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Meltdown 101: Earnings outlooks hint at the future

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NEW YORK -- It's report-card season on Wall Street, when corporations release a flood of second-quarter earnings reports that provide a window into the companies' recent performance.

But during these difficult economic times, investors and analysts are also wondering: What's next?

That's where earnings outlooks come into play. These forecasts, generally released around the time of companies' earnings reports, set expectations for the future and offer some sense of where each company is headed.

But they're not always easy to decipher. Companies may give overly vague outlooks, or purposely set predictions low, hoping they can cheer -- and make investors happy -- when earnings come in "higher than expected."

Here are some questions and answers on how to wade through this torrent of forward-looking information.

Q: What do companies release in earnings forecasts?

A: Companies tend to issue two types of outlooks --short-term forecasts about the coming quarter, and longer-range ones for the next year. Some companies get down to specifics, predicting future per-share earnings, for instance. Others don't.

Given the topsy-turvy economy, it's likely these days that executives will resort to broad statements, such as that "things are looking better," rather than providing actual numbers, said Douglas J. Skinner, a professor of accounting at the University of Chicago's Booth School of Business.

By providing few specifics, executives can't be held accountable, Skinner said.

"No one can really pin them down later on if things don't look that great," he said.

Q: What will these outlooks tell us about the recession?

A: It's hard to come to any conclusions about an economic recovery by merely looking at one company's forecast. But investors may be able to make sense of it all by cobbling together predictions from a range of companies.

If most companies issue dour expectations, for example, that could suggest a bumpy road to recovery. If they tend to look positively into the future, that's considered good news for the market -- and, perhaps, the overall economy.

Q: We've seen companies report good earnings but poor outlooks, and their stocks fall. Why do so many investors shrug off the earnings?

A: A stock is priced based on a company's ability to generate earnings in the future.

"The market is always looking forward," said Brian Bush, portfolio manager with Stephens Capital Management. "So investors are going to focus more on what companies are saying ... than necessarily focusing on this quarter that they're reporting."

Q: Do companies purposely try to set forecasts low?

A: Generally, yes. There's nothing worse for an executive than predicting strong earnings growth and not being able to deliver. Besides legal ramifications -- like the risk of a lawsuit if a company is seen as hiding bad news -- lower-than-expected earnings could cost executives their jobs or affect their compensation, Skinner said.

So companies tend to issue rather cautious outlooks. If a corporation expects to earn $1.50 per share in the next quarter, it may set its outlook at $1.40 per share, just for some breathing room.

From the company's perspective, it's far better to surprise investors with positive results than with negative ones. That's why, increasingly, companies are tight-lipped about the future, said Scott Bleier, president of Createcapital.com, a research advisory service. Some companies don't even offer a forecast at all.

Q: Doesn't the market take this tendency toward low expectations into account?

A: You'd think so, but company stocks can still jump after reporting better-than-expected results, suggesting that the market places plenty of stock in forecasts -- even if they're set cautiously low.

Q: Have any recent forecasts moved the market?

A: Yes. Chipmaker Intel Corp. (Nasdaq: INTC) released strong third-quarter sales predictions Tuesday that lifted investor confidence and gave the market a serious boost Wednesday. The Santa Clara, Calif.-based company said it expects to earn $8.5 billion in revenue, plus or minus $400 million -- far more than the $7.8 billion analysts had originally projected.

On the other hand, the nation's banks -- a big focus of the week because of their strong earnings -- steered clear of specific guidance about the future and commented broadly about such issues as the future of consumer spending and credit card delinquencies.

Q: Is there other information in an earnings report that may reflect how a company will fare in the future?

A: Yes, but it all depends on the industry.

In the technology sector, analysts will be looking at companies' capital spending to gauge their confidence in the industry. If companies start pumping cash into areas such as research and development, that's a sign that they're optimistic about the future and working to invest in the business.

In sectors like banking, where service is key, statistics on the number of employees and total compensation takes much of the focus, said Pierre Jinghong Liang, associated professor of accounting at Carnegie Mellon's Tepper School of Business.

The bottom line, though: Don't expect earnings outlooks to serve as a crystal ball into a company's future.

Even after earnings season ends, many questions will remain about the economy and consumer spending, said Bush of Stephens Capital. And those are key factors in companies' future performance.

"I think the jury's still going to be out," he said. "I think the debate will continue well into the fall."

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