about 1 year ago • 1 min
Companies’ earnings announcements can help you pick the next big winners, but it’s not as easy as picking out the fattest profit or fastest growth. Instead, you’ll want to find the firms that surprise investors on results day, and blow past the expectations that have already been priced in.
But bear in mind that predicting a company’s earnings is a ridiculously tricky task. The chart above tracks the evolution of estimated yearly earnings per share (EPS) over the last two decades, and you can make three important observations. Firstly, most of the lines aren’t flat, which means analysts aren’t very good earnings forecasters. Secondly, analysts tended to underestimate earnings the most during recessionary years (2001, 2007 to 2009, and 2019 to 2020). Finally, while the 2023 estimates might’ve been pushed downward, that’s still nothing compared to past recessions. This all means it’s hard to rely on current forward-looking valuation metrics – like the price-to-EPS ratio, for one – to gauge whether specific stocks, or the general market, are cheap enough to warrant buying. After all, these estimates often rely on lagging analyst estimates.
So instead of taking estimates at face value, stress test them. You can look back to check the sensitivity of a company’s earnings in past recessions, then apply the same declines to next year’s earnings. After that, stress test the company’s current valuation by applying those same forward earnings. Just remember to make adjustments if the company’s made major changes to its business in the last decade. And while those stress-testing sessions might not be the most fun, they could lend you some comfort when markets are in the red.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.