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Yamil Berard
Yamil Berard
Articles (192) 

How Manipulated Earnings Forecasts Can Sink a Blue-Chip

General Electric is the poster child for why earnings forecasts don't work, some say

April 02, 2018 | About:

As a professor of finance at one of the nation’s top Christian colleges north of Boston, Alexander S. Lowry advises his students to play it straight.

No guessing, no cheating and definitely, no whispering.

It’s a lesson, Lowry says, even the biggest companies like General Electric (NYSE:GE) need to brush up on.

Lowry, a former executive at JPMorgan Chase & Co. (NYSE:JPM) is among a growing number of Wall Street types who are calling for changes in the way companies report earnings estimates. In “guidance,” publicly-held entities offer investors a “forecast” about what they believe their earnings “target” will be in the months and the year ahead.

The root of the problem, Lowry believes, is a tendency for Wall Street to paint a rosier picture on projected earnings than what is reflected in the books. The practice began as a way to improve financial transparency, which is a key component in efficient and functioning capital markets. But over time, the intent has been weighted under pressure. Companies aim to “beat” guidance, sometimes at all costs.

“Whisper” numbers also feed in into a similar manipulation, Lowry said. Whisper numbers tend to be those numbers that are collectively shared between Wall Street insiders, including institutional investors, but withheld from the public domain.

According to Lowry, General Electric is a good example of what happens when earnings forecasts are manipulated under the guise of “earnings forecasts.”

Photo: Alexander Lowry

“GE is probably one of the best examples for this view of why earnings forecasts don’t work today,” said Lowry, who is also the executive director for the master of science in financial analysis at Gordon College. “But nobody wants to change the game.”

The finance professor is in good company.

In an article posted on GuruFocus last month, JPMorgan CEO Jamie Dimon expressed dissatisfaction with earnings forecasts. He attacked the practice in a room of Wall Street analysts during a February investor’s conference at the global bank’s New York headquarters.

Legendary investor Warren Buffett (Trades, Portfolio) also agrees the practice can lead to data manipulation by CEOs and corporate boards under pressure to show they are running things properly.

Revisionist history

In recent months, GE announced it would be restating earnings for 2016 and 2017. That has made investors increasingly worried that more bad news is coming out of the conglomerate. A restatement of earnings often means a company’s troubles run deep.

CEO John Flannery has discussed on more than one occasion plans to improve transparency company-wide. Flannery has also discussed a simplification of the business by divesting about $20 billion worth of its assets. 

GE announced today GE was selling off payroll and healthcare related software from its health care segment to private equity firm Veritas Capital Management. Veritas is paying $1 billion for the acquisition of fhe software. The private equity firm is expected to operate it as a stand-alone business.

‘Neutron Jack’

It is easy to understand why GE’s operations appeared opaque and confusing years ago. All you had to do was look at its income statements and balance sheets over the years.

The company saw a real potential for erratic disclosures, for example, on a number of income statements. After reporting net income as high as $17 billion in prior years, the company suddenly began reporting a loss of $6 billion in 2015. Net income was in black again in the following year for a gain in of $8 billion. But in 2017, it fell to a loss in net income of $5.8 billion.


Lowry said top leadership set the stage for a culture that was encouraged to "push the envelope." Former GE CEO Jack Welch delivered a clear directive to employees “to do whatever was required to hit the target” of a favorable forecast, Lowry said.

“We have Neutron Jack, the best manager since sliced bread,’’ Lowry said. “He was buying and selling things all the time, under this guise. It wasn’t a bad rubric, but every quarter, they managed to meet their number."

“That’s why the stock marched higher and higher,’’ he said. “It was basically magical, but basically they were manipulating their earnings, not in a fraudulent way, of course, but they did it consistently, every time, they would have a sale of a business, they would do it just enough to change earnings to meet by just one penny more.”

The forecasts can also tarnish long-term results. If a company has to lower a forecast, investors often will hammer the price of their shares. To avoid this, Lowry said, managers will be tempted to reduce investments in research and development on new machinery and experimental techniques. That may put a damper on innovation and the long-term profitability of a company.

One alternative to the forecasts may be a requirement to disclose financial information that includes long-term strategies and business fundamentals.

Every penny counts

In 2016, Buffett, the famous CEO of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), expressed disfavor with the practice of earnings forecasts. In a televised interview, he called it a methodology that could lead to “a lot of malpractice” and gave a similar example to Lowry’s of how forecasts can be manipulated.

“If a CEO goes out and says we’re going to earn a dollar and six cents next quarter; if it’s going to come in at a dollar-four, there might be a lot of attempts to find a couple of extra pennies in some places,’’ Buffett said. “There are ways you can move earnings toward the end of the quarter, sometimes even after the end of the quarter. I’ve seen guidance produce some bad results.”

Buffett said he understands that companies operate under different rules and strategies.

“I’m not saying don’t do this, you’re dead wrong,’’ Buffett said. “I’m just giving encouragement to companies that really felt uneasy about giving guidance and perhaps have more backbone about it.”

GE numbers

In the past year, Flannery has called a series of shareholder meetings and conference calls to explain unforeseen material events. As a result, the company’s stock has tanked year to date.

GE has lost 59% of its market cap in five years. Its market cap is now $114 billion.

In five years, GE stock has lost 42% of its value. Year to date, it is down 25%. On Monday, GE was trading at $13 a share, down more than 2%. The Peter Lynch chart suggests it is overvalued at that price. The chart gives a median price of under $13.


GE posted a 3% loss in revenue per share over the last decade. It has seen a 3.7% gain in the last 12 months.

The company’s accumulated depreciation stands at a loss of $35.7 billion in 2017 compared to $47 billion in the prior year. In 2003, the number was reported at $37.8 billion.

It reported earnings per share before interest, taxes, depreciation and amortization of 14 cents in December 2017, compared to $2.09 per share in the prior year. Its EBITDA per share has been as high as $6 a share in 2007 compared to $1.65 a share in 2015.

Its forward price-earnings ratio is $31.40; its price-book ratio is 1.78 and its price-sales ratio is 0.94. Its dividend yield is 5.47% versus an industry median of 1.57%.

Rating: 3.5/5 (4 votes)



Alberto Abaterusso
Alberto Abaterusso - 9 months ago    Report SPAM

Excellent article. Thank you for having shared it, Yamil.

I believe a good investor can recognize when a company is manipulating its earnings to reach the highest target. That misconduct also creates opportunities for the investor to reduce its holding or close the position at valuations which have been driven by those who are not the most seasoned on the market.

Jds0933 - 9 months ago    Report SPAM

So companies are manipulating the numbers...yet its the analysts that have been proven to lower their estimates so companies can beat them. This is a one source article (Lowry), and mentions the 1995 definition of a 'whisper number' (whispernumber.com has been providing whisper numbers to the public since 1998). Not very useful overall. Next time get a few more sources and stay current on 'cool' trends like whisper numbers.

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