Thoughts on the Estimates Game

Hi everyone,

I have some thoughts on the Estimates Game. I exaggerate a little for the clarity of the message, but what I am saying is essentially all true. I hope you find these ideas useful:

The whole earnings and revenues estimate game that the analysts play has put the company CFO’s, who give the outlooks, in a no-win situation. Here’s how it has come to work over time:

It doesn’t seem to make any difference how good or bad the actual results are, whether they are up 3%, or 30%, or 70%, or more. The only thing that the headlines pick up is whether the earnings beat the analysts’ estimates or missed the estimates. (Who cares???)

For example, a company whose earnings are up just 3%, but beats estimates by a nickel, will get screaming headlines. The headlines won’t say “ABC earnings only up 3%!” Oh no! The screaming headlines will say “ABC beats estimates by five cents!” The price will undoubtedly rise.

On the other hand, a company whose earnings are up 70%, but misses estimates by two cents, will get equally screaming headlines, not saying “DEF earnings up an amazing 70%”, but saying “DEF misses estimates!!!” The price will undoubtedly fall.

The whole estimates game is only about whether the earnings and revenue beat or miss a number that some analysts have picked. It totally ignores the question of how well the company is actually doing, and how good (or bad) the revenues and earnings really are.

However, the companies aren’t stupid. They have figured this out. And they have started to give lower and lower estimates for their next quarter, picking numbers that they are almost certain to beat (by a lot). They don’t want the bad publicity of missing analyst estimates. (Again, who cares!!!)

So what happens? The companies give low estimates and the analysts say “Good earnings, but disappointing estimates for the next quarter. We’re downgrading them from a buy to a hold.”

Thus the companies are screwed whatever they do. If they estimate high, where they think they will be, and miss, they get the “missed estimates” headlines, and if they estimate low, to let themselves beat estimates handily, they get the “disappointing estimates” headline. They lose either way.

How do we as investors deal with this puzzle. Think “How is the company doing? How much are earnings and revenues actually up?” Ignore the “missed by 2 cents” headlines if earnings are up by 40% or whatever. What the analysts had estimated doesn’t matter a hoot in the long picture, and if a stock sells down in spite of great results because of “missed by 2 cents” headlines, treat it as an opportunity.

Just my opinion.

Saul

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Thus the companies are screwed whatever they do. If they estimate high, where they think they will be, and miss, they get the “missed estimates” headlines, and if they estimate low, to let themselves beat estimates handily, they get the “disappointing estimates” headline. They lose either way.

Saul:

The more important of the two by far is the future earnings estimate. If a company lowers guidance…irrespective of how the present quarter went…the stock gets pummeled.

IMO, it would be best for companies to be as honest as they can be and let the chips fall where they may.

But we should be under no illusion that when we buy a stock, we are paying for its “future” earnings potential…not its present quarter.

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we are paying for its “future” earnings potential

Yes, Duma, “we” know that, and we at MF do invest for the future, but how often do you see headlines “XYZ missed analyst estimates!” It’s pervasive.

Saul

Saul:

IMO, the greater impact on immediate stock piece is guidance going forward. That is what I pay most attention to.

The current “missed by 5 cents” is rarely a sustained stock plunge as compare to guidance going forward.

But we are most certainly in a downdraft across the board so practically anything can happen in such a depressing sentiment.

The task before us now is defining what is a falling knife from what is an opportunity.

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Saul, excellent post I thought.

In my opinion, among the two most useless words in investing are “analyst estimates”.

Logically one would think that beating or missing analyst estimates would be more an indicator about the analyst’s ability rather than the company’s performance. Year-over-year or even sequential comparisons would seem a much more useful indicator in judging a company’s result.

I’m not sure when all the nonsense started but it really became apparent to me maybe a few years ago and I’m not sure who started the “analyst estimates” trend. If I had to bet, I’d guess CNBC. If there’s a way they can make the poor individual investor suffer, they will usually find it.

There is an upside however. Those who can judge real value in the market gets a great Ben Graham “Mr. Market” opportunity when the algo’s, momentum players, and day traders go all ga-ga about some miss-or-beat headline.

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the greater impact on immediate stock piece is guidance going forward. That is what I pay most attention to.

Duma,

I agree. But the point I was trying to make is “How much can you rely on guidance going forward when the companies feel a need to low-ball guidance so they won’t be pilloried for missing estimates?” All this crap about analysts estimates, and the importance of missing or beating them, not only puts the companies in a bind, it lessens by far the accuracy of the information WE get.

Saul

Thanks for this post. You only answered about a thousand of my questions. Long story short, analysts = noise.

It drives me nuts when the experts start talking about “the analysts.” If the analysts were so smart, they could get real jobs that contribute to society instead of nitpicking the real movers and shakers making things happen.

This should be recommended reading.

Brad
long on moving & shaking

You keep saying “who cares?” The answer is that the market cares. You’re looking at the action after the announcement. But the market reacts to analyst estimates before the announcements (that’s why there are estimates), so if the estimates are high, fund managers and others buy the stock prior to the release. A high estimate stokes demand. A low estimate quells it.

If the company doesn’t live up (or down) to the estimate, doesn’t it make sense that the stock price would “correct” to what it should have been, rather than the inflated demand some higher estimates might have caused?

Estimates don’t just fall out of the sky the night before an earnings release, and all the buying for the 89 days in the quarter before the announcement can be driven by that. You seem to be upset about what happens in the 24 hours after.

If you want to buy based on last year’s results, that’s OK with me. But a lot of investors are focused (and rightly so) on what’s coming up, not what’s already happened. Therefore: analyst estimates.

Nobody says you have to pay attention to what the company says (although it would be a fiduciary infraction to knowingly give false guidance.) Feel free to ignore what the company says, and what analysts say. But I am puzzled: what, exactly, are you going to use to base your purchase decisions?

 
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Feel free to ignore what the company says, and what analysts say. But I am puzzled: what, exactly, are you going to use to base your purchase decisions?

I do my own detailed, careful research.

Perhaps you have heard of “channel checks?”

This is the kind of in-the-trenches, nose-to-the-grindstone work that true investors – people who actually deserve the title of “investor” – are willing to do. This is the kind of work that we do here on this board.

I am not judging you simply because you are not aware of such things. But hopefully now you know.

Enough – that is my teaching moment for the day.

Now I am off to do my channel checks, first channel 42 (CNBC), then channel 17 (Fox Business), and finally channel 144 (Bloomberg).

BA

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Now I am off to do my channel checks, first channel 42 (CNBC), then channel 17 (Fox Business), and finally channel 144 (Bloomberg).

Where you will hear nothing except what analysts say.

That was funny.

You were trying to be funny, right?

This is the kind of work that we do here on this board.

So you’re able to tell what the sell through at Target is, quarterly? Impressive.

 
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But I am puzzled: what, exactly, are you going to use to base your purchase decisions?

On how well the company is doing, and my evaluation of how it will do in the future, and how well its price matches its prospects, rather than whether the company came in two cents above, or two cents below, what the analysts predicted.

Saul

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Goofy Hoofy

You asked

But I am puzzled: what, exactly, are you going to use to base your purchase decisions?

and I responded

On how well the company is doing, and my evaluation of how it will do in the future, and how well its price matches its prospects, rather than whether the company came in two cents above, or two cents below, what the analysts predicted.

but in thinking more about it, I think you missed the point of what I was writing about. What I was saying is that if a company makes 70 cents, up 75% from 40 cents, I don’t care a hoot if the analysts expected 72 cents or 68 cents, and if the company thus missed or beat predictions by 2 cents!!! What matters to me is that the company is growing earnings at 75%, and if the company sells off because of an “earnings miss” (which is a ridiculous term for a company increasing earnings by 75%), I might take advantage of it by adding to my position.

Saul

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Hi Saul, I agree completely. I don’t look at analyst estimates as all and don’t care what they think really. I do look for strong growth in revenue and EPS. Thanks for such a well written post.

Take care, Brian