Profits are up at Honda. Profits are down at Papa John’s. But both companies have one thing in common: They “beat expectations.” Whose expectations did they beat?
When business media refer to “Wall Street estimates” or “analysts’ expectations,” they’re usually referring to the mean earnings estimate compiled by First Call, a research division of Thomson Financial. Analysts from established brokerage firms and research houses submit their estimates using First Call’s software. First Call adds up the estimates and divides by the number of analysts to create an average estimate. The estimate can be produced by only one analyst or by more than 30, depending on the company’s size and the number of analysts that follow it.
The analysts surveyed by First Call are sell-side analysts. They work for the brokerages that sell stock to individuals and corporations. Buy-side analysts work for institutional money managers, such as mutual funds or hedge funds.
When analysts say “earnings,” they usually mean earnings per share. EPS is calculated by dividing net income by the average number of shares outstanding during the quarter.
Of the 411 companies in the S&P 500 that reported earnings by Tuesday, 59 fell short of the expectations reported by First Call, 121 met expectations, and 231 beat expectations. Why do so many companies beat expectations? Companies spin their data to analysts in hopes of producing artificially low expectations. That’s why some market observers (such as James Surowiecki) think only suckers pay attention to analysts’ expectations.
Some investors ignore analysts’ expectations in favor of the whisper number, an unofficial estimate floated by Wall Street gossips. In the New York Times Magazine, Michael Lewis noted that a Bloomberg News study found that whisper numbers on amateur Web sites were sometimes more accurate than professional Wall Street forecasts. One Web analyst came up with his estimates simply by raising the professional estimates by 10 percent.
Explainer thanks Ken Perkins of Thomson Financial/First Call, the Securities and Exchange Commission, and Explainer Emeritus Bruce Gottlieb for asking the question.
