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Stock Earnings Estimates – Analyzing Earning Estimates

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Introduction

 

Image result for earnings hedgeye cartoon

 

We you tune in to CNBC in the mornings – even in the afternoon, chance are, you will see an eclectic group of financial analysts in a heated debate about their predictions of stock picks and market sectors. Examples of this can be seen in such programs such as: Squawk Box, Squawk Alley, Fast Money, Power Lunch, or even Mad Money With Jim Crammer. These are all prime examples of financial analysts – and in this lesson, we will be going over the importance of their stock earnings estimates, as these are the numbers that can significantly drive a stock in one direction or another.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Decoding Earnings Estimates

 

Image result for earnings hedgeye cartoon

 

Earnings season can be an eventful time for investors. Prices can jump significantly depending on how a company’s earnings results compare to expectations.

These expectations come from two main sources – analysts earnings estimates and a company’s own earnings estimates, often called “company guidance”. Because of the potential effect of these estimates on stock prices, it’s important to understand where they come from and what they mean to you. Let’s start with the analysts earnings estimates.

Financial Forecasts From The Pros

 

Analysts are financial professionals, who typically work for brokerage firms, investment advisers, banks, or mutual funds. They usually specialize in specific industries or sectors and develop expertise in evaluating investments in those areas.

Analysts use their knowledge to project how much a company might earn over a certain time frame, usually a quarter.

 

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Projecting performance over just a few months may not sound that difficult – but with all the factors that can affect a business’s performance, it’s actually a complex endeavor.

Analysts conduct research, like reviewing past performance, studying economic trends, and meeting with company management. Analysts also draw significantly on company guidance, which is the second main source of earnings expectations.

During the earnings call, company management typically explains why earnings met or didn’t meet expectations. This guidance reflects the internal expectations for sales and earnings for future quarters or years – and reveals management’s perspective on industry and macroeconomic trends.

Image result for earnings hedgeye cartoon

 

Analysts combine company guidance with their own research and sophisticated financial models to forecast earnings – and then proceed to publish their own estimates.

A large company may be closely followed by dozen of analysts from different firms. And because each analyst may use different models, their estimates can vary dramatically.

Many investors use a consensus or average estimate against which actual earnings results are judged.

Analysts may also publish recommendations for the stock, such as a buy, sell, or hold – and explain in detail the merits of their analysis.

Analysts estimates represent the research and insight of knowledgeable professionals, which can be a helpful touch point as you form your own opinions about an investment. However, estimates vary, and earning surprises happen.

 

Image result for earnings hedgeye cartoon

Pitfalls In The Logic Of Earnings Estimates

 

Forecasting financial performance isn’t an exact science – and relying solely on analysts estimates is risky. Although analysts are highly qualified professionals with access to the best data and tools, they can still make faulty assumptions.

For example, the company guidance on which analysts base some of their forecasts can be overly optimistic or overly conservative. Furthermore, unexpected events can swiftly and drastically change an investment’s outlook, no matter what analysts have said.

 

Image result for stocks hedgeye cartoon

 

Some critics also note that wall street analysts can be vulnerable to unique biases.

For example, some analysts work for firms that provide banking or other services to the companies they analyze. This relationship may pressure analysts to provide a positive rating so they don’t lose favor with these firms.

Other analysts may be threatened with loss of access to management’s time and insight if they issue a negative recommendation.

Studies have shown that analysts have been consistently overconfident in their recommendations.

For example, during the “.com” bubble, many analysts were criticized for maintaining buy ratings on questionable stocks, even as they were collapsing.

 

 

In spite of these risks, earning estimates can play a significant role in earnings announcements.

It’s these numbers that companies are expected to beat. Even before actual earnings are released, if a large number of analysts are in agreement, the market may react by pushing the stock price in one direction or another.

Analysts estimates and company guidance are valuable tools. Just remember to carefully weigh their opinions with other forms of analysis when making an investment decision.

 

Quick Recap

In Review…..

Stock Earnings Estimates

  • Earnings season can be an eventful time for investors. Prices can jump significantly depending on how a company’s earnings results compare to expectations
  • These expectations come from two main sources – analysts earnings estimates and a company’s own earnings estimates, often called “company gudidence”. Because of the potential effect of these estimates on stock prices, it’s important to understand where they come from and what they mean to you
  • During the earnings call, company management typically explains why earnings met or didn’t meet expectations. This guidance reflects the internal expectations for sales and earnings for future quarters or years – and reveals management’s perspective on industry and macroeconomic trends

Financial Analysts

  • Analysts are financial professionals, who typically work for brokerage firms, investment advisers, banks, or mutual funds. They usually specialize in specific industries or sectors and develop expertise in evaluating investments in those areas
  • Analysts use their knowledge to project how much a company might earn over a certain time frame, usually a quarter
  • Analysts conduct research, like reviewing past performance, studying economic trends, and meeting with company management. Analysts also draw significantly on company guidance, which is the second main source of earnings expectations
  • Analysts combine company guidance with their own research and sophisticated financial models to forecast earnings – and then proceed to publish their own estimates
  • Many investors use a consensus or average estimate against which actual earnings results are judged
  • Analysts may also publish recommendations for the stock, such as a buy, sell, or hold – and explain in detail the merits of their analysis
  • Analysts estimates represent the research and insight of knowledgeable professionals, which can be a helpful touch point as you form your own opinions about an investment. However, estimates vary, and earning surprises happen

Cons To Earnings Estimates

  • Forecasting financial performance isn’t an exact science – and relying solely on analysts estimates is risky. Although analysts are highly qualified professionals with access to the best data and tools, they can still make faulty assumptions
  • Some critics also note that wall street analysts can be vulnerable to unique biases
  • Studies have shown that analysts have been consistently overconfident in their recommendations
  • In spite of these risks, earning estimates can play a significant role in earnings announcements
  • It’s these numbers that companies are expected to beat. Even before actual earnings are released, if a large number of analysts are in agreement, the market may react by pushing the stock price in one direction or another
  • Analysts estimates and company guidance are valuable tools. Just remember to carefully weigh their opinions with other forms of analysis when making an investment decision

 

 

And this was a thorough overview of stock earnings estimates. These are critical numbers – and are factors that need to be examined, since they represent the strength of a corporation’s financial performance each quarter. After all, it is market speculation and psychology that moves price action, more so than economic data itself.

Most investors will then turn to financial analysts, who know the markets and have already conducted a thorough examination of the company’s well-being, to render a verdict of their future financial expectations. You, as the investor, can use this information as a way to keep tabs on the stocks that you already own, adjust or rebalance your portfolio, or even consider unlikely candidates for your investing watchlist.

However, as an investor, you should not solely rely on earnings estimates, as financial analysts do make mistakes. Some may overestimate or underestimate a particular stock, sector, or market. They may have failed to anticipate any unexpected changes in the market since making their forecast – and they may be prone to their own personal biases for many different reasons.

But this is not to say that their judgment can not be trusted – as these analysts have spent many many years and many many hours studying the stock market and conducting various research techniques that we have already covered in this course – only theirs is on steroids.

Overall, estimated earnings is a vital indicator of how a company and it’s stock is performing. This can be incorporated in your methods of fundamental analysis no less, and typically companies make an announcement about a week before the grand reveal. Use these facts and figures to your advantage to identify is your stocks are outperforming or beating analysts expectations.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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