What is an Earnings Estimate?
An earnings estimate is an analyst’s estimate for a company’s future quarterly or annual earnings per share (EPS). Future earnings estimates are arguably the most important input when attempting to value a firm.
By placing estimates on the earnings of a firm for certain periods (quarterly, annually, etc.), analysts can then use cash flow analysis to approximate fair value for a company, which in turn will give a target share price.
Investors often rely on earnings estimates to analyze different stocks and decide whether to buy or sell them.
Introduction of Earnings Estimates
A consensus earnings estimate is the average estimates of market professionals covering a public firm. It is used as a standard for evaluating the performance of the firm.
When a firm reports earnings that are different from the consensus earnings estimates, it is called earnings surprise. Public firms need to submit quarterly reports to the Securities and Exchange Commission (SEC) within 40 days of the end of a financial quarter.
For most firms, the financial quarters may be the same as the calendar ones. Earnings surprises can be positive or negative. If the firm manages to beat the earnings estimate, it is called a positive or upside surprise. If the firm fails to reach the earnings estimate, it is called a negative surprise.
It’s been found that the stocks of firms with substantial positive earnings surprises tend to perform above average, and the stock prices with substantial negative earnings surprises perform below average.
Firms manage their earnings to make sure that they do not miss earnings estimates. Firms that consistently beat earnings estimates are said to perform better than the market.
Impact of Earnings Estimates on Stock Prices
Earnings estimates are an important component to consider while analyzing and selecting stocks of firms. They are the quantitative views of estimations, and prices are driven by changes in the expectations.
Firms with high earnings estimates tend to underperform, as it becomes difficult for the firms to meet the high estimations of the market. Conversely, firms with low earnings estimates tend to perform better than anticipated.
Consensus earnings estimates are reflected in the stock prices. If a stock is highly recommended, the basis of such a recommendation will be the earnings estimates, which should be significantly above the current option.
Earnings estimate is a very important factor in the market. It helps in determining the share price. It is always good for a company to beat the earnings estimate as it helps build a reputation for the company in the long run.