained for now. "It's very painful to downsize, so they're going to want to see some quarters of pretty good growth before they start to open it up again," he says.

SANGUINE REACTIONS. Shareholders, so far, seem remarkably patient with the tamped-down forecasts - partly because they're confident the recovery is sustainable, but also because they aren't as worried about imploding earnings statements as they were a few years ago. It used to be that the first earnings miss was the start of a long downward slide, says Anderson. As earnings quality has improved, "You don't get that 'Uh-oh, this is the start of some huge horrible fess-up?'" reaction from investors that you used to, he says.

Yet what if CEOs are being reticent for good reason? Peter Cohan, an author and management consultant, believes economic growth has been driven by tax cuts and low interest rates and that it could fizzle in coming months. "The economy may not be as good as people want it to be," says Cohan. He agrees that CEOs are being careful because they don't want to disappoint investors, but says the important point is that "they just don't know what the future will bring."

Likewise, investors encouraged by 2003's stronger-than-expected bull market may be too willing to ignore warning signs. "People are struggling to find ideas, to stay fully invested," says Foster. "They aren't so quick to pull the trigger."

There's a lot to be said for a more laissez-faire investing environment, as opposed to one in which stocks got hammered for any tiny downside miss in results. Yet there's always the risk that the pendulum has swung too far from the days when stocks were punished mercilessly, sometimes even if they made their estimates. If the lackluster economic recovery doesn't regain some speed soon, it may turn out that this new era of diminished expectations was actually warranted, and a flat market could lead to a downwardly spiraling market. Stone is a senior writer at BusinessWeek Online and covers the markets as a Street Wise columnist


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