Wall Street Analysts Flunk on Predicting Own Profits (Update2) 2005-03-18 09:05 (New York)

(Adds table of predictions at bottom of story.)

By Adrian Cox

March 18 (Bloomberg) -- Wall Street analysts, whose earnings estimates help money managers decide when to buy and sell stocks, strike out when it comes to predicting profits for their own industry.

Morgan Stanley, Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Bear Stearns Cos. in the first quarter earned an average 23 percent more than estimated by more than a dozen analysts surveyed by Thomson Financial. The New York-based securities firms exceeded forecasts by an average 16 percent during the past six quarters.

"I guess I should be blushing now," said Sanford C. Bernstein & Co. analyst Brad Hintz, a former chief financial officer of Lehman. His earnings per share estimate for Goldman was 25 percent below what the company earned and his forecast for Bear Stearns was 14 percent short of the firm's actual results. He didn't make forecasts for Morgan Stanley and Lehman.

All but Morgan Stanley, the second-biggest independent U.S. securities firm, reported record quarterly earnings this week, with combined profits up 19 percent. The industry is benefiting from a three-year boom in fixed-income trading, which accounted for 35 percent of combined revenue in each of the past two years and 38 percent in the first quarter, up from 17 percent in 2002.     The 12-member Amex Securities BrokerDealer Index rose 7.5 percent during the past 12 months, compared with the 6.1 percent advance of the Standard & Poor's 500 Index.

Hard to Predict

"This is a really hard industry to predict,'' said David Viniar, Goldman's chief financial officer, in an interview yesterday. ``It's so dependent on the market environment. While there's a fair amount of transparency on investment banking and asset management, trading is very hard for analysts to predict.''

Earnings per share at Morgan Stanley, Goldman, Lehman and Bear Stearns jumped by an average 38 percent during the past six quarters, compared with the same quarters a year earlier.

``Every quarter, they blow through estimates and everyone wonders what's going to happen going forward,'' said Keith Davis, a Washington-based analyst at Farr, Miller & Washington, which oversees about $500 million and holds shares of Goldman. ``The fear has been that rising interest rates are going to impact results going forward."

The toughest companies to forecast are in the brokerage, metals and paper industries, said Chuck Hill, president of Veritas et Lux LLC, an investment research firm in Boston.   ``I'd hate to be an analyst covering those areas,'' said Hill, a former head of research at Thomson's First Call financial- data services unit. ``It's like a blindfolded man throwing darts at a dartboard.''

Trading Revenue

Bear Stearns, the fifth-biggest independent U.S. securities firm, is the company that most often beats estimates, having posted 16 consecutive quarters of positive surprises, followed by the industry's No. 3 firm Goldman and No. 4 firm Lehman.

The firms with the highest dependence on trading are also the ones that have outperformed forecasts. Goldman, where stock and bond trading accounted for 63 percent of first-quarter revenue, has exceeded forecasts by an average 25 percent in the past six quarters. Lehman and Bear Stearns, where 71 percent and 62 percent of revenue respectively came from trading, have posted results that are 18 percent and 16 percent above estimates on average. By contrast, Morgan Stanley, whose retail brokerage and Discover credit card unit mean that only 44 percent of revenue came from trading in the three months ended Feb. 28, topped estimates by 5.7 percent. Analysts say it's almost impossible to guess how much firms will make from bets on foreign exchange, oil and derivatives.

Compensation Costs

Wall Street firms buy and sell the total value of their investments every eight days, so any information they give to analysts about their holdings is already out-of-date, said Bernstein's Hintz, the No. 3-ranked U.S. financial-services analyst in Institutional Investor\'s 2004 survey of money managers. Companies reveal little about businesses such as commodities trading, which accounted for 9 percent of revenue at Goldman and Morgan Stanley last year, Hintz estimates.    

Merrill Lynch & Co., the industry's biggest firm by capital, relied on trading for 37 percent of its revenue last year and has been more likely to meet estimates. Its earnings per share, up 39percent on average for the past five quarters, were 5.3 percent higher than forecast on average. Merrill reports first-quarter results next month.",1] firm, is the company that most often beats estimates, having posted 16 consecutive quarters of positive surprises, followed by the industry's No. 3 firm Goldman and No. 4 firm Lehman.    

The firms with the highest dependence on trading are also the ones that have outperformed forecasts. Goldman, where stock and bond trading accounted for 63 percent of first-quarter revenue, has exceeded forecasts by an average 25 percent in the past six quarters.

Lehman and Bear Stearns, where 71 percent and 62 percent of revenue respectively came from trading, have posted results that are 18 percent and 16 percent above estimates on average.

By contrast, Morgan Stanley, whose retail brokerage and Discover credit card unit mean that only 44 percent of revenue came from trading in the three months ended Feb. 28, topped estimates by 5.7 percent.

Analysts say it's almost impossible to guess how much firms will make from bets on foreign exchange, oil and derivatives.


Compensation Costs

Wall Street firms buy and sell the total value of their investments every eight days, so any information they give to analysts about their holdings is already out-of-date, said Bernstein's Hintz, the No. 3-ranked U.S. financial-services analyst in Institutional Investor's 2004 survey of money managers. Companies reveal little about businesses such as commodities trading, which accounted for 9 percent of revenue at Goldman and Morgan Stanley last year, Hintz estimates.

Merrill Lynch & Co., the industry's biggest firm by capital, relied on trading for 37 percent of its revenue last year and has been more likely to meet estimates. Its earnings per share, up 39 percent on average for the past five quarters, were 5.3 percent higher than forecast on average. Merrill reports first-quarter results next month.

Because compensation accounts for about three quarters of expenses at the Wall Street firms and changes little from quarter to quarter, "your net income can go up a lot faster than revenue," said Carole Berger, a managing director at TIAA-CREF Investment Management Inc. in New York, which oversees $320 billion for clients.

Record Earnings

"A trader could do `x' in business in the first quarter and '2x' in the second quarter," said Berger, who was a sell-side analyst, covering banks and brokerages, for more than 25 years."You're going to pay him more, but you're not going to pay him`2x.'"'

Morgan Stanley's fiscal first-quarter net income rose 20 percent to $1.47 billion, the highest in five years, and Goldman's profit climbed 17 percent to a record $1.51 billion.

The firms beat the highest forecasts by 7 percent and 18 percent, respectively.

Lehman said profit was up 31 percent to a record $875 million, exceeding even the most optimistic estimates. Bear Stearns said that profit rose almost 5 percent to $379 million, also a record, on increased revenue from bond sales and trading. It beat expectations for earnings per share by 13 percent.

Rhetorical Question

For now, investment banks aren't planning to change how they guide analysts in giving forecasts.

``We try to be as upfront as we can about the environment, but we can't tell them anything about our earnings, "Goldman'sCFO Viniar said.    

Lehman Chief Administrative Officer David Goldfarb, when asked in an interview to explain how the analysts underestimated his firm's earnings by a third, joked that "I'll take that as a rhetorical question."

Positive and Negative Surprises since Q12000
Based on 20 quarters (*21 quarters, reported Q105)

NamePosNegEvenAvg % SurpriseConsecutive Pos Surprises
Bear Stearns201018.216
Lehman Bros191114.210
Goldman Sachs190213.212
Merrill Lynch181110.62
Morgan Stanley15516.92
Citigroup17124.011
JPMorgan Chase1190-2.90
tOTAL1191879.20

--With reporting by Justin Baer in New York and David Pierson in Princeton. Editor: Quinson.

To contact the reporter on this story: Adrian Cox in New York (1) (212) 893-3377

To contact the editor responsible for this story: Erik Schatzker in New York at (1) (212) 318-3849