Are Earnings Estimates Just a Scam?

One of the best-received pieces of news a stock can get is when its quarterly earnings beat analyst estimates. Yet for some companies, topping the numbers that Wall Street's best and brightest set for them isn't just a goal -- it's the way they do business, and it's something investors have come to count on, quarter after quarter.

Truth or coincidence
Early on in your investing career, you'll quickly realize that when it comes to doing stock analysis, you're not on your own. An entire profession is dedicated to tracking the minutiae of thousands of different companies, trying to figure out what impact various news items and business conditions will have on a given company's stock price. Moreover, although some third-party stock analysis is proprietary and can cost a great deal to obtain, anyone with an Internet connection can find at least basic estimates of earnings both for the coming quarter as well as far into the future.

Of course, as with anything else involving making predictions, stock analysts don't always get their earnings calls right. On any given day, you can expect some companies to beat estimates while others fall short. But what's strange is that in analyzing certain companies, analysts consistently underestimate what their earnings will be -- resulting in a long string of positive earnings "surprises" that generates a stream of enthusiasm among shareholders and industry followers alike.

So the obvious question is this: since beating estimates usually boosts a company's stock price, are the stocks that consistently beat estimates among the top performers? Or have investors gotten used to the idea that these companies will always beat estimates, diluting their impact on share prices? Let's take a closer look.

The usual suspects
I went in search of companies that consistently managed to top analyst estimates. Here are some of the ones I found:

Stock

Consecutive Quarters Beating
Estimates Since 2004

5-Year Average
Annual Return

Cisco Systems (Nasdaq: CSCO  )

8

8%

Kohl's (NYSE: KSS  )

19

2.2%

Priceline.com (Nasdaq: PCLN  )

15

57.8%

Green Mountain Coffee Roasters (Nasdaq: GMCR  )

9

77.2%

Apple (Nasdaq: AAPL  )

25

40.6%

Amazon.com (Nasdaq: AMZN  )

8

31.3%

Source: Thomson Reuters, Yahoo Finance.

You can see that some of these stocks have given shareholders amazing returns over the past several years. But it's not universal -- some stocks keep beating and beating, yet there hasn't been a big payoff for shareholders recently.

All other things being equal, you'd expect analysts to be just as likely to make mistakes overestimating earnings as underestimating them, making streaks like this seem a bit suspect. Moreover, one of the peculiar things I noticed is that with many of these stocks, the company managed to beat estimates by a single penny -- often less than 1% of the total reported figure.

So is there something going on? Can analysts be trusted?

Not a new issue
The question of analyst earnings has been around for a long time. Over 10 years ago, the SEC investigated Microsoft (Nasdaq: MSFT  ) over allegations of improperly accounting for revenue reserves, which it allegedly used to help smooth quarterly earnings.

More recently, some have questioned the fact that so many companies beat estimates during the past year's market rally. In the second quarter of 2009, for instance, close to 80% of S&P 500 companies reported earnings that beat analysts' projections. Given that analysts are free to change their opinions up until the actual figure is announced, you wouldn't think that so many companies could take analysts completely by surprise.

How to handle earnings
Perhaps the most important lesson to take from this is not to give analysts' figures too much credence. You're far better off building your own expectations of a company's earnings, since you then have complete control over the information you use and its reliability. By contrast, relying solely on analysts for your opinion of a stock leaves you vulnerable to the whipsawing that stocks often see when companies perform differently than those analysts expected.

So when you hear about a company beating expectations in the news, don't automatically jump for joy. It may well be something that everyone was really expecting to happen.

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Fool contributor Dan Caplinger is always on the lookout for a scam. He doesn't own shares of the companies mentioned in this article. Green Mountain Coffee Roasters is a Motley Fool Rule Breakers recommendation. Apple, Amazon.com, and priceline.com are Motley Fool Stock Advisor picks. Motley Fool Options has recommended a diagonal call position on Microsoft, which is a Motley Fool Inside Value choice. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy won't pull a fast one on you.


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  • Report this Comment On April 08, 2010, at 8:02 PM, plange01 wrote:

    ebay already fills with ipads...

  • Report this Comment On April 08, 2010, at 8:04 PM, plange01 wrote:

    the only people foolish enough to pay attention to earnings estimates are on wall st but those fools wait for the fed to tell them gabage to!!!

  • Report this Comment On April 09, 2010, at 10:22 AM, mikecart1 wrote:

    I believe estimates are a huge conspiracy on wall street. If I was an analyst that had leverage and publicity on my estimates, I'd call my local friends before I gave estimates to tell which stocks to buy and which ones to sell. I don't know if others do this, but that is what I'd do. I'd take part of the profits too since I don't think it is legal for me to buy stocks. If it is, I'd bump estimates up so I profit myself.

    Being a stock analyst on wall street is like taking candy from a baby!!!

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