Analysts miss mark on Wall St brokerage profits

ST. LOUIS (Reuters) - Wall Street is puzzling Wall Street.

When it comes to estimating the profits of top brokerages, securities analysts can miss their mark -- big time.

And that has some financial experts warning investors to be wary of the estimates, which sometimes seem to hit their marks about as well as darts thrown at a board.

Joe Terril, President of Terril & Co., a private money manager in suburban St. Louis, said he understands why analysts miss so badly on Wall Street firms.

"One thing you can't underestimate is the ability for literally one or two trades to be immensely profitable in a given quarter," Terril said. "It might be the difference between 40 cents a share of profit in the quarter.

Wall Street firms also can be on the wrong side of trades, which could cut profits by a similar amount.

"It is still an incredibly volatile, high-risk business, no doubt about it," Terril said.

Brokerage companies beat analyst forecasts by an average of 10.8 percent over the last four quarters, according to Reuters Estimates. That compares with an average beat of just 3.8 percent for S&P 500 components as a whole.

"If you're off by 50 cents a share on a brokerage firm, well, you're within the realm of possibility," said Richard Bove, a Punk Ziegel & Co. analyst who covers investment banks and brokerages.

Bear Stearns Companies Inc. <BSC.N>, Goldman Sachs Group Inc. <GS.N>, Lehman Brothers Holdings Inc. <LEH.N> and Morgan Stanley <MS.N>, which all reported third-quarter earnings earlier this month, beat analysts forecasts for the period by an average of 12.1 percent, according to Reuters Estimates.

BROAD FACTORS

Among that foursome, the biggest surprise was for Morgan Stanley, whose earnings per share came in 27.5 percent higher than the average estimate. That's nothing new for the largest brokerage, which also beat forecasts by an average of 26.8 percent over the last four quarters.

"What you're doing is looking at broad factors: trading volume on New York Stock Exchange or how many Treasury bonds were issued in the quarter," Bove said. "You don't know who did the trading and you don't know if it was profitable."

How companies generate their profits is important to consider when taking a long-term view of their prospects, said Sanjeev Bhojraj, an accounting professor at Cornell University and director of The Parker Center for Investment Research.

Bhojraj said brokerage financial results come with a double-edge sword because they can be opaque and volatile. For example, Bear Stearns got a boost in the third quarter from a revenue category simply called "other."

That revenue jumped to $82.7 million, or 4 percent of total net revenue, from $11.9 million in the year-earlier period, leaving analysts unsure of what triggered that upswing.

"I can see how the analysts have difficulty following (Wall Street earnings)," Bhojraj said.

Sam Molinaro, Bear Stearns' top financial officer, was asked about the "other" revenue category several times during a conference call with analysts. He described it as a collection of things that have to do with the way Bear Stearns internally allocates the value of the firm's equity.

Molinaro noted that higher interest rates helped increase other revenue.

Bear Stearns' net revenue that quarter was $2.1 billion.

EARNINGS MANAGEMENT

Bhojraj, who has studied earnings management, or maneuvers companies may take to beat analysts' estimates, said investors should be wary of companies that take shortcuts to boost profits, he said.

Bhojraj said his research has found that companies that fall marginally short of expectations are better off, in most cases, than companies that managed earnings to beat estimates.

Companies that massage their earnings may cut discretionary expense items, for example, hurting their chances for future growth.

"As an investor, you hope (beating estimates) is sustainable," Bhojraj said. "The question to ask is, 'Will it unravel?"'

PAST DEBACLES

Wall Street firms say their risk management systems will prevent any major negative earnings surprises, and protect them from the sort of collapses of years past when rogue traders sent companies reeling.

Still, the risks are very real. Hedge fund manager Amaranth Advisors LLC of Greenwich, Connecticut suffered a $6 billion loss this month in wrong-way bets on natural gas derivatives.