Bill Fleckenstein: Why earnings estimates don't matter; mining stocks

Contrarian Chronicles7/30/2010 7:00 PM ET

Game on: Number nonsense continues

Wall Street has failed to grasp that consensus earnings estimates have no bearing on a company's financial health. Plus: Why mining stocks (wrongly) get the shaft.

By Bill Fleckenstein
MSN Money

Fairly early in the equity bubble of the late 1990s and early 2000s, I began spilling my share of online ink on the subject of the Wall Street game of beat-the-number.

This silly approach to what should be the fairly sober-minded, if not serious, activity of corporate accounting and financial analysis essentially evolved into a vicious cycle whereby Wall Street rewarded -- and therefore encouraged -- companies that consistently beat consensus earnings estimates, even by a penny. Check that -- especially by a penny, even for an improbable number of consecutive quarters.

The beat-the-number nonsense fit perfectly into the Bubblevision mentality and was eagerly lapped up by Wall Street. However, as the excesses of that era unwound, I was certain that superficial "analysis" would end. A return to sanity should involve a return to more-intelligent behavior, and nothing is dumber than looking at a company's earnings, "analyzing" whether it made a penny more or less than the average guess and then buying or selling the stock on that basis.

Such a simple approach leaves out a host of actually relevant factors, such as valuation, competitive position, balance sheet issues, deceleration or acceleration of growth rates . . . the list goes on.

It turns out that I was wrong. The game continued. But as the real-estate bubble grew, I became even more convinced that after that bubble burst, the days of beat-the-number would be behind us. Yet here Wall Street is to this day, still playing that same nonsensical game (along with Bubblevision).

Mine over matter

I don't know of an industry more than mining where it is crazier to judge a company's results by the beat-the-number yardstick.

There are so many issues and moving parts that can affect a mining company's quarterly results -- but don't tell you anything about whether the near-term or long-term prospects of the business have changed -- that a judgment based on beat-the-number considerations is almost comical. If doctors behaved as many analysts or money managers do, they would be sued for malpractice.

I make the point about mining because, after having been a director of Pan American Silver (PAAS, news, msgs) for about 14 years, I know the mining business reasonably well. But I am sure the same point can be made about other industries, from close cousins to mining, like energy extraction, to enterprises that are quite different.

In fact, as I have maintained for the past decade, companies that excel at beating their numbers probably are managing earnings -- therefore, their success at that game tells you nothing about what the businesses are actually worth. Witness the long run of wins "by a penny" of financial entities during the credit/housing bubble, many of which went bankrupt (or nearly did) in 2008-09.

There's no joy in winning a loser's game

Last week conveniently offered us a case study of this phenomenon with a mining company (which triggered this rant on my part).

Newmont Mining (NEM, news, msgs), which I have followed for a long time, reported earnings July 27 that were less than what Wall Street analysts had predicted, so it was deemed a loser at beat-the-number.

Click graphic to see interactive chart

Newmont Mining
Graphical chart for NEM
If you looked under the hood, however, you'd see that the company's production was as expected, and the company upped its dividend by 50%. Cash flow was on the order of $1.50 per share for the quarter ($6 or so for the year). All in all, after sifting through all the quarterly data, it was clear to me that the company was humming along just fine.

Newmont earned slightly less than people had forecast due to a few issues that were not earthshaking nor indicative of trouble. Yet the business headlines all focused on whether it had won or lost at the game.

Making or beating an estimate in the mining business can be particularly misleading, because inventories, to pick one line item, can change meaningfully due to short-term production and logistical issues. Newmont has more than $1 billion in that category (counting ore on leach pads). If less than 10% of that had been shipped, the company would have been deemed a winner.

Continued: Looking for a change of chart

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