Learn to Play the Earnings Game (and Wall Street Will Love You
The pressure to report smooth, ever higher earnings has never been fiercer. You don't want
to miss the consensus estimate by a penny--and you don't have to.
By Justin Fox
In January, for the 41st time in the 42 quarters since it went public, Microsoft reported earnings that
met or beat Wall Street estimates The 36 brokerage analysts who make the estimates were, as a
group, quite happy about this - the 57 cents per share announced by the software giant was above
their consensus of 51 cents, but not so far above as to make them look stupid. Investors were
happy too, bidding the already high-priced shares of the company up 4% the first trading day after
In short, for yet another quarter, Microsoft had kept its comfortable spot in the innermost sphere of
corporate paradise. This is what chief executives and chief financial officers dream of: quarter after
- quarter after blessed quarter of not disappointing Wall Street. Sure, they dream about other
things too-- mega-mergers, blockbuster new products, global domination. But the simplest, most
visible, most merciless measure of corporate success in the 1990s has become this one: did you
make your earnings last quarter?
This is new. Executives of public companies have always strived to live up to investors'
expectations, and keeping earnings rising smoothly and predictably has long been seen as the
surest way to do that. But it's only in the past decade, with the rise to prominence of the consensus
earnings estimates compiled first in the early 1970s by I/B/E/S (it stands for Institutional Brokers
Estimate System) and now also by competitors Zacks, First Call and Nelson's, that those
expectations have become so explicit.
Possibly as a result, companies are doing a better job of
hitting their targets: for an unprecedented 16 consecutive quarters, more S&P 500 companies have
beat the consensus earnings estimates than missed them.
Microsoft's prodigious record of beating expectations is due in large part to the company's
prodigious growth, from annual revenues of $198 million at the time of its IPO in 1986 to more than
$9 billion now. It also helps that it dominates its industry. But even the Microsofts of the business
world have a few tricks up their sleeve. The most obvious is to manage earnings. "Managing
earnings" has a pejorative, slightly sleazy ring to it, but even at the most respected of companies
accounting and business decisions are regularly made with smoothing or temporarily boosting
earnings in mind. Not all are as up front about it as General Electric, where executives say openly
that they don't think their company would be as popular with investors if its profits weren't so
consistent and predictable. But neither can it be a complete coincidence that of the top ten
companies on Fortune's 1997 Most Admired list, seven--Coca-Cola, Merck, Microsoft, Johnson &
Johnson, Intel, Pfizer, and Procter and Gamble--have missed fewer than five quarters in the past