Skarbeck: Analysts' quarterly focus can lead investors astray

February 8, 2014

Ken SkarbeckWall Street analysts are notorious for their short-term attention spans. Their obsession with the next quarter is evident in the questions they ask on the corporate earnings conference calls that are broadcast on the Internet.

Managements are regularly asked questions that are fishing for numbers to plug into the earnings models analysts use to prepare their quarterly estimates. Common questions surround tax rates, capital spending for the next quarter, gross-margin expectations and administrative costs. Services like Zacks and StarMine track analyst forecasts and score them for their accuracy. No doubt these rankings play a large part in analyst compensation, so it’s no wonder the cycle of short-termism is perpetuated.

This ritual, repeated every three months, leads to undue scrutiny of a company’s quarterly figures and can lead to poor decisions by investors.

A recent example of this was seen in IBM’s fourth-quarter earnings report a couple of weeks ago. There was plenty of good news for investors. Earnings in the quarter were up 14 percent and for the year they advanced 7 percent. Gross margins and net margins were up in the quarter and free cash flow was $8.4 billion.

IBM management also disclosed that it spent $3 billion buying 10 companies in 2013. Significantly, the company spent $14 billion during the year buying back 73 million shares of IBM common stock.

However, there was one figure in the report that grabbed the attention of analysts and investors. IBM “missed” on its revenue, which was down 5 percent for the year, mostly due to tough conditions in its hardware business.

What followed was a slew of analyst downgrades and comments criticizing IBM for spending money on buybacks instead of seeking large acquisitions to boost growth. Investors were counseled to pass on IBM and instead look elsewhere for faster-growing technology companies for their portfolios. Presumably, many of these analysts believe the new kids on the block, like Facebook and Twitter, represent better investment values.

We strongly disagree. IBM doesn’t have a revenue problem. It’s Facebook and Twitter that have the revenue (and earnings) problem—that is, a relative lack of either. Amazingly, Facebook’s market value, at $157 billion, is approaching IBM’s $183 billion. Yet IBM reported $27.7 billion in revenue in the fourth quarter, more than 10 times Facebook’s $2.6 billion.

In addition, analysts who disparage stock buybacks need to retake Accounting 101. Stock buybacks are beneficial to shareholders if the shares are purchased at undervalued prices, and that appears to be the case with IBM. The company is on track to earn $20 per share in 2015, which puts IBM’s forward price-to-earnings ratio under nine.

IBM’s large buyback program serves to raise earnings per share and also increases a shareholder’s percentage ownership of the firm. Buybacks can be an intelligent use of capital, as opposed to overpaying for a large acquisition that increases business risk and requires time to integrate.

Wall Street’s “sell side” analysts excel at writing detailed research reports full of useful data. But when it comes to valuing businesses and selecting securities for purchase, investors should always carefully evaluate the logic behind the recommendation.•


Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.


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