Analysts’ Earnings Estimates – Can you trust them?

by Grant Gigliotti

Fact 1: Analysts cannot predict the future

Analysts are not very good at predicting the future. Nobody is able to accurately predict what will happen with a company because there are too many variables in effect and nobody can accurately calculate unknowable situations, especially when they are complex, as is with all of the factors that can influence stock earnings.

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Fact 2: Analysts’ forecasts can affect stock price

This is because if a company misses the analysts’ earning prediction, it is considered a surprise and these surprises have an immediate effect on stock price and a long-term effect on stock price.

Typically if a stock has a negative miss, the stock will decrease in price and this decrease in price can be exaggerated and is not necessarily pegged to the actual value of the company.

If a stock has a positive surprise, the stock will typically increase in price. Again, this can be exaggerated and does not accurately reflect an increase in the actual value of the company.

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Fact 3: Analysts’ forecasts can drive stock prices up

If analysts give an overwhelmingly generous forecast, this can cause more investors to invest in a company. This can drive the price up. However, an overly generous forecast is harder to live up to. Therefore, the company could be more likely to have a negative miss on their earnings report, which in turn can cause the stock to experience a decline at the time of reporting earnings.

Conclusion: it may be wise to stay away from investing in companies with overly generous analysts’ forecasts, especially if you plan to hold beyond the earnings report date.

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Fact 4: Analysts’ forecasts can drive stock prices down

If analysts give an overwhelmingly negative forecast, this can cause more investors to sell their shares of a company. This can drive the price down. However, an overly negative forecast is easier to overcome. Therefore, the company could be more likely to have a positive surprise on their earnings report, which in turn can cause the stock to experience an increase at the time of reporting earnings.

Conclusion: it may be wise to consider investing in good companies at bargain prices if analysts have given an overly negative forecast, especially if you plan to hold beyond the earnings report date.

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Fact 5: Analysts are not all equal

When you read an analyst’s forecast or a consensus of analysts’ forecasts, it is difficult to know how reliable these analysts are. Obviously, some analysts will have better track records than others. An analyst might make an error or have an off-day. Often times, there are only a few analysts that determine the earnings forecast for millions of investors. Is it reasonable to believe that a handful of individuals should be trusted to determine which companies millions of investors should invest in?

Conclusion: Don’t heavily rely on analysts’ predictions when choosing your investments. You should always do your own research and analysis on each company that you intend to invest in. After all, your money is your responsibility.

I hope this info is useful for you.
-Grant

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