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Posted on Sun, Sep. 22, 2002
Guiding light: Forecasts trade in trust

The Journal Gazette
When a Fort Wayne-based steelmaker predicted its third-quarter earnings would outperform analysts' estimates earlier this month, investors suffering from malnourished portfolios went into a feeding frenzy.

Steel Dynamics Inc.'s stock price soared more than 17 percent Sept. 12 - the day after the company said it expected to beat analyst estimates by as much as 16 cents.

Publicly traded companies often provide guidance or forecasts on their earnings and financial performance to keep stakeholders informed and surprises to a minimum when the real earnings numbers are reported.

After all, the one thing investors hate is a surprise.

But with jittery regulators scrutinizing corporate America's accounting practices, companies are becoming conservative and in some cases even tightfisted with their financial forecasts, analysts say.

Revised earnings guidance helps lessen the surprise for investors and analysts "so all the wheels don't fall off the wagon on D-Day," said Steven Artuso, analyst with Pittsburg Research in Great Neck, N.Y.

Analyst estimates are based on a company's financials, past performance, future outlook and industry conditions, Artuso said.

"It's a little bit of art and a little bit of science," he said.

Through guidance, businesses keep investors informed, gaining their trust and developing a rapport with analysts and institutional investors who invest in the companies.

Typically, businesses offer guidance when they feel their earnings could come in lower than analyst estimates, said Raghavendra Rau, assistant professor of finance at Purdue University in West Lafayette.

"They do that to prevent investors (from) penalizing the company after the earnings come out lower than the analyst estimates," Rau said.

Guidance is a way companies keep analysts "in the loop," said Dennis Houlihan, managing director with Houlihan Asset Management LLC.

If analyst estimates are way off the reported earnings, the analysts look bad and may retaliate by calling into question the credibility and honesty of management, Houlihan said.

But providing an earnings estimate is viewed as a crutch for analysts who are spared having to crunch the numbers themselves, some finance experts say.

Earnings estimates provided by companies make life easier for the analysts because it provides them with a reference point, Purdue's Rau said.

"Analysts do their own analysis, but I wouldn't be surprised if the (earnings estimate) the company is providing is kind of a focus number for analysts," he said.

Artuso, the Pittsburg Research analyst, said he uses company estimates as a guide when doing his own calculations.

Another downside to guidance is it sometimes forces management to commit to financial results it can't always meet. If the estimate is not met, the company can take the flak from a disappointed investment community.

Or management can achieve the "estimates" through accounting acrobatics - often without skirting the law.

"There is a lot of leeway which accounting rules provide," Rau said.

One such such accounting trick involves capitalizing certain costs that ought to have been expensed, Artuso said.

In such a case, a company spreads costs - that should have been reported up front - over a period of time.

"Instead of taking the $1 million loss in a single quarter, you're spreading the $1 million over a year," Artuso said.

After markets closed Sept. 11, Steel Dynamics said it expected third-quarter earnings could approach 60 cents per share citing increasing steel prices. Analysts had suggested a more modest 44 cents per share.

The next morning, investors gobbled up the steelmaker's stock which climbed to a high of $15.03 during the day and closed at $14.78, up $2.20. The company has lost some of that gain since and was trading for about late last week .

Providing earnings guidance is not standard practice for Steel Dynamics, said Fred Warner, investor relations manager.

"It's rare that we provide guidance about earnings numbers at all," Warner said.

Steel Dynamics typically offers general forecasts on volume and price trends at a conference call after each quarterly earnings release.

Only when the company is "virtually certain" that analysts' estimates on earnings numbers are significantly off the mark will it make a pre-earnings announcement such as the one it made early September, Warner said.

The guidance was offered to correct the analysts' estimate the company believes is incorrect, he said.

Two-thirds into the third quarter, Steel Dynamics knew with "some degree of certainty" the analyst estimates were wrong based on the shipments it had made and its costs for the quarter, Warner said.

"Therefore we had a high degree of confidence that the quarter's results are going to be in this case substantially higher than the analysts consensus estimates," Warner said. "We thought that (the) information that was available to the public . . . required correction or an update."

Steel Dynamics' third quarter ends Sept. 30. The company expects to report earnings Oct. 14 after markets close.

Investors and analysts singed from the fallout of the Enron, WorldCom and Tyco scandals are holding chief executive officers and their boards more accountable than ever.

At the slightest hint of financial hanky-panky investors are voicing their displeasure and sending stock prices into free fall.

As a result, companies are likely to be conservative and low-ball earnings estimates and forecasts because they'd rather "pleasantly surprise" investors, Houlihan, the investment adviser, said.

Companies are refraining from hyping their guidance because of potential lawsuits and negative media reports if revised estimates are not met, Houlihan said.

"If (the company says) things are looking up for the next two quarters, and all of a sudden if that doesn't materialize," Houlihan said, "you've got a bunch of pissed-off shareholders and analysts that could come back to the company claiming fraud."

Businesses are going to be as conservative and cautious as possible, Artuso echoed. They don't want to raise expectations and then not meet it, he said.

But while being cautious in upgrading earnings estimates, corporate America is also likely to be aggressive in alerting the investment community if the estimates are too high, Artuso said.

Companies are more likely to fess up today if they think their earnings are going to come in short of the estimates - even if it is by a small margin, Artuso said.

If they don't, they could face the wrath of investors who hungered for positive news but ended up being served unappetizing financial results.

"I don't think (businesses) want any bombshells to really hit their stock," Artuso said. "The market environment really would be unforgiving today if they don't meet (the) estimate."

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