Why Analyst's Estimates Can be Misleading

By moshe kalige - September 11, 2012 | Tickers: AAPL | 0 Comments

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Along the years, investors and media channels adopted simplified earning season criteria for earning results analysis:

1. Quarterly revenues - compared to analysts estimates.
2. Earnings per share - compared to analysts estimates.
3. Next quarter / future guidance

In seconds from earnings release, the share price responds only to these numbers! Share prices can drop or increase by a high percentage and immediate investor reaction can be dramatic.

This behavior is common; Most of the investors aren't really looking into company numbers to see if it did well or not. It doesn't matter if the company made a profit or lost money, it doesn't matter if the earnings per share is $0.01 or $10.

Just watch Bloomberg TV during earning season. It is mostly about analyst estimates and weather the company has missed / beat analyst estimates and you can see the immediate impact of the earnings release on share price.

But, what are these estimates anyway? To simplify the process: a bunch of analysts calculate numbers and decide that this is what the company is about to do. The average number becomes the criterion for the company's performance. But, do they know better than the company? Have they taken into consideration all aspects of the quarter?

My answer is simple! Let's examine the last four quarters of Apple (NASDAQ: AAPL) and see why the whole analyst system is obsolete in its current form.

Everybody in the world has heard about Apple. Nobody can deny that the company is doing well and the majority of the analysts (48 out of 55) recommend the stock as a buy.

What can we extract and learn from the table?

In most cases, analyst estimates are far off from actual results. Why, in Apple's case the mistakes were very simple:

October 18th 2011, they did not look at the late introduction of iPhone 4s.

Jan 24th, 2012, same mistake, they didn't look into the launch of iPhone 4s and therefore the sales from the previous quarter, moved to this quarter…,

The same mistake goes in the following quarters (Launch of iPad, waiting for iPhone5 etc)!

Apple shares responded dramatically to the news of the following trading day but, along the way, in one to two weeks or so, the share price corrected because financially, in the important metrics, AAPL was doing great: Revenues, EPS, P/E, growth, new products and services etc.

So, why do we listen to analysts? Why do the media follow them and focuses on that?

The answer is obvious: Analyst metrics are simple to understand and calculate even for the smallest investor. Nobody really wants to dig into the result and start a boring analysis of company financials, it is much easier to just seemingly "guess" two numbers and send them away.

Based on the current market behavior and performance metrics, one can see the share price up or down with no reasonable reason other than beating/missing the guessed numbers and as I showed you, given enough time, share price makes a correction.

But, really we are not doing justice to the market by focusing on these numbers. We need better metrics to analyze company performance. One must understand if the company is growing and are these growth metrics a positive or negative sign for the company or the market it operates in.  

Bottom line, the best way is to invest in a company and not to trade it often on analyst news! If you held your Apple stock from Oct 18th 2011 until today, Apple share went up from 420$ to 683$, but, if you listened and traded than most probably, you either lost money or earned a lot less!

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