- The Washington Times - Thursday, January 25, 2001

Popular Internet search engine Yahoo's stock has fallen almost $60 over the past two months because analysts expect the company won't perform well during the first part of this year.
As the economy slows, companies every day are reporting that their earnings are not meeting analysts' expectations, sending their stocks down.
Investors big and small are often guided by analysts' recommendations, giving these "experts" the power to send Yahoo's stock, which was trading at more than $200 nine months ago, plummeting to close at $42.88 yesterday on the Nasdaq Composite Index.
The analysts are employed by large investment firms and banks, like Merrill Lynch, Goldman Sachs and Bank of America. They study businesses and industries and make their living by predicting from their studies whether a company is a worthy investment or not.
Investing institutions like mutual-fund companies, in turn, often deal with the money of everyday Americans trying their luck in the market.
Santa Clara, Calif.-based Yahoo's stock wasn't hurt by earnings. The company performed financially as officials expected, but the stock began dropping last fall when analysts started predicting that sales would slow in the first half of this year.
"Expectations are algebra," said Ric Dube, a senior analyst at Webnoize, a Cambridge, Mass., research firm. "And so it's A plus B plus C equals D. If you get one of the factors wrong, the whole thing will be off."
Although Webnoize specializes in studying digital entertainment companies, Mr. Dube's metaphor is one that applies to all businesses.
"[Financial analysts] make predictions of the health and viability of a business venture," said Mr. Dube, a market analyst focusing on digital entertainment. That means that to make a prediction, he talks to consumers and studies buying trends and technological advances in the industry, as well as other factors.
If an analyst sets favorable expectations for a company, investors who hire the analyst's company for advice may pour money into recommended ventures, hoping to benefit from the company's profits.
But if expectations are low, investors will steer away from the company's shares or sell their shares before they drop, causing its stock to fall further.
Analysts have existed for centuries. But their job and the way they derive expectations has changed over time, giving them more responsibility and increasing their audience from a few wealthy men to banks, mutual funds and individual investors.

Putting two and two together

So how do analysts come up with their expectations?
"We meet up with the company, look at the potential, listen to [management] about what potential there is for the product," explained Niva Almala, an analyst with New York's Mehta Partners.
"We also do our own research to back it up and get statistics from, say, the National Cancer Institute and we factor in our own opinions and impressions of what we think [will] happen. We also make our estimates depending on when the product is going to hit the market."
A major factor is the economy. If it's doing well, analysts expect companies to grow and make more money and grow some more. But if the economy isn't doing as well, their expectations are lower.
For instance, in the summer of 1999, many dot-com companies went public, capitalizing on a red-hot economy. They saw their stock prices skyrocket, only to plummet in the second half of last year as the economy began to slow.
One company that benefited from the market was Reston's Musicmaker.com, which raised $117.6 million from its stock offering. Initially offered at $14 a share, the stock zipped to $20.
Meanwhile, Mr. Dube said, if investors had looked thoroughly at the company's financial situation and the market potential for customized CDs sold on line, they would have realized Musicmaker was not a worthy investment. Earlier this month, the company announced it would shut down because it had little business and its stock had fallen to less than $1 a share.
The shake-up among dot-com companies led to a market swing: Suddenly, expectations for most Internet-related businesses dropped dramatically, scaring off investors and causing the stocks to plunge. Even shares of market-leading companies like Yahoo, Amazon.com and EBay.com tumbled.
The turmoil raised the eyebrows of Securities and Exchange Commission Chairman Arthur Levitt, who is expected to retire at the end of the month. He has said analysts should be more skeptical when setting expectations and has urged investors to ask tougher questions from their advisers.

Biotechnology bounce

Another industry that was hurt by the market swing is biotechnology, which until this month was the best-performing sector for 12 months.
For instance, Rockville-based Celera Genomics Group, a biotech leader, saw its stock climb as high as $276 in February when analysts recommended biotech stocks, saying their products could revolutionize medicine.
But then analysts began realizing it would take the company at least several years to deliver a product, so they lowered their expectations and shares of Celera with other biotech stocks fell. Celera closed at $50.38 on the New York Stock Exchange yesterday.
Ms. Almala, who mostly covers biotech stocks, said investors began realizing in the fall just how much risk is involved with volatile biotech stocks. So analysts warned investors by lowering their expectations to be more realistic.
"I'm sure [investors] would rather hold and go for companies that are more likely to deliver earnings or have a product on the market rather than to invest in companies that might have a product five, 10 years down the road," she said.

Flying high

Aerospace is another industry in which expectations are closely tied to the economy.
During good economic times, as in the past decade, air traffic increases. This means airlines have to buy new planes and fly into new locations, which means more passengers and more revenue and, hopefully, more profit. So analysts set their expectations higher than during slow economic times, when fewer people can afford to travel.
Setting expectations is "far from being a positive science," said analyst Paul Nisbet with JSA Research Inc. in Newport, R.I.
His airline formula is based on the projected growth of the world economy: If the world's economy is growing at a 3 percent annual clip, he assumes air traffic will climb some 5 percent, because it historically has risen faster than economic growth.
"That gives you a basis for estimating how many new aircraft must be added for expansion of the world fleet, and as aircraft approach 25 years of age they have to be replaced, so we see how many of the world fleet are 25 years of age and add that to the need for expansion and come up with number of aircraft needed per year that will have to be added to meet demand," Mr. Nisbet said.
"Airlines tend to stop buying airplanes in the down economy and buy them [during good economic times] to make up for what they didn't buy" previously.
The defense side of aerospace is more stable: The Defense Department sets five-year forecasts, giving analysts an idea of future contracts.
"You've got a beginning in looking at the political picture," Mr. Nisbet said. "One has to figure out whether the president's budget is likely to be raised or lowered, so we take our clues from that on the defense side."
Unlike most businesses, which suffer during slow economic periods, defense contractors tend to benefit from downturns because the government spends more money on defense to help prime the economy.
"So the defense stocks usually do reasonably well," Mr. Nisbet said. "They are pretty much recession-proof."
For instance, shares of aerospace and defense contractor Boeing Co. hovered between $30 and $60 from the late 1980s to the mid-1990s. Since then the stock has risen: It closed at $57.44 yesterday on the New York Stock Exchange.
Lockheed Martin Corp., another large defense contractors, also is fairly stable. It has fluctuated between $30 and $60 since Lockheed bought Martin Marietta Corp. in 1995. The stock dipped to under $20 in late 1999 and early 2000 because of uncertainty about the future of its F-22 fighter planes, among other woes. It closed at $32 yesterday on the New York Stock Exchange.


Copyright © 2018 The Washington Times, LLC. Click here for reprint permission.

The Washington Times Comment Policy

The Washington Times welcomes your comments on Spot.im, our third-party provider. Please read our Comment Policy before commenting.

 

Click to Read More and View Comments

Click to Hide