Where do earnings expectations come from?
Every earnings season, when companies announce how well a quarter went for them, you’ll see a pretty common headline: whether or not a given company beat or missed Wall Street’s expectations.
But what exactly are expectations, and who makes them? We made some calls to find out.
Expectations compare a company’s performance with Wall Street’s predictions
Whenever we say a company met, beat or missed expectations, we’re saying how close analysts’ estimates were to the company’s actual performance.
“Performance refers to financial metrics like profit/sales, new customers, return on investments and other data points to tell you how healthy a company actually is,” said Caleb Silver, editor in chief at Investopedia.
That data is released via each company’s quarterly earnings report, and that’s compared to predictions from the analysts who watch the company.
Those predictions come from sell-side analysts
“Earnings expectations, typically, are estimates by sell-side analysts,” said Sarah Williamson, CEO of the nonprofit FCLTGlobal. “So analysts at the large investment banks.”
Unlike some other types of analysts who follow companies, sell-side analysts make public recommendations about whether investors should buy, sell or hold a company’s stock.
These recommendations are aggregated by media outlets and research firms, and that becomes the basis for the earnings expectations you see mentioned in the news.
Analysts base their predictions on what the company tells them … and a little bit of legwork
While analysts do get a lot of their information from the company itself, they also have to think outside the box.
“A very good analyst will go out of their way and to find nontraditional ways of being even more accurate,” said Stephanie Link, head of global research at Nuveen.
“So an analyst who covers a retail store might go to the store, or the stores around in, say, a tri-state area,” said Link. “You really just get any kind of information at all in order to get a feel for how the business trends are shaping up.”
It’s not an exact science
Sometimes, the expectations end up being on the mark, but other times, they’re not.
“When you hear about companies meeting or not beating expectations, you don’t have to care too much about what’s happening with individual companies,” said Investopedia’s Silver. “But if you hear, let’s say, in the retail sector, that a lot of companies are missing expectations, that means sales are weakening, and the consumer isn’t spending as much. Which is a bad sign for the economy.”
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