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October 22, 2016

Earnings Estimates’ Effect on Stock Prices

By Charles Rotblut, AAII
One of the most-discussed stock screens on the AAII discussion boards is Estimate Revisions: Up 5%. The screen seeks out companies with a one-month increase in the consensus earnings estimate for the current year of 5% or more. A post about the screen currently has 86 responses.
Earnings estimates are forecasts made by analysts about how much a company will earn over a given quarter or year. The consensus estimate is simply the average of all the analysts’ forecasts made for a given quarter or year. Changes in consensus earnings estimates are a driver of stock prices. Positive estimate revisions lead to higher stock prices and negative estimate revisions lead to lower stock prices.
Beyond the direction of the change is the dispersion of the individual forecasts. Analysts frequently engage in herd mentality behavior by keeping their forecasts close to the consensus. A comparatively few brave souls do venture out to the edge with bold projections, but they are not the norm. It can be worthwhile to look at the outlier forecasts and how actual earnings compare to them. A study in this month’s Financial Analysts Journal says that the price reaction is larger for companies whose beats (actual earnings above the consensus estimate) exceed the most positive forecast or whose misses (actual earnings below the consensus estimate) are below the most pessimistic forecast.

The Week Ahead

Third-quarter earnings season will hit full stride, with 178 members of the S&P 500 on the docket. Included in this group are 12 Dow Jones industrial components: Visa (V) on Monday; 3M Co. (MMM), Apple (AAPL), Caterpillar (CAT), DuPont De Nemours (DD), Merck & Co., (MRK), Procter & Gamble Co. (PG) and United Technologies Corp. (UTX)on Tuesday; Boeing Co. (BA) and The Coca-Cola Co. (KO) on Wednesday; and Chevron Corp. (CVX) and Exxon Mobil Corp. (XOM) on Friday.
The week’s first economic report of note will be the October purchasing managers manufacturing index (PMI), which will be released on Monday. Tuesday will feature the August S&P/Case-Shiller home price index (HPI) and the Conference Board’s October consumer confidence survey. September international trade and September new home sales will be released on Wednesday. Thursday will feature September durable goods orders and the September pending home sales index. The first estimate of third-quarter GDP, and the University of Michigan’s final October consumer sentiment survey will be released on Friday.
Four Federal Reserve officials will make public appearances on Monday: New York president William Dudley, St. Louis president James Bullard, Chicago president Charles Evans and governor Jerome Powell.
The Treasury Department will auction $26 billion of two-year notes on Tuesday, $15 billion of two-year floating-rate notes and $34 billion of five-year notes on Wednesday, and $28 billion of seven-year notes on Thursday.
About The Author - Charles Rotblut, CFA is the VP and Editor for American Association of Individual Investors (AAII). Charles is also the author of Better Good than Lucky. (EconMatters author archive here
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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