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It helps to know the rules on Wall St.

Kai Ryssdal Oct 21, 2009

It helps to know the rules on Wall St.

Kai Ryssdal Oct 21, 2009


Kai Ryssdal: We started the broadcast yesterday with a report on corporate profits. How a lot of companies have been doing better than expected. Some of them even while their earnings actually fell. It’s no fun digesting those earnings announcements. But there are always interesting things to learn about how Wall Street really works. Our senior business correspondent Bob Moon is here to tell us what’s what. Hi Bob.

BOB MOON: Hey Kai.

Ryssdal: Where do we stand on the scorecard better than or not better than expected?

MOON: Well, so far about three-quarters of the companies reporting their earnings have beat expectations. Now some skeptics are saying that that just might mean that the prognosticators are setting that bar too low.

Ryssdal: Where does the bar come from though? I mean, what is this expectations thing?

MOON: Well, some of those expectations are based on the guidance that the companies themselves have provided. Now the cynics will tell you there that those companies can try to lower expectations so they can beat the number. Well, that’s where the analysts come in. It’s their job to determine if those management expectations are too low or too optimistic. And then the market watchers put those numbers together and they arrive at a consensus estimate. An actual number that predicts where those earnings should actually fall.

Ryssdal: And that number is expressed usually in earnings per share.

MOON: That’s correct.

Ryssdal: And then what happens the company usually beats it or doesn’t, the share goes up or down and we’re off and running in the stock market.

MOON: That’s right. Well, Apple did that. It just soared tremendously because of their performance. If you’re an investor trying to play the market, you might think that that’s pretty straightforward, and you can take a look at that consensus estimate, and make your own judgement. And then maybe ride the stock up or down. But you know, it’s risky to make assumptions about the stock market.

Ryssdal: Yeah, it kinda sounds here Bob like you’re going to tell me I don’t know something that I don’t know.

MOON: Well, it sounds to me that maybe you had a hunch, though. You know, I learned a lot about the way Wall Street operates from what I learned in high school.

Ryssdal: Ok, go ahead…

MOON: Well, let me take you back to when I was a wee lad of 15. We had this candy drive at our school, bear with me here, I’ll try to make this short and sweet, OK? We were selling chocolate bars for a fundraiser, and I was in a dead heat with a classmate for the grand prize, a shiny new TV. So heading into the final weekend I was very careful to guarantee that at the very least I was going to tie her. I took out as much candy as she did, and I made sure to sell every last bar, and then when I came in Monday morning I was shocked to discover that she had aced me out of the grand prize.

Ryssdal: How did she do it, Bob?

MOON: Well, this was really traumatic. It was heartbreaking for me. Some time during the weekend she called up a teacher, and she got more candy to sell. And I had naively assumed that that was against the rules, right? And that pretty much parallels the way you can get burned if you’re trying to make assumptions about Wall Street. Just when you thought you got it figured out, they go and change the rules on you. Or what you thought were the rules. That may be what we saw happen with Goldman Sachs.

Ryssdal: But Goldman, if I remember, actually beat expectations.

MOON: That’s right. And if you were an investor expecting to ride that stock up on those expectations you were in for a big surprise because the stock actually tanked that day. And if you were expecting a resulting rally in financials, that never materialized.

Ryssdal: So what happened?

MOON: Well, we think that what happened is that the whisper number came into play.

Ryssdal: All right, the what?

MOON: The whisper number. This is something that is actually known on Wall Street. This is something that is too late to maybe make into a published analyst report so it spreads around among people in the know. This number that you think is going to change the actual analyst projections. And in Goldman’s case the consensus estimate was earnings 4 bucks a share. They came in around 5 bucks a share. But the whisper number we heard was around 6 bucks a share, so they disappointed.

Ryssdal: Yeah, but they’re not whispering to the average investor. Are they allowed to do this?

MOON: It’s not insider trading. Remember, Wall Street trades on rumor all the time. Buy on the rumor, sell on the news.

Ryssdal: And what you don’t know about Wall street can hurt you. Our senior business correspondent, Bob Moon. Thank you, Bob.

MOON: Thanks, Kai.

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