Another earnings season is here and once again we will be subjected to a deluge of misconceptions, status quo references, and general unchecked ‘known facts’. Here are the top five earnings season myths to be aware of and avoid:
Myth #1: When a company reports earnings that beat analysts estimates, the stock will see strength
While you could easily find examples of stocks experiencing price strength after reporting earnings that top estimates, over time there is just no proven correlation that this occurs with the majority of earnings reports. In fact, studies have proven that “there isn’t anything surprising about earnings surprises. They aren’t the exception; they are the rule. “All the numbers are gamed at this point,” says James A. Bianco, President of Bianco Research.
For the past twenty consecutive quarters, according to Bianco Research, 66% of the companies in the S&P 500 earned more than the consensus, or median, forecast by analysts. Last quarter was also the 60th consecutive quarter in which at least half of the companies surpassed the consensus forecast of their earnings.
Did all (or even a small majority) of those companies experience price strength following their earnings reports? Certainly not.
Myth #2: The stock market as a whole will earn higher returns after periods with more positive surprises
This is a “macro” earnings myth, and is a carry over from myth #1. Simply put, there is no reliable evidence to support this premise.
Myth #3: Analysts
Yes, analysts are a myth. According to the Wall Street Journal, “with trading volumes down on Wall Street and commission rates near record-low levels, brokerage firms are starved for the revenue that stock trading used to provide. Since changes in earnings forecasts encourage many investors to buy or sell, analysts have an incentive to revise their predictions more often. But that hasn’t made the forecasts more accurate. On average, according to Denys Glushkov, research director at WRDS, stock analysts are revising their earnings forecasts nearly twice as frequently as they did a decade ago. And while the typical forecast missed the mark by 1% in the 1990s, that margin of error has lately been running at triple that rate.”
The name “analyst” imply analysis, and if the above statement is correct, analysts can simply be called “pawns.”
Myth #4: The mainstream financial media cares about better earnings data
To be completely honest, we have no idea what the mainstream media cares about. Yes, obviously viewers, eyeballs, ad revenue, etc. But when it comes to the data they provide viewers, it really comes down to each journalists individual preference. The bias does tend to be more towards Wall Street analysts and estimates (see myths 1 thru 3), which should come as no surprise as many of the talking heads and financial media types were at one time (or still are) directly involved with Wall Street. Well known anchor Joe Kernan of CNBC was a VP at Smith Barney (having trained at Merrill Lynch). Pete Najarian, also of CNBC fame, is a founding member of One Chicago, an electronic exchange committed to becoming the global leader in futures on individual stocks, narrow-based indexes, and ETFs.
These are not independent influences looking to provide you with the best possible data. They are looking to provide you with what they know, are comfortable with, and prefer.
Myth #5: Independent earnings research is of lesser value
All data should be judged based on its performance and quality. Independent data is becoming more acceptable by the mainstream media, but they still promote (and give more weight) to ‘Wall Street’ data. The independent Apple (AAPL) analysts/bloggers/fanatics come closer to predicting Apple’s actual earnings than any other source (they’ve proven their value over the past few years). WhisperNumber.com has provided more accurate and more useful earnings expectations data than any other source for the past fifteen years. There is great data available to all traders and investors and it’s not that difficult to find and qualify. It’s the reason why sites like SeekingAlpha are so popular – investors are hungry for the best possible source to provide them with the best possible data, and it’s not coming from analysts or the mainstream media.
So the next time you’re reading an article or watching the financial news, and an analyst comes on and says something like, “I expect most companies will top earnings estimates this quarter”, or a reporter says “the stock is moving higher because they topped analyst estimates”, just remember what you read here today, and go find some useful independent information.
Since 1998, WhisperNumber.com has been tracking and publishing crowd-sourced estimates for earnings. We call these earnings expectations whisper numbers. Our whisper numbers are gained from individual investors and traders just like you that have registered with our site. WhisperNumber is completely open and free for anyone to contribute. While the whisper number itself is an important part of our analysis, a company’s ‘price reaction’ to beating or missing the whisper number expectation is the key. On average, companies that exceed the whisper are ‘rewarded’, while companies that miss are ‘punished’ following an earnings report. Trading on whispers is a technical play on market psychology, rather than a bet on a company’s fundamental strengths.