Analysts' Accuracy Forecasting U.S. Profits Worst in 16 Years

By Lynn Thomasson

Aug. 22 (Bloomberg) -- Analysts' accuracy in predicting U.S. profits dropped to the lowest level in at least 16 years last quarter, adding to a worsening track record since regulators forced companies to stop leaking information to Wall Street.

Earnings estimates from analysts matched results for 6.7 percent of companies in the Standard & Poor's 500 Index that reported second-quarter profit, the fewest since Bloomberg began compiling the data in 1992. Accuracy peaked at 30 percent in the fourth quarter of 2000, the year Regulation Fair Disclosure, known as Reg FD, was adopted, and has fallen for six of the seven years since.

``They're winging it,'' said John Kornitzer, who oversees $5 billion as chief investment officer of Kornitzer Capital Management in Shawnee Mission, Kansas. ``They can't find out the stuff they want to find out, and they've got so much to do because there have been so many cuts.''

The Securities and Exchange Commission's law stripped analysts of their edge in forecasting earnings by making companies release information that affects profits to the public. More than $500 billion of bank losses from the collapse of the subprime mortgage market has made predicting company results even harder.

Second-quarter earnings declined 22 percent for the 459 companies in the S&P 500 that released results so far, according to data compiled by Bloomberg. That's twice the drop analysts projected in the first week of July, before the reports began.

Missing the Mark

Analysts are increasingly likely to miss the mark because companies are more cautious with information following the SEC's rule, said John Wilson, co-director of equity strategy and chief market technician for Morgan Keegan, which manages $120 billion in Memphis, Tennessee.

``You no longer have that favored guy who gets the wink and the nod before everyone else,'' Wilson said. ``Unless you've got an analyst with a really good handle on an industry, it just gets tougher and tougher in an environment like this.''

Not all research has gotten worse, said Jerome Dodson, a fund manager who oversees $1.7 billion at San Francisco-based Parnassus Investments.

``Often an individual analyst knows the company better than we do because they follow it on a daily basis,'' said Dodson. ``Good analysts will bring a company to our attention that's not getting a lot of attention on Wall Street.''

Citigroup, Bear Stearns

Meredith Whitney, the bank analyst at Oppenheimer & Co., predicted Citigroup Inc. would cut its dividend two months before it did. Wachovia Corp.'s Douglas Sipkin lowered his recommendation on Bear Stearns Cos. in May 2007, when it was trading at $150. JPMorgan Chase & Co. later bought the company $9.43 a share, the deal's value when it closed in May.

Job cuts and a decline in analysts' pay after government efforts to prevent research operations from mingling with investment banking may have exacerbated the drop in the quality of research, according to Morgan Asset Management's Walter ``Bucky'' Hellwig. The SEC requires banks to separate research and investment banking divisions to prevent the leaking of nonpublic information about corporate transactions.

Bank of America Corp., the second-biggest U.S. bank, fired about a quarter of the stock analysts in its New York-based securities unit in January. Newark, New Jersey-based Prudential Financial Inc., the second-largest U.S. life insurer, shut its 420-person stock research and trading unit last year because it wasn't making money.

Lower Profits

``It's not the high-profit, high-dollar profession that it used to be,'' said Hellwig, who helps oversee $30 billion in Birmingham, Alabama. ``In the wake of all the regulation to separate investment banking from analysis, the job of the analyst became just that, often just watching the stocks and checking the estimates.''

Accuracy in the second quarter worsened as complex, illiquid securities caused unexpected losses, said Sean Ryan, a New York- based analyst with Sterne, Agee & Leach Inc.

American International Group Inc.'s report was among the biggest misses of all companies in the S&P 500 after the world's largest insurer wrote down more than $11 billion of holdings. The adjusted loss was 51 cents a share, compared with analysts' estimate for a 77-cent profit. New York-based AIG's shares plunged 18 percent Aug. 7, the day after the report, for the steepest drop since the company went public in 1969.

National City Corp., the Cleveland-based bank whose market fell by 70 percent this year, reported a loss that was more than twice what analysts estimated, as did Seattle-based Washington Mutual, the biggest U.S. savings and loan, and New York-based Merrill Lynch & Co., the largest U.S. stock brokerage.

Morgan Keegan's Wilson, who uses technical and quantitative analysis to make investment decisions, says investors can't rely only on analyst reports because ``nobody knows right now how bad it could be'' as the U.S. economy slows and banks' credit losses continue to climb.

``You've got to do lots of other things beside read an analyst report and take an earnings estimate at face value,'' he said. ``Schmoozing the company doesn't help anymore.''

To contact the reporter on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net.