Greenberg: Ignoring the Warnings

For the past two and a half years, as the economy has attempted a recovery, the mantra on Wall Street has been: As long as the “story” is alive, ignore the little things.

Companies still get punished when they deliver stunningly bad results or forecasts, as was the case yesterday with Finisar .

But for that to happen, they’ve got to be really bad.

In the meantime, story continues to sell over substance. Since the financial collapse, investors have chosen to look the other way on such things as bloated inventory, rising receivables or any number of metrics that normally would be red flags—even slowing growth or a rise in competition.

“Investors were encouraged not to pay attention to the current earnings periods,” recalls Matt Kliber of Voyant Advisors, an independent accounting-based research firm. “There was a notion that earnings would normalize once the economy recovered.”

A funny thing happened on the way to the recovery: The concept of so-called “normalized earnings,” for many companies, the reinvigoration of stronger-than-expected growth for others —or performance to match the ridiculously high multiples for still others—became a manana story.

Except for many, tomorrow has yet to come.

Examples include the normal cast of characters, some of which I’ve written about previously, including: , whose real earnings and growth are a fraction of the numbers (excluding non-cash expenses) the company has convinced investors to watch.

Netflix , whose competition appears to be growing by the day – whose earnings growth, some critics believe, are increasingly unsustainable.

Nuance Communications , the voice-recognition software rollup that, for a decade, has rarely made a dime on GAAP earnings. (Never mind that it’s getting a run for its money on cell phones from free, high-quality competitors like Google.) While its shares got whacked in recent disappointing results, Nuance’s shares still hover at the same levels they’ve been at for most of the past two years.

Then there’s Rackspace , whose main business is the commodity of selling managed hosting on servers, but which now bills itself as a “cloud” story.

“The Street is so focused on ‘the story’ and the cloud opportunity that they’re willing to overlook the small, narrow earnings beats,” Kliber says. “In the old days, if you were selling at a big multiple, you had to blow out the numbers to sustain it. But they haven’t exceeded estimates by any significant amounts. Yet their multiple has expanded significantly and their stock has more than doubled on low-quality beats” that have been juiced by such things as reserve reversals.

Another example from Voyant: NII Holdings, the Nextel of Central and South America. “For five quarter the company has missed consensus earnings estimates in four out of five – and had to restate one quarter,” Kliber says. “Yet investors are so focused on the emerging market/telecom play that earnings don’t matter in this case.”

My take: For many of these companies, thanks to the economic upheaval, the best excuse for under-performance has been patience. But patience, even on Wall Street, only goes so far.

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