Market Expectations vs. Results: Tracking Analyst Earnings Revisions
by Wayne A. Thorp, CFA
The stock market is forward looking. As such, stock prices are established based on expectations of how a company will fare in the future. Over time, stock prices adjust as these expectations change or are proven wrong.
While long-term earnings strength is often a hallmark of companies with solid investment performance, the market appears to have an obsession with short-term performance in the form of quarterly earnings. More accurately, the market focuses intensely on how quarterly results stack up against the market’s expectations. As a result, changes in earnings expectations, no matter how slight, can have a significant impact on a stock’s price—the effects of which can be felt for as long as a year.
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Expectations regarding a company’s quarterly or annual earnings typically take the form of earnings per share estimates. These estimates are shaped by many company, industry, and economic forces. They embody an analyst’s opinion of such factors as sales growth, product demand, competitive industry environment, profit margins, and cost controls. Many stock valuation models use earnings and, therefore, slight changes in expectations for future earnings per share or earnings growth can translate into a significant and lasting impact on stock prices.
Investor services such as I/B/E/S, First Call (both of which are now under the Thomson Reuters umbrella), and Zacks provide consensus earnings estimates by tracking the analysts that follow specific companies.
Tracking these expectations and their changes is an important component of stock analysis. In addition, tracking significant revisions can be turned into a rewarding investment strategy.
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