What Are Earnings Estimates?
Earnings estimates are the projected profits of a company for a period. Estimates can be provided by a company’s executive management as part of public disclosure in forward-looking statements, or by analysts who serve in the interests of investors, and the figures are usually expressed on a per-share basis.
For publicly traded companies, these estimates might appear in a financial statement that is filed quarterly and annually with the Securities and Exchange Commission. They may also appear in press releases or be announced verbally by an executive to the media. Any forward-looking statement issued by a publicly traded company, including any internal estimate provided at presentations, must be disclosed to the public as part of SEC regulation.
Analysts would publish earnings estimates in their reports prepared for investors, and they typically would provide an explanation for their forecasts.
How Are Earnings Estimates Calculated?
Earnings are calculated based on the line items that make up a company’s income statement. Analysts at institutional brokerage firms or asset-management firms make earnings projections based on forecasts for revenue and costs, and these forecasts may vary by year, quarter, or season.
Christmas sales during the fourth quarter could be the biggest quarter of the calendar year for retailers, for example, as shoppers make large purchases of goods as gifts to family and friends. A company’s traditional release of new products in the third quarter could make that period the biggest, while the first quarter could be the slowest earnings growth period as consumer purchases ebb after the winter holiday season.
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Financial data providers such as Bloomberg LP and FactSet compile analysts’ earnings estimates on listed companies, and they usually publish what’s known as a consensus earnings estimate, or the average of analysts’ earnings estimates.
Why Are Earnings Estimates Important?
After a company reports its net income, that figure is matched against its earnings estimates, and if the two figures aren’t about the same, the result is an earnings surprise. Earnings that were higher than estimates are said to be, in investorspeak, above expectations. If they were short of estimates, they’re below expectations, and if on target, they have met expectations.
The market’s reaction to earnings surprises can be instantaneous. Being above expectations can push stock prices higher and provide strong returns to investors, while being below can bring share prices down and offer poor returns.
In other words, if a stock fails to match earnings estimates, investors may react by bringing the stock price down. On the other hand, they may react positively when profit exceeds estimates. For example, if a company reports earnings at $2 a share in its fiscal first quarter, and analysts’ consensus earnings estimate was $3 a share, that’s called a "negative surprise." If the company reported earnings at $4 a share, it "beats" estimates, and that’s called an "upside surprise.”
Profit that comes in above expectations can also suggest future earnings growth, which leads to higher price-to-estimated-earnings ratios. And, conversely, profit that was below expectations could drag potential earnings in future periods.
How Do Earnings Estimates Relate to Profit Warnings?
Sometimes, publicly traded companies will issue a profit warning on their earnings performance for a future period, be it a quarter or a year. This may portend net income coming in below analysts’ consensus earnings estimates, or possibly a loss. Reasons for issuing a profit warning vary from a force majeure at a facility to a sudden downturn in the economy depressing consumer demand. Analysts could also consequently adjust their earnings estimates to reflect the profit warning.
How Does a Whisper Number Differ From an Earnings Estimate?
The market may also react to an unpublished earnings estimate, known as a whisper number. This is an unofficial estimate often released by an anonymous analyst, or even an anonymous company insider, to give investors a heads-up on profit prior to the release of official financial results. Sometimes, the whisper number is the actual number or very close to it.