This article originally appeared in Net Interest, Marc Rubinstein’s weekly newsletter on financial sector themes. Rubinstein was a partner at hedge fund Lansdowne Partners for a decade, having previously been a top-ranked bank analyst at Credit Suisse and Schroders.
Earnings season is when stock analysts get to shine.
They head into the office early, standing by their desks for the earnings release. When it drops, usually around 7AM, they feverishly scan it for surprises, cross checking numbers against the set of forecasts they scratched into a spreadsheet a few weeks earlier. If there’s time, they may put in a quick call to Investor Relations to clarify a few points. Then they write up a “first take”, outlining all the differences versus the numbers in their spreadsheet, which they pass through compliance before blasting it out to clients via email. There’s not usually much time to give it a snappy title, so they may go with something like “First Take: In-Line Results”. If it’s an important stock, they’ll stop by the firm’s morning meeting to brief the salesforce on how the earnings look and what it all means. By now, they may be on their third or fourth coffee of the day.
And then the fun starts: it’s time for the quarterly earnings call.
The earnings call is a forum for the company to discuss its results directly with analysts. It has two parts. The first consists of pre-prepared remarks, crafted by company speechwriters and delivered by company management, often to the beat of some Powerpoint slides. The second is a freestyle Q&A session with analysts.
Over the years, the nature of these calls has changed. Tighter regulation around disclosure means that companies are nervous to provide information that isn’t already in their published materials. Meanwhile, analysts have come to realise that these calls provide them with a platform to market themselves to those listening in, particularly as audiences have grown via dissemination of transcripts.
As a result, earnings calls have developed a largely predictable rhythm. I’ve been listening to a fair few this week, with US banks having reported fourth quarter earnings. Three types of questions tend to come up.
The first is the information-tease. This is when analysts try to extract more guidance from management on the outlook for earnings than has already been offered. It doesn’t have to be subtle. One analyst on Bank of America’s call this week asked, “I was hoping you could provide just more explicit guidance for full year ‘22 Net Interest Income.” (The answer: no.)
While incremental colour on the big ticket drivers like net interest income (48% of Bank of America’s revenues) may be helpful in evaluating a stock, analysts sometimes use the information-tease to extract guidance on small, neglected areas of the P&L. (“Is there any incremental drag to ‘other income’ that we should be thinking about?”) No doubt this gives them a sense of fulfilment when preparing their earnings models for next quarter’s go-around.
The second type of questions are those that allow analysts to cosy up to management. Often they are prefaced with compliments like “great quarter”. One reason analysts do this is to win favour with management teams in order to gain private access at a later date. Public debasement in exchange for private access may seem an odd trade-off, but Wall Street is an odd place. Perhaps they also calculate that it enhances their brand with clients to appear chummy with management.
There’s a large body of academic work which examines this phenomenon. One paper, analysing over 16,000 calls, found that more than half of all calls included some form of praise from analysts. Analysts suck up to management at an average rate of 2.5 times per call in the sample, with the rate going as high as 21 times in the most extreme case. While it may be justified on occasion, it’s frequently the case that an analyst who lavishes praise is likely to go on to be a repeat offender.
Another paper shows how companies ‘cast’ their conference calls by disproportionately calling on friendly analysts. A recent survey of investor relations officers finds that while a majority of respondents (58%) allow all participants on a call queue to ask questions, a similar proportion of respondents (59%) indicate they actively manage the order in which callers are selected.
And to add to the reasons why analysts may want to get on the call, another paper shows that those analysts invited to ask questions early on the call have better career trajectories.
These days, most analysts are too self-aware to come straight out and bark “great quarter, guys”. Within the financial sector, you’ve got to go back all of nine months at Visa to hear it. But the banter is still there. Morgan Stanley reported a pretty good set of numbers this week and unveiled some new targets in the presentation accompanying its call. One analyst challenged the CEO with this:
“If you look at the last slide, I think those are great long-term goals. And if you could do that sustainably, I think you would get your multiple expansion, people would love it.” (“Would be a $200 stock, my friend,” the CEO responded delightedly.)
The third type of question is more rare – the one that cuts straight to the chase and interrogates the key issue overhanging the company. Asking questions is a skill that lawyers, investigative journalists and others practice diligently, but it is one that is understated among stock analysts.
One stock analyst who has perfected it is Mike Mayo. He currently works at Wells Fargo Securities, but has attuned his skill over 120 earnings seasons as a banks analyst. In a memoir published in 2012, he wrote:
Earnings calls are strange events—at times they’re like kabuki theater, in that they’re pretty ritualistic and scripted, and often the one thing that doesn’t get discussed is the thing that everyone’s wondering about.
While others were flattering Morgan Stanley’s CEO this week, Mayo asked this:
“How much longer do you plan to stay as CEO?”
It’s not as obtuse a question as it sounds. Morgan Stanley had just flashed up a new long-term 20% return on capital goal but its CEO has said on earlier occasions that he won’t be around in five years time. So how confident is he in the goal?
And at Citi, where the group’s strategy is in transition under a new CEO and large parts of the business are in the process of being sold off, he asked:
“When all is said and done, who is Citigroup?”
This line of questioning has put Mayo in hot water. He has had public spats with management teams at KeyCorp and Citi in the past. The CEO of KeyCorp once called his questioning “a little bit offensive”. His exchanges with Jamie Dimon, Chairman and CEO of JPMorgan, have become legendary.
Last week, Mayo pushed Dimon on tech spend:
“But $15 billion of investments, that’s up 1.5 over the last three years. And that $15 billion is enough to capitalise the 11th largest US bank. So you gave us that, but you didn’t tell us what to expect from all those investments in terms of what specific market share gains are you targeting? What specific revenues do you expect? When do you expect that? Can you put some more meat on the bones here?”
“Michael, I feel your pain and frustration… we can’t – we’re not going to tell you all of those things.”
A year ago, he pushed Dimon on JPMorgan’s competitive positioning:
“Jamie, you said you’re going to win, right? But based on the valuations of the PayPals and Stripes and Visa and Mastercard, anything that’s fintech-related, I mean, they trounce the valuation of your stock. So I think the market’s saying that others are going to win. So how is JPMorgan going to…”
The history goes back a long way. In 2013, Mayo asked Jamie Dimon whether UBS’s higher capital ratio offered it a competitive advantage in wealth management. Dimon hit back, “So you would go to UBS and not JPMorgan?” Over Mayo’s rebuttal, Dimon continued, “That’s why I’m richer than you.”
Mayo’s pugilistic approach isn’t for everyone. But it serves a purpose. We’ve discussed the role of equity research here before. There are multiple jobs bundled into the role:
sharing industry knowledge
facilitating access to company management and to industry experts
publishing summaries and analyses of company filings like S-1s and earnings reports
lending a sounding board for investors to bounce ideas off
hosting company earnings models
feeding consensus earnings estimates
making stock calls
maintaining oversight on company management
building networks for institutional investors
promoting their firm’s brand
and much more, depending on research analysts’ entrepreneurial flair.
Analysts who ask the first type of question prioritise the modelling aspect of the role; analysts who ask the second type are focused on facilitating access to company management. Mayo places most emphasis on oversight. In testimony to the Senate Banking Committee in 2002, he said:
“As analysts, we’re at the intersection between the interests of corporations and the interests of investors. We provide institutional memory, act skeptically, challenge corporate authority, question assumptions, and speak up if something does not smell right. We are on the front lines of holding corporations accountable.”
The reason more analysts don’t do this is because the economics of holding corporations accountable don’t stack up favourably. As a public good, it’s a job few private firms want to pay for. Short-sellers have developed a model to make it work but its variance is very high, which is why many have exited the industry over the past two years.
Mayo does okay, but that’s after years of personal brand-building. Based on a statement of claim he filed against a former employer, he earned a basic salary of $300,000 from 2013 onwards and took home an average bonus of $2.5 million a year between 2010 and 2015. But he’s also been fired by three of his six previous employers, and was made to feel unwelcome at a fourth.
Mayo’s motivation comes from a classic outsider’s mindset. He was rejected from numerous Wall Street firms when he was younger. After spending five years in the late 80s and early 90s at the Federal Reserve, he resumed his quest to get a job on Wall Street. “I needed to prove that the people who had dismissed me were wrong,” he writes in his book. Twenty years later, in the midst of a feud with Citi over management access, he recalls “the difficulty I’d had of even getting a seat at the table to conduct my research in the first place.”
For many years, investing clients were no more enamoured by Mayo than management teams. Back in the late 90s, Institutional Investor magazine included Mayo on its list of “All-Star Analysts”, naming him as the magazine’s top regional bank analyst. But then he dropped off the top of the list. Even while he was awarded a prize for professional ethics and standards of investment practice by the CFA Institute, investors rated other analysts more highly. In the past two years, he’s made a comeback, reclaiming his position at the top of the rankings. As short sellers have retrenched from the market along with the accountability they bring, Mayo’s star has been in the ascendancy.
It’s been an eventful earnings season for the big US banks. Revenue forecasts are moving higher as rate hikes get baked in and loan growth restarts, but expenses are rising even faster. Looking through the noise, though, an investment case always revolves around one or two key questions and surfacing them is a skill analysts would do well to cultivate. If they help to hold management to account at the same time, so much the better.