Jason Zweig had a great article the other day in the Wall Street Journal telling people not to get too excited about earnings surprises. Being in the industry, we know not to get excited by earning surprises, but sometimes we forget that people not in the industry don’t know that – especially when the guy on the screen is screaming at you telling you how great it is.
Say there’s news one day that “such and such” company beat earnings by a penny or two, and so their stock price went up 3%. Here is the thing: earnings surprises happen often and about 80% of the time to the upside and 20% to the downside.
When they happen to the downside, that means the company is probably in pretty bad shape, at least momentarily, and when they happen to the upside it’s because the company’s management and analysts keep bringing their estimates lower and lower so that they can beat them.
Why do they do this? Because it makes them both happier: management gets a pat on the back for beating earnings (which, remember, they have intentionally lowered) and the analysts want to carry favor with management so they’ll give a low-ball estimate.
If you own a stock or work at a company that beat earnings, that’s great, but it means absolutely nothing for the long-term viability of the stock. It might do well that day, but maybe if you look at it every quarter and it seems to do well around that day, then drifts back down to be more in line with expectations or not.
The point is don’t even think about what analysts earning expectations are and don’t be happy when they surprise to the upside.
