Swinging on Analyst Estimates

Jon is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Analyst estimates are an interesting thing.  Companies give guidance on what the future holds, and then analysts sit around and come up with what they estimate for earnings based on companies' guidance.  This can be helpful for investors when evaluating investment opportunities.

But what makes them interesting is that they have become one of the most important metrics for investors. People eat up all the estimates that the analysts give.  Sometimes people analyze, not the companies themselves, but rather the estimates.  We have even gotten to the point that analyst estimates hold more weight than the real numbers companies put up.

This can lead to a very emotional stock market.  If a company misses the estimates, investors feel disillusioned.  If a company beats analyst estimates, investors become giddy.  And then, when a company just delivers in-line with the estimates, investors find this news about as bland as a water chestnut.  These emotions often lead to pendulous swings in the stock market.  Jan. 23 was one of the more violent after hours swings I can remember.


Let's start with Apple (NASDAQ: AAPL).  The tech giant reported that they had record revenue of $54.5 billion.  Net income came in at $13.1 billion.  The iPhone only sold 47.8 million units.  The iPad only 22.9 million. Macbooks only saw 4 million sold.  With the exception of the net income, these were all analysts estimate misses.

But is this really bad news?  Both the iPhone and the iPad sold more units than ever.  Apple put $13.1 billion into their proverbial iTreasure Chest.  Their rainy day fund is now up to $137 billion.  With that kind of money they could pay cash and buy outright companies such as the Pepsi Company, Bank of America, or Visa and still have money leftover.  Not that they will.  They'll probably just invent the next greatest product we've never seen.


Then we have Netflix (NASDAQ: NFLX).  Netflix, for the quarter, had a profit of $8 million or $0.13/share. Revenue was up over 10%.  What had investors most concerned leading up to the quarterly release was subscribers.  Netflix was able to give favorable news that they added 2.1 million subscribers to their largest segment: US streaming.  Overseas saw subscriber growth as well.  All of these things beat (by a long shot) the analysts' estimates.

But is this really good news?  Consider that last year Netflix earned $41 million, or $0.73/share, on revenue of just $876 million.  What is happening is that Netflix is growing subscribers, but the subscriber growth is coming from streaming.  The DVD business is more profitable than streaming.  The bad news is the US DVD business actually lost 380,000 subscribers.  As the DVD business shrinks, the profit margin will continue to fall.

Does this add up?

So did Wall Street get it right?  Look at how the results from these two companies look side-by-side.

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>Revenue Growth</strong></td> <td><strong>Net Income Growth</strong></td> <td><strong>Future P/E</strong></td> <td><strong>Dividend</strong></td> <td><strong>Analysts' Estimates?</strong></td> <td><strong>Shares After Hours</strong></td> </tr> <tr> <td>Apple</td> <td>+17%</td> <td>+0.5%</td> <td>8.23 </td> <td>$2.65</td> <td>Missed</td> <td><span>-10%</span></td> </tr> <tr> <td>Netflix</td> <td>+10.1%</td> <td>-78%</td> <td>101.6</td> <td>n/a</td> <td>Beat</td> <td><span>+36%</span></td> </tr> </tbody> </table>

If you had to choose which company was up 36% and which was down 10% just based on the numbers, I think we would have chosen the other way around.  But when you factor in that one company beat analysts' estimates and the other missed, you see how important these estimates have actually come to be.

Playing nice with the swing

There are three possible responses to the analyst estimate situation.  

  1. Wish that analyst estimates didn't exist
  2. Pretend like analyst estimates don't exist 
  3. Acknowledge that analyst estimates do exist and carry a lot of weight

We can wish that this wasn't reality all day long, and it's not going to change anything.  The short term is extremely influenced by analyst estimates.  We could also pretend that they don't exist and just look at the concrete numbers.  I think that's what a lot of investors (myself included) do on a regular basis.  I'm more concerned with the financial strengths of a company and I'm in for the long haul, so I pretend that these analyst estimates don't exist.  That is also not the appropriate stance to take.

The best approach is to acknowledge that the short term is effected by beating or missing the estimates.  I don't believe in timing the market.  But we can use these short term swings to our advantage.  These violent swings provide great entry points to our favorite investments.  And when we are looking to get out of an investment they can also provide excellent exit points.

<img src="http://media.ycharts.com/charts/c27263596d9a73760bddc2f45b82b980.png" />

AAPL Net Income TTM data by YCharts

Based on what I've seen over this past year, I know which ship I'd rather be on.  If you're in Netflix, the market has given you a good exit.  If you're wanting in Apple, now's your chance.

thequast has no position in any stocks mentioned. The Motley Fool recommends Apple and Netflix. The Motley Fool owns shares of Apple and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus