Does consensus estimates = current value of the stock?

Water Cooler Investing
#1

Stock price often goes up or down based on whether earnings make the consensus estimates.

But let’s say the entire street is bullish on the stock with a 30% upside on average. Wouldn’t the consensus estimates in that case represent a stock price higher than the current price? In that case, it doesn’t make sense for the stock price to go down if earnings miss, since the consensus estimate is based on a much higher valuation. Can anyone shed light on this to clarify?

#2

Hi alphabetsoup,

I can appreciate your line of thinking but I do have a few comments.

  1. The street normally issues one year price targets, while earnings are announced quarterly, so there is a mismatch there. If a company hits consensus earnings, it’s likely just one item to check off the list for the sell side thesis that justifies the stock’s price target.

  2. You say the street is bullish on the stock with a 30% upside on average - sometimes the dispersion of forecasts matters more than the average. Also, the credibility of different sell side shops needs to be taken into account - the market may be pricing in the assumptions from a certain analyst that has a good track record for predicting EPS trends for the company/industry. Alternatively, a strong buy recommendation from some shops could be viewed as meaningless.

  3. Sometimes (quite often, in fact) an EPS beat/miss is not the most important driver of stock returns following earnings - investors may be focusing on other issues including top line growth, FCF generation, debt reduction, management guidance, M&A commentary, and other factors.

  4. We shouldn’t assume that the market is pricing in the same EPS assumptions and has the same price expectations as the sell side, which tends to have a consistently bullish view on stocks. In your last example, clearly the market was pricing in a higher EPS/better outcome/different view than the sell-side was representing.

#3

OP - No. Earnings is a one period number that is often guided to in advance by the company and is subject to all kinds of weird accounting treatments. The market value of the stock is derived by price action, and reflects (among other things) expectations for future earnings, supply/demand, uncertainty in earnings, and many other factors.

Also consider that earnings analysts are a tiny portion of the overall market. They are just 15 guys who sit in their office, read each others papers, and come up with some number in their head. The “Price Target” is an even worse indicator that is influenced by the bank’s relationship with the company.

Earnings announcements are important because they show how much money the company has accrued in that quarter. However, the forward guidance during earnings announcements is often more important.

#4

Thanks ConvexPayoff.

I didn’t know that different weights are placed on different estimates based on the analyst’s credibility. I thought it was just taking the average/median of all the estimates. How is this process conducted?

Re point 4), I have never heard of such a scenario before. So say the consensus earnings estimate is $1.00, the market could actually be pricing in $0.95 instead??

#5

I guess my question is: Assuming all else is equal, given that the analysts providing the consensus EPS growth % for the coming years are predicting an upside of 30% for the stock, if I was similarly predicting a 30% for the stock, my projected EPS growth % can be the same as the ‘consensus’ in this case, right?

#6

Thanks ohai. So is it fair to say that, the consensus estimates for future EPS growth % as derived by the 3 brokers that I see provided their input on Bloomberg, is NOT the actual market consensus? If so, is there a way that I can figure out what the ‘market’ is projecting for future growth, to make sure that my long thesis is projecting higher growth than the market?

#7

The research I’ve seen on this says the buyside is actually more optimistic. The sell side has pressure not to appear to far out of consensus, but the buyside can make that EPS number whatever they want. This is different from the fact the sell side is trying to sell stock, so some act like Cramer on CNBC (BUY BUY BUY)). So I agree that they are more bullish in their behavior, but not certain their EPS assumptions are more optimistic.

Often, consensus reflects a good approximation of expectations. But sometimes the buyside has highly discounted that earnings in periods of higher uncertainity. And the stock will move back on things that get reported that impact future earnings, not just if they beat or miss by a penny

#8

forward guidance is most imp. but keep in mind they usually just do guidance for one year ahead. as an investor you should try to forecast the short term growth rate (5 or 10 years), and try to figure out what its long term growth rate should be (10 to 50)