Consensus estimates: How accurate are they and why is it such bad news if companies miss them?

Nick Sundich Nick Sundich, February 20, 2024

If you’ve read some of our articles before, you might hear us talk a lot about consensus estimates. You may have heard the term ‘missed consensus’ when a stock reports results below that number. Just what is meant by this?

 

What are consensus estimates?

Consensus estimates refer to the predicted future performance of a particular stock, as forecasted by professional analysts. This can apply to individual stocks or sometimes for economic metrics – although for the purposes of this article we are focusing exclusively on stocks. These estimates are typically based on analysts’ own research about the company, its industry and often company guidance (if any).

Consensus estimates provide the investor base with valuable insights into the potential profitability and volatility of a particular stock. This information can help informed investment decision making and guide portfolio management strategies.

The more analysts included in the consensus estimate, the more accurate and reliable it is likely to be. However, it is worth noting that there can be a substantial difference between the top estimate and the bottom estimate. Consensus estimates can nonetheless help inform market expectations and influence stock prices. When actual earnings or revenue comes in lower than consensus estimates, it can trigger a sell-off in the that stock, resulting in a decrease in stock price. Conversely, if a company outperforms consensus estimates, it can lead to a boost in stock price.

It is important to keep in mind that consensus estimates are merely predictions and there is always a degree of uncertainty and risk involved in investing. Factors such as unpredictable market events or unforeseen changes in a company’s financial situation can impact a stock’s performance, regardless of previous predictions. But when consensus estimates are missed – whether due to the company’s mismanagement, analyst optimism or for some other reason – then there is trouble.

 

When stocks miss consensus

Is it a bad time when stocks miss consensus estimates? The answer is not always black and white. While investors may be quick to panic and sell off their shares when a company doesn’t meet expectations, it’s important to consider the context behind the miss.

For example, if a company misses its consensus estimates due to unforeseen circumstances, such as a natural disaster or global economic downturn, it may not indicate long-term issues with the company itself. On the other hand, if a company consistently falls short of expectations, it could be a warning sign of underlying problems with the business.

Additionally, the severity of the miss can also play a role in determining its impact on the stock. A small miss may not cause much of a ripple in the market, while a major miss could lead to a significant drop in share price.

It’s also important to note that stock prices are often influenced by a variety of factors beyond earnings estimates, such as industry trends, global events and investor sentiment. While a miss in earnings may cause a short-term dip in stock price, it may not necessarily reflect the long-term health or potential of the company.

 

 

Nonetheless, it is a bad sign when the stock keeps missing consensus (particularly if it has issued guidance). Simply put, if a company doesn’t know where it is going – how can investors? You need to look no further than Appen (ASX:APX) as an example for what can happen to stocks that keep missing consensus estimates.

 

Where can you find consensus estimates?

There are several places where you can find them. Financial publications such as the Wall Street Journal and Bloomberg will have dedicated pages for them. Paid platforms such as Morningstar, IRESS and the Bloomberg Terminal will outline them as well.

 

Consensus estimates can vary

Consensus estimates can vary due to a variety of factors.

One key factor is the inherently unpredictable nature of markets and economies. Despite the best efforts of analysts and experts, unforeseen events can occur that significantly impact a company’s performance. For example, natural disasters, changes in government policies or consumer behavior can all affect a business’s revenue and profits.

Additionally, the methods used to calculate consensus estimates can differ among analysts and institutions. Some may rely heavily on quantitative analysis, looking at financial data and market trends to make projections. Others may incorporate more qualitative factors, such as management strategies, industry trends, and overall sentiment.

Another reason for variation in consensus estimates is the time horizon over which they are calculated. Some estimates may focus on short-term performance, while others may take a longer-term view. Factors like research and development spending, investments in new markets or technologies, and M&A activity can have a significant impact on a company’s long-term prospects, but may not be reflected in short-term estimates.

It’s also important to note that consensus estimates are simply that – estimates. They are not guarantees of a company’s future performance, and they do not take into account unexpected events that may arise. As such, investors should always conduct their own due diligence and not rely solely on consensus estimates when making investment decisions.

 

Source: WallStBets/Reddit

 

So, how much weight should I place on them?

As an individual investor, it is important to be mindful of consensus estimates when considering investment decisions. Consensus estimates can provide valuable information about the company’s performance and potential future growth. However, there are several factors to consider before relying entirely on consensus estimates.  

First, it is important to understand that consensus estimates are just that – estimates based on the collective opinions of a group of analysts and other industry experts. These estimates can be subject to bias or other factors, so it is important to use additional sources when making investment decisions. Furthermore, these estimates may not accurately reflect the reality of the company’s performance or operations. As such, it is essential for investors to take these numbers with a grain of salt and conduct due diligence before committing funds.  

Second, consensus estimates should not be used as a sole basis for making investment decisions. It is also important to take into account fundamental analysis such as reviewing financial statements and taking into consideration macroeconomic trends before making any decisions regarding investing in a company’s stock.

Additionally, investors should look beyond just consensus earnings and consider how different events could affect the company’s future stock price such as mergers and acquisitions or changes in management structure.  

Overall, while consensus estimates can provide useful insights into a company’s performance, they should not be taken as gospel by individual investors when making investment decisions. In order for an investor to make informed decisions about investing in stocks, they should rely on additional sources of information in addition to consensus estimates. 

 

Consensus estimates shouldn’t be the only factor used to make a decision

Consensus estimates can vary for a multitude of reasons, including unpredictable market events, differences in estimation methods, varying time horizons and the inherent limitations of forecasting. It’s important to keep these factors in mind when evaluating investment opportunities and use other factors, not just consensus estimates.

Nonetheless, it is worth being aware of the consensus, especially if it is a company with a substantial number of analysts covering it.

 

 

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