Earnings season is now in full swing, as American corporations begin to report their profits and revenues from the fourth quarter of 2011. Investing professionals recognize that the name of the game is not so much how much a company's earnings have increased, but the extent to which those earnings meet – or fall short of – Wall Street's expectations. For instance, when Alcoa reported a three-cents-per-share loss to kick off the season, the company's stock responded by ticking up a couple of points – because that three-cent loss met the consensus estimate of Wall Street analysts. (Alcoa is traditionally the first major American company to release its earnings report, kicking off each earnings season.)
With so much on the line for their share prices, corporations have become very good at beating those estimates. In fact, historical studies show that 61 percent of all companies beat their consensus estimates during each earnings season. According to research conducted by the Bespoke Investment Group, at least half of all reporting corporations have beaten their earnings estimate in every single quarter since the year 2000.
In other words, a company should be expected to beat its earnings estimates, which means that status is hardly newsworthy. On the other hand, since a minority of companies actually miss those estimates, that presents a much more significant situation. Indiana-based medical-equipment company Hill-Rom announced earnings of just 52 cents a share on January 11, falling just short of the Wall Street consensus of 56 cents a share. The market responded by dropping Hill-Rom's stock price by 12 percent.
One way in which corporations are able to temper the expectations around them is by issuing pre-announced earnings guidance reports. The Web site Thestreet.com has looked at all the companies that offered such guidance in the weeks leading up to earnings season, and found that the ratio of negative-to-positive news averaged 2.3 to 1. More than twice as many companies try to damp down expectations before reporting earnings than those who present good news.
For the current earnings period, companies have become even more pessimistic than that: According to Strategas Research Partners, negative pre-announcements for the just-concluded fourth quarter are outnumbering positive ones by a whopping 3-to-1 margin. If that sounds like bad news, it's not. That kind of ratio makes it likely that a higher percentage of stocks will beat expectations and get an earnings bump in the market. "The ratio of negative-to positive earnings preannouncements has been a reliable contrarian indicator of market performance during earnings season throughout the years," Strategas wrote in its report.
