In the past few weeks big companies in the engineering sector have been announcing big profits. But they weren't big enough and they're being treated as losses. E&T explains why.
To gauge the reactions to Shell Royal Dutch's fourth-quarter results released in early February, and those of the City in particular, you might have thought the company had gone into the red for the first time. In fact it made billions - okay, £748m once you've converted it to Sterling but nevertheless it's substantial in the midst of a recession.
The share price nevertheless went down whole percentage points, mostly due to this profit being some 70 per cent less than 'expected'. The first question a manager should ask when moving into an environment that will be open to shareholder influence is: who are these people? Who is doing the 'expecting'?
In fact there are several groups of people who are pretty influential in this area. Analysts and brokers are of course vital. When Reuters reported the share-price slip it spoke first to Citigroup, which believed the action the company had taken would bring it into a period of strong growth and relative performance, and secondly to Collins Stewart, which, conversely, revised its forecast down to reflect 'persistent downstream weakness'.
Note that none of this actually refers to the trading as it was happening, but to trading as it might conceivably happen in the near future. One commentator told E&T that it was 'All about futures. By the time you declare profit, the City has already been trading on the figure they guessed ages ago.'
Some readers may notice worrying echoes of the sort of generous betting that brought the world's economy down when they see words like 'futures' bandied about, but it's true enough. The Citigroup optimism for Shell and the Collins Stewart pessimism weren't a reflection of a company still in profit; instead they reflected where the company was likely to go according to a couple of key commentators.
Again, the question to ask is: Who? Who are these 'key commentators'? Well, although their identities are likely to be closely guarded by the various news-gathering organisations, Reuters refers in its report to Shell's net profit of $2.77bn, 'short of an average forecast of $2.87bn from a Reuters poll of ten analysts'.
In effect, it's educated guesswork by a basket of analysts. Bloomberg takes a slightly different tack, talking to Bank of America Merril Lynch Global Research - but in a report, that organisation refers to Shell being 4 per cent down according to 'our and consensus expectations'.
It's almost as if there's a little club of people urging everyone to buy or sell shares, not quite on a whim but on the basis of entirely speculative reasoning.
Unilever share prices
For further evidence that it's not to do with profits as they are, it's useful to look at Unilever. On the same day that Shell posted its profit drop the company appeared to be doing pretty well. Once again it was in profit, it was still growing, but it was cutting prices. The City had expected more on growth and less on price cuts, and scented - rightly or wrongly - a business that might fall out of profit any time.
Accordingly, the shares fell 3.5 per cent in a day, not because the business was performing badly. Despite analysts recognising the business performing well enough they also forecast that the competition would continue to do better and additionally forecast that the business managers wouldn't be able to do very much about it. It might all make sense and be perfectly logical, but that's a lot of supposition and speculation making a lot of difference to the value of individual holdings and the pension sector - more on that sector later.
Chris Wheal, editor of the AOL-owned Dailyfinance.co.uk blog, draws a distinction between the individual share owners - 40-something readers will remember 'Sid' in the gas flotation adverts - and the institutions.
'If [smaller shareholders] think they can get a faster return on another similar company's shares they will at least bellyache about the difference and demand quick-fixes,' he says. 'But institutional shareholders often cannot just sell their stakes because they are committed to holding shares in the top 100 companies or in particular sectors as part of their investment plans.'
It's when you're responsible for managing a business with shareholders who, as part of their policy, can't sell their shares that you end up with real issues. 'That means they demand changes. In some companies this is getting to the point of micro-management,' says Wheal. 'Institutional shareholders are currently organising boardroom coups - naming the directors they want fired and the replacements they want voted in.'
This is where individual managers become increasingly vulnerable, and explains why some of the pronouncements made after, say, the Shell results were so tough - you might even call them aggressive. Chief executive Peter Voser pointed out that he had made $2bn savings the previous year and announced a further plan in which 1,000 jobs would be axed among other cuts. Presumably it was the lack of tough-guy talk from the Unilever people that led the City to suspect they didn't have a similar plan in place. Granted, the phrase 'tough-guy talk' sounds glib, but that's what it is - spin to persuade the markets that you're being tough in your sector.
Companies the size of Shell and Unilever can actually affect the stock market overall and they did so. On the day of their announcements the FTSE Top 100 index ended up down by a few percentage points. You could speculate or pontificate all you wish but you're unlikely to come to any solid conclusion about why these results were so damning when the market leader in Shell's industry, BP - which was able to post results 33 per cent ahead of expectations - did nothing to reverse that trend.
It's also noticeable that the stuff that attracts a lot of public interest doesn't lift a sector very much either. Electronics and technology has generally been acknowledged to have been declining for some years - it's almost as if it were over-over-over-valued during the dotcom boom and still has some way to fall. This will have been frustrating for Vodafone, which casually announced that its results would be $1bn ahead of market forecasts and saw its share price enjoy the biggest jump it had seen since June. Quite why this didn't matter to the FTSE when the others did - particularly when it was the first mobile phone company to announce such results (other than Nokia claiming market share back from Apple in the smartphone market a couple of weeks before) - is difficult to pin down.
Wheal: 'It is not possible to predict how shareholders will react. Shareholders are a temperamental bunch. They think 10 per cent profits in a supermarket are excellent but 25 per cent profit in a media company signals apocalypse. Two similar companies announcing similar results will not be treated the same.'
The manager stuck in the middle of this - and for 'manager' please read 'MD, CEO or anyone else who sounds powerful, but is first in line for a kicking when things go slightly wrong' - has a lot to think about. Ethically many people go into business wanting to preserve jobs and to make profits through market growth, not through damaging the competition.
Once the institutions are in, with the stakes they're playing with, these scruples start looking very dispensable. The profit motive has to take over, which is why pronouncements like those of Shell's CEO Voser have to come out loudly and clearly to anyone who can be persuaded to listen. $1bn in cuts plus 1,000 jobs to go and an acceleration of refinery divestments probably sounds like a disaster to the casual investor who wanted to see the company grow rather than shrink, but the analysts like it because it will increase profitability. Not only that, it tells the analysts that the managers are prepared to make the decisions that will reinforce those profits regardless of pain levels. And if the right analysts are persuaded it's good news and report this when talking to the Reuters panels and their counterparts elsewhere, then the share price goes up and the future starts to look just that little more secure.