Earnings Estimates Definition & Accuracy Rate

Earnings Estimates Definition

An earnings estimate is an analysts' expectation of what a company will earn on a quarterly or annual basis.  This estimate is calculated by looking at previous earnings statements, current market conditions, and the management team in order to estimate the net income over a specified period of time.

How are Earnings Estimates Calculated

Earnings can be forecasted by anyone.  A blogger, grocery clerk, or a high school student can all give their opinions of where a stocks earnings are headed.  However, we in the finance community place the most weight on the predictions and analysis generated by investment banks and other large financial institutions.  These analysts follow not only the company but the company's industry as well.  These analysts watch for any major developments; such as management changes, economic conditions and the global markets.  These inputs are then analyzed and used to determine how they will impact a company's earnings potential.  The output of this analysis is the projected net income number.  This net income is the primary input into the earnings per share (EPS) calculation, which determines how much money the company is earning per share of stock.  The EPS is calculated as follows:  EPS = Net Earnings/Outstanding Shares.  The earnings estimate can be revised a number of times between each quarterly report as analysts make adjustments to to account for changes in the market.

Accuracy of Earnings Estimates

The University of Pennsylvania did a study and noticed that analysts inflate the earnings per share growth estimates by over 40% during a 5-year period.  For example, analysts believed Google would have a 20.8% EPS growth estimate, while the actual number was 12.7%.  So, remember to exercise caution with earnings estimates, because while these analysts are paid top dollars, they may not know it all.

Earnings Estimates and Trading Strategies

Earnings estimates can be used as an additional tool in an investor's trading strategy, but should never be the sole input.  An estimate is just that, an estimate.  The last thing an investor should do is base their investment decisions on the forecast of an analyst.  There are simply to many factors to assess when making any sort of forecasts.  Remember, if it were this easy, everyone would simply follow the stocks with the highest earnings estimates and be rich over night. 
Tim Ord
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