Many traders use earnings estimates to assess a company's growth potential and therefore its stock's trajectory. So what are traders to make of the fact that an average of 78% of companies in the S&P 500® Index have beaten their estimates on a quarterly basis since 2020?
"Company executives—who provide the earnings guidance that analysts use to create their estimates—are loath to disappoint investors," says Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research. "Just as airlines can pad flight times to avoid being considered late, company executives can issue conservative earnings guidance so it's easier to meet or beat analysts' expectations."
Given that such underestimates are par for the course, are earnings forecasts actually useful when making trading decisions? "In isolation, not really," Randy says, "but looking at the data over time can be helpful." Specifically:
- Stock performance: How does the stock tend to perform when the company surpasses its earnings estimates? "If it has a track record of rising after the company beats analysts' estimates, there's a good chance it will do so next time," Randy says. Conversely, a company that regularly beats its estimates but nevertheless experiences share-price declines may have underlying weakness. "In that case, you may want to dig into the company's earnings reports, which tell a more granular story than the top-level figures," Randy adds.
- Estimates over time: Are estimates trending upward? "Generally, you're probably better off with companies that are increasingly optimistic about their prospects, even if current estimates aren't particularly rosy," Randy says. "A company with flat or declining earnings estimates is rarely a good buy."
To research a company's earnings history and expectations, log in to schwab.com, search for its ticker symbol or name, then scroll down to Expected Earnings.
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