By Jack N., Communications Analyst and Blog Contributorr
Everyone likes a little validation in life. Take me, for example. Back in the day, when I struggled mightily to find stocks that were set to soar, I would spend hours doing fundamental analysis on company earning and income statements, sector analysis, competitor analysis, and company news.
As a final step, I would review what analysts covering the company were saying. I focused intently on their revenue and earnings estimates, both near- and long-term. I did it to validate my investing decisions. What I eventually discovered more than 20 years ago is equally true today: Take what analysts say not as validation, but as one more piece of information in your portfolio decision making process.
Which brings us to today with the end of the 2012 third quarter earnings season, and the implications of analysts’ earnings estimates for investors and traders. Prior to the reporting period this year, the theme was downbeat: The consensus among analysts was for weak company earnings thanks to a fitful U.S. recovery, uncertainty over the presidential election, a slowdown in China and a general reduction in global business activity. Those subdued expectations were built into stock prices prior to the start of earnings season. What have we seen so far?
While earnings per share for the quarter have hardly been robust, analysts were overly pessimistic. Day after day, upside earnings surprises – meaning companies whose profits per share exceeded the consensus estimates by analysts – outnumbered downside surprises. For every company that had a downsize surprise, such as Amazon.com Inc. (AMZN), there were companies that handily beat the consensus earnings forecast, such as Raytheon Co. (RTN) and a Weyerhauser Co. (WY). Based on my calculations of earnings surprise data compiled by Yahoo! Finance, upside surprises have exceeded downside surprises by a 65 percent to 35 percent margin with a week left in earnings season.
Perhaps analysts had an all-too-human reaction to the constant negative news and kept their profit estimates low, or maybe they’re becoming more conservative following years of criticism that they were far too bullish. And presidential politics no doubt played a role. Analysts (and the markets) don’t like uncertainty. Numerous companies, for example, warned about the impending fiscal cliff on their bottom lines, and that spurred speculation about which candidate would be more likely to not fall off of it. President Obama’s re-election could help clarify things, or make forecasting even cloudier. Whatever the case, there’s a lesson here for investors and perhaps an opportunity for traders.
For investors, it suggests that if, after all of your research, you like a company, you might not want to give too much weight to earnings forecasts. Earnings forecasts might be better used as an indication, not a validation, of what to buy. For traders, there’s plenty of opportunity because earnings misses help foster a volatile market during earnings season. Misses, whether up or down, can oftentimes mean big, fast price hikes; so be ready to strike. Expect earnings misses to happen frequently.
Do you own any securities that benefitted from beating consensus estimates this quarter? Leave a comment and let me know.
Jack N. is a communications analyst at Scottrade. He works to demystify the markets and the economy for all types of investors and traders.
Also of Interest:
- Video: Analyst Ratings & Reports for Your Positions
- Looking for Growth in all the Right Places: The PEG Ratio
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