Surprise! No one cares about earnings beats

May 15, 2012, 6:30 PM UTC

FORTUNE — One of the most watched–and least meaningful–financial metrics each quarter is the number of “earnings surprises,” or instances in which companies’ profits beat analysts’ expectations.

The feat is, ironically, completely unsurprising. Over the last three years, an average of 74% of the businesses in the S&P 500 have beaten analysts’ expectations each quarter. Market watchers know these so-called surprises have become the status quo, but they track them obsessively, in large part because they still have the power to make stocks pop.

But that is beginning to change. In the first quarter of 2012, shares of companies that beat earnings expectations achieved a median two-day return of 0%, down from 0.7% last quarter, according to a recent report from Barclays strategist Barry Knapp. Stocks that missed forecasts fell 2.8%.

The discrepancy between beats and misses suggests that investors still believe analysts’ projections possess informational value–but that positive surprises aren’t impressive enough to make shares move. The shrinking importance of earnings beats is likely related to their ubiquity; more than 65% of companies in the S&P 500 have topped expectations in every quarter since 2009. Nearly 60% of big corporations surpassed expectations in the third and fourth quarters of 2008, when the global economy started to implode.

The trend shows no sign of abating. In the first quarter this year, about 65% of companies achieved earnings surprises, according to Zacks Research. Compare that to the late 1980’s, when less than 50% of companies beat analysts’ projections.

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The most likely explanation for the dramatic uptick in beats is that corporations have grown more adept at managing analysts’ expectations. Many pin this on an SEC rule created in 2000, Regulation Fair Disclosure, which forbid companies from sharing material information with select individuals.

By limiting analysts’ exposure to companies, the rule actually made it easier for executives, who are all too aware of the pitfalls of missing the consensus numbers each quarter, to dispense information in a calculated–i.e. deliberately pessimistic–manner. This is called guidance. Companies are known to issue increasingly dire warnings as a quarter progresses so that analysts’ projections hit a nadir right before they announce earnings.

“Management learned the fine art of how to manage expectations, and they anchor it nicely so that they can come out and beat it,” says Sheraz Mian, director of research at Zacks. “The ability to lowball expectations has been one of the unseen consequences of Reg FD.”

Mian points out that, at the beginning of the most recent earnings season, analysts projected an aggregate earnings decline of 2%–a wildly negative prediction, he says. The S&P 500’s earnings ended up rising more than 7%.

Companies have also become skillful at manipulating their actual bottom line. Numerous studies in recent years have exposed this practice, which is called earnings management. Executives have a “broad palette” of accounting tricks available to them, according to David Burgstahler, an accounting professor at the University of Washington.

“It ranges from things that are completely illegal and clearly unethical to things that are arguably a little bit shady,” he says. For example, he says, companies can cut their research and development budgets right before the end of the quarter to boost earnings, or offer extreme promotions to increase sales so that they meet projections.

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Analysts also bear some of the blame for the phenomenon. While it’s true that companies try to sway them to lower their prognostications, some forecasters have their own incentives to set low bars–according to a 1997 Fortune story, former Microsoft (MSFT) CEO Bill Gates reportedly high-fived then-sales chief Steve Ballmer after learning that he had scared a group of analysts. Many analysts work for firms that look for other business opportunities with the same companies they cover, creating a potential conflict of interest. A 2003 study found that companies were less likely to beat projections issued by independent analysts, or forecasters who didn’t work for big banks.

A meaningless metric

Investors have historically benefited from earnings surprises, which for years boosted stock returns. Numerous reports, tracing back to a 1968 study by Profs. Ray Ball and Philip Brown, have confirmed the correlation between earnings beats and rising stock prices. A more recent study found that shares of companies that topped estimates posted an average return of 0.81% in the first trading day after their earnings announcements.

So why did earnings surprises get such a chilly reception this quarter? The median 0% return could signify that other factors, like the weakening global economy, simply matter more to investors right now. Another possible explanation is that revenues–which are harder to manipulate than earnings–grew at a slower rate than profits last quarter. Just 38.7% of the companies in the S&P 500 beat analysts’ revenue projections, according to Zacks.

The mere fact that earnings beats didn’t lift stocks at all suggests that the metric has lost its potency. Even though 65% of the companies in the S&P 500 topped projections this quarter, the index is down about 3% over the last month. The one sector that has posted the smallest number of surprises–utilities, only 41% of which surpassed expectations–is doing well; the Utilities SPDR ETF is up 4%.

Investors use analysts’ projections to assess companies’ future earnings streams, and then price their stocks accordingly. They profit when these prognostications don’t match up with reality–which is, theoretically, what happens when a company beats expectations. But now that surprises are the norm, the market has devalued them. The metric, once significant, is nothing more than noise.