Eyes Wide Shut

Mar 12 2001

Three scientists - a physicist, an engineer and an economist - find themselves trapped on a tiny desert island. They have no radio, no tools and no food but for a box of matches and a can of beans that washed ashore with them. They debate how to open the can.

"I know what to do," says the physicist. "I'll light a fire underneath the beans, which will raise the temperature beyond the boiling point, exploding the can and yielding its contents!"

"Brilliant!" says the engineer. "I'll take some palm leaves and bamboo and create a device to capture the beans as they hurtle from the exploding can."

"No, you've got it all wrong," says the economist. "First, assume a can opener ..."

Economists are infamous for their assumptions. Financial analysts - economists lite, if you will - are only slightly better, mixing economic assumptions with direction - direction from the companies they analyze. The combination of those assumptions and that direction is the basis for most economic theory coming out of Wall Street. But increasingly, a new trend is producing what is surely the shakiest economic analysis in years. In the face of uncertain economic times and increased regulation from the Securities and Exchange Commission, more companies refuse to offer detailed guidance. Indeed, in recent weeks companies from Dell and Gillette to Lucent and Nortel have thrown up their hands and given Wall Street analysts little or no guidance about the coming year.

As a result, analysts are flying blind, and economists, with no idea what corporate profits will look like in the coming year, are left with fewer projections upon which to base their assumptions. In other words, more can openers.

"There's definitely a rise in the number of companies saying, 'Hey, we just don't know,'" says Chuck Hill, Thompson Financial First Call's director of research.

Fueling this is the inability of companies to match predictions, even their own. Stocks are punished when management "pre-announces" earnings that fall short of Wall Street estimates. Pre-announcements tend to come late in the quarter, when companies can see how they've done. But this quarter, negative pre-announcements are piling up at a record pace, with 321 thus far, according to Thompson Financial First Call. This time last year saw just 44 negative pre-announcements. [See chart.]

Rather than open themselves to such punishment, some companies refuse to set any expectations. This makes the job of analysts exponentially more difficult. "The schmooze-and-tell research game is over," says David Readerman, director of Internet strategy at investment firm Thomas Weisel Partners. "There were guys whose idea of analysis was being the last person to have drinks with the CFO. That's gone, and that's good."

In its place is the much more difficult practice of fundamental research: counting the number of trucks leaving a factory, customer channel checks and getting moles within the company. "We've got too many rookies out there who came into the business in the '90s or the '80s, and they've never experienced anything like this," says Hill. "This new lack of guidance will separate the men from the boys."

And what of investors? Strangely, the lack of guidance might be a good sign. "I like companies that say they don't know what's happening right now, because it means they're telling the truth," says Nicholas Moore, who recently launched a technology hedge fund for Jurika & Voyles. "It's bad enough if they're lying to me; that's a problem. But if they're lying to themselves, if they think they know what's going on this year, that's when you really worry."