The Curse of Expectations

    February 1, 2006

I remember driving home one night listening the radio (in the days before podcasting, maybe 20 months ago).

The host was interviewing recently retired Fortune 500 CEO. He asked about the biggest obstacle the CEO faced in his tenure. The CEO didn’t hesitate. His answer: “Investment analysts.”

Because of the huge influence investment analysts wield when they set earnings expectations for each quarter, business leaders need to focus their energies on hitting those quarterly targets. If they don’t, stock prices plunge and companies have less resources to invest in the future. I’m paraphrasing, but what the CEO told the radio host was pretty close to this: “I was prevented from looking after the company’s long-term growth because our survival depended on meeting this quarter’s expectations.” He could make no decision that might mean unprecedented growth in a year or five years if it threatened the earnings-per-share analysts projected for the quarter. As he spoke, you could hear the frustration mounting in the CEO’s voice.

It must be a lot like the frustration they’re feeling over at Google this morning. Reports are flooding business media and the blogosphere about the end of the honeymoon at Google, which failed to meet analyst projection when it released earnings yesterday, resulting in a 12% slide in Google’s stock price, translatable into the ereadication of $16 billion of shareholder wealth.

Never mind that the quarterly earnings were double those for the same quarter a year ago. Forget that it delivered net earnings of $372.2 million. Read how the Associated Press report put it:

Google stunned almost everyone who follows its stock by failing to deliver a pleasant earnings surprise for the firsttime since its August 2004 initial public offering…Investors have become accustomed to much bigger things from Google, which has topped analyst estimates by at least 14 cents per share in each of its previous five quarters as a public company.

So $16 billion of shareholder wealth was wiped out becuase investors weren’t surprised by Google exceeding expectations that probably weren’t grounded in reality in the first place.

Analysts aren’t inside the company. They follow more than one organization and crank out numbers based on only those factors they’re aware of. Their biases most likely creep into the calculations. And a company’s ability to invest and grow is based entirely on whether they’re able to live up to those numbers. God forbid they should be able to simply execute their plan.

In fact, Google has resisted projecting its own earning potential, leading investors to make even more of a SWAG (scientific wild-ass guess) than they are accustomed to. The company also insisted it would spent heavily (according to the AP report) “to improve its long-term competitive position even if those investments diminish its short-term profits.” Makes good business sense. And Google has been punished for it. Companies with fewer resources and less temerity would flounder in mediocrity in order to satisfy short-term demands at the expense of their long-term growth.

I worked for one organization that had a layoff every single quarter. Sometimes it was a couple dozen people, sometimes more. The layoffs were designed to reduce SG&A in order to boost the bottom line so quarterly results would fall in line with analyst expectations. Of course, six months later the company would scramble looking for knowledge it needed to execute its plan because the people who had that knowledge had been dismissed in order to satisfy the artificial numbers demanded by the Street.

There is no question but that investors need some kind of metric by which they can assess a company’s value. But the system that gives so much power to analysts whose numbers are frequently just plain wrong is broken. The analysts continue to earn outrageous salaries while businesses suffer.

Shel Holtz is principal of Holtz Communication + Technology which focuses on helping organizations apply online communication capabilities to their strategic organizational communications.

As a professional communicator, Shel also writes the blog a shel of my former self.