Earnings Expectations

Sep 2018 //
Investing

In the first quarter of 2018, 78% [of companies] beat the consensus [of analysts’ expectations]. If that sounds implau­sible, consider this: Company CEOs like their stock prices to rise after their financial results are reported— it helps validate the CEO’s management. Accordingly, CEOs frequently “guide” analysts’ expectations lower than they expect to achieve. (Analysts depend on access to CEOs, so they are often happy to go along with the game of under-promising.) When actual financial results come out ahead of such “expectations,” only the uninformed are truly surprised. This can set up a seeming paradox: For example, Acme Widget reports earnings growth of 6%, beating the analysts’ consensus estimate of 5%—yet the stock drops. The explanation is that even Mr. Market is wise enough to know that 5% was an artificially low estimate. Unspoken, but more realistic, estimates might have been closer to 10% earnings growth, so 6% was actually a disappointment, not a happy surprise.