What are Consensus Estimates and Why are they Important?

Why do stocks go up?

There are a number of reasons.

One is this: a stock often goes up if it beats expectations.

By expectations, we don’t mean in a general sense, but in a quantifiable sense, i.e. Consensus. Consensus is, essentially, the average of earnings estimates made by professionals.

You may notice that occasionally articles in the financial press refer to earnings estimates. Publishing earnings estimates is one of the functions of analysts, whose job is to research stocks. They are employed by companies such as J.P. Morgan, Goldman Sachs, Barclays, and many others and cater mostly to large, institutional investors.

Putting Consensus into Practice

Let’s start with an example and take a look at Apple (AAPL).

That refers to the average of analyst earnings estimates for the particular quarter we are in. Notice that the number is $1.00. This number will likely fluctuate as analysts adjust their numbers as the earnings date approaches.

If you are a trader, you may seek to determine whether Apple will beat or miss that $1.00. You can do that by reading research reports, following the news, reviewing management appearances, and if possible looking into scuttlebutt. You would consider laterals. And you will distill all that information into a viewpoint on earnings — perhaps Apple will make $1.05 in the quarter. Maybe you’ve found evidence that sales for laptops are higher than expected. Or perhaps you conclude that Apple will make $0.90 instead because of chip shortages.

And if you do determine that Apple will make $1.05, and Consensus remains at $1.00, all things equal, Apple stock may go up if you’re correct. However, there are exogenous factors. What if inflation skyrockets? What if interest rates rise?

Important Considerations

A company beating Consensus estimates does not *guarantee* that their stock will go up. There are times when a company will beat the Consensus earnings estimate, but its stock goes down.

That may be because the Consensus estimate may not be a “true” reflection of the actual expectations of all market participants. Analyst estimates can be stale, so what’s listed as Consensus may be higher (or lower) than it should be. For example, Consensus for Apple may be higher than it should be because not all analysts have adjusted their estimates downward for chip shortages.

Moreover, a company may beat quarterly Consensus and its stock go down because of forward-looking comments that miss expectations. To go back to Apple, the company may beat the current quarter, but provide comments that suggest they will miss expectations for the following quarter, and, as a consequence, the stock goes down. If a trader anticipated this scenario, they may want to trim their position.

While one should pay close attention to quarterly earnings reports, Consensus is also applicable to a longer-term, investor-oriented mindset. You may have noticed in the company profile “Fwd EPS (Curr Yr).” That pertains to this year’s Consensus earnings estimate, which is $5.16. Maybe you don’t care about the chip shortages temporarily impacting the stock and subscribe to a longer-term view that Apple’s on-going revenue shift toward software and services is not fully appreciated, and that will drive earnings beats over time. That could manifest in Apple exceeding $5.16 in earnings this year, as well as next year’s expectations.

The bottom line? Whether you decide to undertake short-term trades or invest with a long-term mindset, Consensus is a useful framework for understanding stock price dynamics.

Originally published on Tornado.com: What are Consensus Estimates and Why are they Important?

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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