How to think of analysts' earnings estimates 🧮

Sometimes they tell you more about the analyst than the company 🤷🏻‍♂️

(Photo by Joshua Hoehne on Unsplash)

Wall Street analysts are paid a lot of money to make predictions about the stock market and the businesses underlying those stocks.

As a result, Wall Street’s research departments attract some of the smartest, most resourceful people you’ll ever meet. And the research and analysis these folks produce is often very informative — TKer references their findings often.

But for many people counting on these analysts, the only numbers that matter are the earnings estimates and price forecasts that come from all this research and analysis. And unfortunately, while these estimates and forecasts are generally within a reasonable range of what actually happens, they’re often not accurate enough for investors and traders to be able to generate a ton of alpha.

I think one of the bigger risks investors sometimes take stems from ill-informed attempts at extracting signals from analyst estimates, and trading too heavily on that information.

The truth about analysts cutting estimates 📉

For example, much is often made about when analysts revise their estimates for earnings in the following few quarters. Specifically, this attention comes when analysts cut their estimates for earnings — as they have been in recent weeks — as it’s seen as a bearish sign for stocks.

However, history says this dynamic isn’t so simple.

As the chart below from Deutsche Bank shows, analysts usually cut estimates for the next quarter’s earnings in the months leading into earnings season. This is not news to TKer subscribers.

Analysts usually cut earnings estimates ahead of earnings season. (Source: Deutsche Bank)

Since 2010, analysts have lowered quarterly earnings estimates by 1% on average. They made cuts in all but 12 quarters during that period.

And yet the S&P 500 quadrupled along the way. (I’ve actually been writing and tweeting about how stocks have climbed as analysts have cut estimates for the last 11 years.)

There are three big things to be said about all this.