Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Analyst Expectation

What it is:

An analyst expectation is typically a prediction of a company's quarterly or annual earnings per share.

How it works (Example):

Securities analysts are tasked with the job of making earnings estimates for the companies they cover. This involves analyzing and accurately forecasting the performance of these companies. They often do this by reading all of the disclosure about a company as well as talking with management, visiting the company, studying the product and monitoring the industry. For each company, they create detailed mathematical models that reflect the facts and the analyst's judgment about what will happen next. These form expectations. The analyst disseminates these earnings estimates to his or her clients, who may use that information to buy or sell securities. Many companies and websites also publish the earnings estimates for any given security.

Many analysts might follow the same security, and this is why many people often consider the average or median of these expectations as more important that any one analyst's expectation. So if the consensus estimate is that Company XYZ will report $0.50 of earnings per share next quarter but the company reports $0.45, Company XYZ has "missed estimates." If Company XYZ reports more than the consensus, Company XYZ has "beaten estimates" or "beat the street." In both cases, if the company significantly beats or misses consensus, this is often called an earnings surprise. Missing or beating numbers can be a telling sign for the company, but it can also mean that the analyst simply got it wrong.

In many (but not all) cases, companies might help analysts refine their expectations. They're not offering to do this just because they're nice guys; they want to see what the analyst is thinking and tell him where he might be out of line. This benefits the company, which knows what will happen to its stock if it doesn't meet expectations, and so it behooves the company to correct the analyst if an estimate seems too high. Likewise, it's often to the company's advantage to get the analyst to lower his expecatations as much as possible so the company can soundly beat it and improve the stock price. In some cases, the company might encourage the analyst to raise his expectations so that it can publicize the fact that an analyst thinks even better of the company, which in turn may spur investors to want the stock and drive up the price.

Why it Matters:

Many people make investment decisions based on earnings, and so expectations about those earnings are important not only because they provide some indication of what financial experts think might happen next for a company, but they set the tone for the security's trading in the short term (note that long-term investors are less sensitive to this ebb and flow). A stock price often goes down if the company misses, and if often goes up if the company exceeds expectations. Thus, many investors know that the degree of divergence from expectations matters. This can be frustrating for companies that produce strong growth and good products but still suffer a decrease in stock price for failing to meet Wall Street's expectations.