Herds and Shepherds

Having followed the financial performance of two superb businesses, namely Starbucks (ticker symbol SBUX) and Bed Bath & Beyond (ticker symbol BBBY) for some time, I have noticed a pattern in market reaction to them. It goes something like this:

  1. The company outperforms the expectations of security analysts by delivering quarterly earnings or monthly same-store sales growth in excess of analyst consensus.
  2. Analysts conclude that the days of superb performance are finally over, and foretell doom and gloom for the company. Its stock falls.
  3. Having underestimated the company, analysts raise their expectation for the subsequent quarter or month.
  4. Steps 1-3 repeat a few times, and the stock may rise over the longer term.
  5. Finally, the analysts catch up to the company, and it delivers earnings or sales growth in line with their estimates
  6. In retaliation for not beating estimates, the company is punished by analysts and the market with a sharp decline in its stock price.

What is even more amazing is that the market, with its herd mentality, seems to follow the analysts more closely than the companies themselves, which frequently meet the earnings guidance they provide to the public. Furthermore, when the stock falls, analysts sometimes issue “buy” ratings, which are quickly invalidated because they cause a sharp surge in the stock price.

A part of me is heartened by unwarranted drops in stock price, as they create excellent buying opportunities. I honestly wish I could exploit these fluctuations, which are reasonably predictable, but I am unwilling to trade on as frequent a basis as monthly or even quarterly.

So I have learned not to trust analysts. It is not that they are stupid, but they are highly motivated to publicize their reports, which the market responds to quickly.

Tags: Business

Updated at: 1 January 2006 5:01 PM

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