| Focus on the Price
By John Jagerson, CFA, CMT Monday, January 21, 2019 1. Earnings estimates can change 2. Analysts have a bias for underestimating performance 3. Guidance can have the biggest impact on the price How can we improve the new Chart Advisor? Tell us at chartadvisor@investopedia.com Major Moves So far earnings have been looking good. The big banks hit new profit records and growth numbers are better than expected. However, not every stock that has reported so far has subsequently behaved the way we might expect based on the headline. For example, Delta Air Lines (DAL) beat profit "expectations" on Tuesday yet made no headway from its current lows.
Not all investors know precisely what is meant by some of the terms used routinely during earnings season, but these terms represent concepts that can help explain confusing reactions to earnings data. Let's review a few key terms that should help you understand more about what is moving the market this month.
Expectations and Estimates When a company reports their earnings it is routine for the headline covering the report to indicate whether or not their performance missed or beat "expectations" or "estimates". Most of the time when we talk about estimates or expectations we are referring to estimates created by sell-side analysts. These are financial analysts who are publishing estimates that are available to professional and individual investors.
These analysts are referred to as "sell-side" because their estimates and recommendations are intended for their firm's clients rather than for the firm itself and routinely underestimate companies' financial performance. It is typical for 60% or more of the companies in the S&P 500 to beat average sell-side expectations in any earnings season.
Analysts also revise their estimates as they get closer to the actual earnings report. For example, average estimates for Macy's (M) had been rising 60 days ago, which older studies have shown to be correlated with the better performance. However, I have found that since some of the early statistical work on earnings revisions was done in the 1990s and early 2000s, any positive effect has become more difficult to detect in recent years.
In my experience, stocks with upper earnings revisions are no less likely to rise higher after their earnings report (or similar announcement) than their peer group. However, what I have noticed is that increased expectations are correlated with larger moves to the downside following a disappointment. As you can see in the following chart, Macy's (M) dropped 17% last week when they missed sales expectations. I am always a little wary when a company is running up into a resistance level on rising analysts estimates just as they are due to release sales or earnings numbers.  Source: finviz.com
Guidance vs. Actual Performance
Along with the actual performance numbers that are released with the quarterly earnings report, a company's management will usually provide "guidance" for what they expect their performance to be over the next quarter and the next year. It seems reasonable to assume that because management has inside information that their estimates would therefore be more accurate than analysts.
Interestingly, although management guidance tends to change less frequently than analyst estimates, they have not been shown to be more accurate. The accuracy problem makes the reaction we often see to management guidance perplexing. It is not unusual for a company to perform very well and beat expectations, but because management's guidance for the next few quarters was low the stock will drop dramatically even though guidance isn't perfectly reliable.
Sometimes this guidance is provided in advance of the earnings report and it can set companies up for a fall in much the same way earnings estimate revisions can. For example, LogMeIn (LOGM) had been increasing their earnings guidance in early 2018, but when they fell short during their July earnings report the stock dropped 15%. You can see that reaction in the following chart.
In my experience, I have found these price shocks to be more common amongst companies that are new or distressed. Investors who follow Blue Apron (APRN) should keep this phenomenon in mind. Traders were willing to push APRN up 40% in a single day last week after the company increased guidance for their earnings report due next month.  Bottom line: Preparing for More Earnings You are not alone if you feel a little confused when you compare the reaction to earnings represented by a stock's price movement versus what was written in the headline. Previous changes to management's guidance or revisions to analyst estimates can put a company in a position where it is very difficult to truly surprise investors with their actual performance. So far this earnings season, expectations have been kept low compared to actual results; we may not see as many negative spikes as we have in prior reporting periods. However, understanding everything that may have affected the price going into the earnings report should help you to understand why a stock is moving regardless of what you read in the headline.
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Monday, January 21, 2019
When Prices Don't Match the Data
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