Heard on the prairie: Managing expectations

  • Article by: PATRICK KENNEDY , Star Tribune
  • Updated: November 22, 2009 - 12:10 AM

More big companies are managing expectations to deliver positive results.

Any business owner looking to satisfy customers knows it is better to underpromise and overdeliver than the other way around. Big publicly held companies are reemphasizing that philosophy with their earnings guidance.

After all, one way to paint a bad quarter better is to say you at least did better than expected.

The third quarter of 2008 was particularly tumultuous as global credit markets froze, spawning the Great Recession. Not surprisingly last year, many companies failed to meet quarterly expectations. And failing to meet those expectations further fueled investors' uneasiness and contributed to the market sell-off in late 2008 that continued in early 2009.

Since then companies have gotten better about matching or exceeding earnings expectations -- much better. According to Bloomberg News, 80.1 percent (371 of 463) of the Standard & Poor's 500 companies that have reported earnings so far this third-quarter earnings season have delivered positive earnings surprises, which is to say actual earnings exceed the expectations of analysts even though year-over-year comparison may have been negative. Only 12.7 percent (59) have reported negative surprises.

That's a big improvement over the third quarter of 2008, when just 58.1 percent of the S&P 500 companies reported positive earnings surprises while 32.3 percent of the companies delivered negative surprises. That negative surprise number hadn't been that high since fourth quarter of 1997 while the positive number hadn't been that low since fourth quarter of 2001.

Companies have gotten so much better at beating expectations that they may be overcompensating. Since 2000 the average positive earnings surprise number was 63.7 while the negative number was 19.4.

"I believe there is some game playing going on," said Steven Leuthold, founder of the investment management and institutional research firm the Leuthold Group. Leuthold doesn't put a lot of weight on recent guidance figures. "Companies may have been overly conservative on setting expectations," he said.

That's not to say that companies are making money. Many are still reporting negative year-over-year comparisons -- they are either losing money or making less than they did in the year-ago quarter. Earnings from S&P 500 companies are improving. But in the third quarter 269 companies reported negative earnings growth. That's an improvement over the first and second quarters, when an average of 326 companies in those quarters experienced negative earnings growth.

Still, companies want to shine a positive light on those results, and beating expectations is one way to do that.

Locally it looks like the 25 largest Minnesota-based companies by market cap haven't played the expectations game to the same extent as others have. Among Minnesota's largest companies, 16 (or 64 percent) reported better-than-expected earnings this quarter while a year ago 14 reported positive earnings surprises. Nine companies (36 percent) reported negative earnings surprises in the most recent quarter; a year ago 10 did.

But on average those companies are beating expectations by a wider margin that they were last year. Donaldson Co., which last week released fiscal first-quarter numbers for the period ended Oct. 31, is an example. Its earnings per share of 44 cents were off 26.7 percent from last year. But they beat analysts' expectations of 36 cents a share.

"While our year-over-year comparisons were negative ... our first-quarter results were better than our expectations," Bill Cook, chairman, president and CEO, told shareholders last week. The company, which makes industrial air-filtration equipment, has cut costs, increased operating margins and is expecting a gradual recovery during the second half of their fiscal year.

Patrick Kennedy • 612-673-7926

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