If you hold stocks in your portfolio, it’s important to understand how an earnings estimate could affect their value. Learn how earnings estimates can be used to determine what a company is worth, which in turn can influence that company’s stock price.
Definition and Example of Earnings Estimate
An earnings estimate is a projection about the level of earnings a company will report on a quarterly, semiannual or annual basis. Wall Street analysts use financial modeling to predict a company’s future earnings, or earnings per share (EPS). Stock analysts can issue earnings estimates prior to the start of each new earnings season. Earnings season represents the time periods each year when companies release their quarterly earnings reports. Analysts then compare actual earnings with earnings estimates to determine whether the company was able to meet or beat estimates, or whether it missed the mark. For example, 82% of companies that had released their third-quarter earnings reports as of Oct. 29, 2021, reported an EPS above earnings estimates, according to FactSet data. On an aggregate basis, those companies reported earnings that were 10.3% above earnings estimates.
How an Earnings Estimate Works
Financial analysts use modeling to develop earnings estimates for individual companies. Again, they’re specifically trying to determine a company’s Earnings Per Share (EPS). The formula for EPS is as follows: EPS = Total Earnings / Total Outstanding Shares Once analysts calculate EPS, they can then use this figure to make a cash flow estimate for a company. This can be used to calculate the company’s approximate value. Financial databases can report earnings estimates from individual analysts. But they can also use consensus estimates. A consensus estimate or consensus forecast represents an average or median of earnings estimates from individual analysts. Once earnings season begins and earnings reports are released, investors and analysts will look at whether a company beat its earnings estimate, reported earnings in line with the estimate, or fell short of expected earnings. This comparison is typically made against consensus estimates, rather than individual estimates. For example, the earnings estimate for Microsoft (MSFT) for the first quarter ended Sept. 30, 2021, was $2.06, according to Zacks Investment Research. The company reported diluted earnings per share of $2.27, beating analyst estimates by 10.2%.
What It Means for Individual Investors
Earnings estimates are important for investors to consider as they can influence stock pricing. When there’s a wide gap between a company’s reporting earnings and the earnings estimate, this is referred to as an earnings surprise. An earnings surprise can be positive, meaning the company beat its earnings estimate by a wide margin. Or a surprise can be negative, meaning the company did not perform as well as expected. Companies can contribute to earnings estimate expectations by providing their own forward guidance. Along with earnings estimates, consider other fundamentals of a company, such as price-to-earnings ratio (P/E), price-to-book ratio, and debt-to-equity ratio when evaluating a company’s financial health.
