How Best One Can Trust Analysts’ Earning Estimates?

12 August 2018

One often hear this stock market slang during every earning seasons;  “The company has beaten or its earnings has exceeded consensus’s estimate with a surprise”.     This article will tell why this happens so often at the Walls Street.

Earning Surprises

 One could always find this kind of table in the web and very often,  the list of companies with “surprise” positive earnings is always longer than the negative earnings .

Why?

There is usually only one answer i.e. the Analysts have under-estimated the earning results. 

How could that happen?

Lets examine one of the earning summary report by Lippe Alpha Insight as shown below,  one will notice that the companies are always reporting negative EPS when they make preannouncements.   These preannouncements by the companies will affect the Analysts’ estimates as no Analyst has better knowledge about the operation  than the companies.

Could this Just Be a Coincident for Q3 2018?

FactSet,  an organization who provides  financial data and analytics for  investors,  has this chart in  their web page

 One can see that there is a consistent pattern for most companies to provide negative preannouncements.    Note that not all companies will make preannouncement but those who did,  always do it with a purpose to get better stock prices.

Is This Fair?

Obviously,  not fair to the investors.  But there are no hard rules for such  preannouncement.  Moreover,  the companies are said to provide the  estimates to their “best knowledge”.   The market is now so used to this pattern of reporting that Analysts and investors are comparing  which year the market has the most positive preannouncement issued by the companies. 

Should we be concerned?

Most investors have learnt  not to trust fully the Analysts’ earning reports.   However,  there are many investors still rely on the Analysts’ report to buy stocks particularly those investors who  go after “growth stocks” rather than “valuestocks”    If these investors were  not careful in sorting out the genuine and accurate  earning reports from the bad ones,  they can be taken by surprise and lose a lot of money.

What Should We do?

To protect our interest,  always take stock market reports especially the earning reports of the Analysts as reference and confirm the earnings with other form of market reports or other reports  from other companies.  Do not just trust the market report from one company or Analyst.   Read through the company’s financial statements especially try to decipher  how the company can get such good earnings.

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A Warning Sign for Stock Market?

1st August 2018

NASDAQ fell about 4% after reaching its all time high of 7,932 on 25 July 2018.   It may appear to many that this is just another rotational play where investors are selling away winning stocks and shifting their money from one segment of the market to another especially when NASDAQ has just reached its all time high.  There is nothing to worry about.

What’s Behind NASDAQ’s  Drastic Sell Off?

There are many reasons.   One of the reason is that the US investors were going more for  “growth” stocks which are subjected more to speculation as they are often  “fueled” by news of future earnings or growth.   The US investors has shifted their portfolios more to buying "growth" stocks rather than "value" stocks.

What is Growth and Value  Stocks ?

Growth and Value are two fundamental approaches  in stock investing.  Growth investors will buy companies or Growth stocks that offer strong earnings growth while Value investors will seek undervalued stocks or Value stocks that has good fundamentals.

How to know there is a Shift?

The shift can be seen from the following chart that compares the trend of S&P 500 Growth ETF( IVW) and the S&P 500 Value ETF (IVE).   The chart clearly shows that investors shifted from Value stocks to Growth stock after mid 2015.   The shift is more pronounce in the last leg between 2017 and 2018.

This shift has unfortunately created a market that is  extremely sensitive to news and prepared to respond rapidly.  When growth-stock investors become disappointed with a company, they would   dump  the company's stock and proceed to buy the next exciting company.  

On July 29, 2018,  almost all the growth stocks  like   Facebook,  Apple,  Amazon,  Netflix,  Google and Alphabet in NASDAQ and S&P that have been sold off .

 Are There Any Sign?

Analysts who tracked closely the “Value/Growth” ratio of the US market are showing us the following chart

With courtesy of the following article

The chart plotted the value/growth ratio of the US market in the last 10 years between 2008 and 2018.   It shows that the growth/value ratio,  last peaked around mid 2008,  peaked again recently with investors buying 4 times as much “growth” stocks than the “value” stocks.   A "near peak" occurred around mid 2015 (Point A above) 

Do We Need to Worry?

It is quite common to see market selling off especially when NASDAQ has just retreated  from its recently peak.   It is also common to see investors adjusting their portfolios,  rotating between one segment of the market to the next segment.  

However,  if we examine the above Growth/Value chart closely and compare the happenings to the DOW chart,  we can see that the peaks or near peaks of value/growth ratio occurred around the time when market took the plunge as shown in the following chart.

What the Market Was Telling Us?

On July 26, 2018,   Facebook had the biggest  single day loss of about USD$120 billions in US history.  Mark Zuckerberg lost more than USD$16 billion as a result.

S&P’s market cap shaved off around USD$2 Trillion since all time high in 2018.   The 5 big companies lost a total of USD$330 billions altogether since their highs.

 

S&P 500 lost $2 trillion in market cap since all-time high from CNBC.

In Conclusion

While it all appears fine with markets started to stabilise and even recovered some of its losses,  we mustn’t be too complacent with the market because

1.  The investors have shifted from value stock to growth stock  since mid 2015. This is especially so,  after Trump was elected to office in Jan 2007.  Unfortunately,  this shift has increased the risk of a market plunge as growth stocks are often fueled by speculation of future earnings and growth;

2.   Studies showed that the Grow/Value Ratio has again reached another peak since the last market plunge in 2008 about 10 years ago;

3.  The market experienced tremendous price shock on July 26,  2018.  It resulted big investors having to lose a lot of fund and money.   It is not known how well  they  could handle this market shock.

Disclaimer:  This article is for information and  educational purposes.   Readers are advised to  conduct their own research and study to make their  own investment decisions.

References
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