One of the simplest investment strategies is to pick a few companies you like, wait for one of them to deliver a lousy earnings report and buy at the dip when the stock price falls. It’s a good strategy because it’s predictable — like clockwork, the market reacts to earnings estimates.
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What Are Earnings Estimates?
Earnings estimates are kind of like a report card for publicly traded companies. They represent the average opinion of all the different professional analysts that cover a specific company. Those analysts give their predictions for the company’s future earnings per share (EPS), which is a key measure of a company’s profitability and a standard metric that investors use to decide whether or not to buy or sell a stock. Estimates are issued for the coming fiscal quarter or year.
Earnings Estimates Can Steer Stock Prices
All kinds of forces drive changes in stock prices, but few more directly than earnings estimates. When analysts report high estimates, it’s a reflection of an optimistic consensus — that the experts expect the company to grow and increase its profits. Investors, naturally, want to buy into a company like that, which increases demand for shares. That increased demand sends stock prices up.
On the flip side, low estimates tell investors that analysts think a company is taking on water. It sends a signal that a company is unlikely to grow, to be profitable or to make money for its investors. That, of course, sends investors fleeing as they sell their shares and look for greener pastures — and better earnings estimates — elsewhere on the market.
Revisions Can Change Even More Minds
It’s common for analysts to revise previously issued earnings estimates when facts change on the ground. Maybe a drug company gains or loses a key patent, an aerospace company gains or loses a major Defense Department contract, or an automaker is forced to issue a recall. Sometimes it’s nothing so dramatic — a change in management or a change in sales can trigger a revised earnings consensus. But one thing is certain: revisions make waves.
When Wall Street revises its expectations down, it sends a signal that analysts were too optimistic with an original earnings report — that they no longer expect a strong showing from a certain company.
That kind of revision, naturally, sends investors fleeing. But Wall Street can also revise its expectations up, which makes shareholders happy. Upward revisions indicate renewed faith in a company, which attracts new investors and sends its stock price up.
In the End, It’s the Company’s Performance That Matters
All publicly traded companies are required by law to submit quarterly reports to the Securities and Exchange Commission (SEC). That’s the moment of the big reveal when investors find out if a company matched, missed or beat Wall Street’s expectations.
Negative earnings surprises occur when a company falls short of its consensus earnings estimate. It’s disappointing news that causes investors to flee and sends stock prices southward. When a company outperforms its estimates, it’s called a positive earnings surprise. When that happens, Wall Street takes notice and the stock heats up as investors jump on board and share prices rise.
A Look at the Impact of Earnings Estimates on Real-World Stocks
Every quarter, new earnings estimates steer public perception and, therefore, stock prices. Here are just a few recent high-profile examples:
- On May 19, Analog Devices (ADI) reported sales of $1.66 billion and adjusted earnings of $1.54 per share compared to analyst estimates of $1.61 billion and $1.45 per share. Shares soared by nearly 4% by noon that same day.
- On April 29, Amazon (AMZN) reported earnings of $108.52 billion, well ahead of Wall Street’s estimate of $104.47 billion. Its shares, too, saw an immediate bump of 4%.
- Also at the end of April, the media company Discovery (DISCA) reported net income of 21 cents per share compared to Wall Street estimates of 33 cents per share. That negative surprise sent shares tumbling by almost 8% before regular trading even started.
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Last updated: June 9, 2021