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How to Read Into Analyst Reports and Earnings Estimates

By: , dated January 25th, 2013

Analyst Reports and Recommendations

Wall Street investment firms employ thousands of analysts whose job is to issue reports and recommendations on specific stocks. These analysts typically look at the company’s fundamentals and then build financial models in order to project future trends, most notably future earnings . They then use these projections as a basis for issuing recommendations on whether or not they think the stock should be bought or sold. Analyst recommendations vary from one firm to another, but usually they resemble something along the lines of “strong buy,” “buy,” “hold,” and “sell.” Many investors take these recommendations quite seriously, and you’ll notice that often times when an analyst changes his or her outlook on a stock the price will rise or fall immediately.

You should be careful when looking at analyst recommendations for several reasons. First of all, many analysts suffer from a conflict of interest between the firm that employs them and the company whose stock they track. Often times, an analyst will be responsible for issuing reports on a company that is a current or potential client of their employer (usually an investment bank). Since they know that their employer would like to keep the client’s business, the analyst may be tempted to issue a rosier outlook for the stock than what it really deserves. You should also be careful regarding the actual recommendations themselves. There are very few “sell” recommendations issued; “buy” and “strong buy” are much more common, so much so that “buy” is sometimes interpreted to mean “not good enough for a strong buy, so not worth buying”. Again, analysts do not want to offend any company that could be a potential client for their bank (which is every company), so many analysts put a positive spin on even the gloomiest of stocks.

Earnings Estimates and Earnings Whispers

In addition to issuing buy, hold, and sell recommendations, analysts also issue earnings estimates for companies. These earnings estimates are earnings per share numbers that the analyst believes a particular company will report in its next quarterly statement . Earnings estimates have become increasingly important on Wall Street in recent years, as companies that “beat” the estimates typically see their stock prices rise while those that do not usually watch them fall.

But earnings estimates and reports are subject to conflicts of interest. In an all-too-common practice, companies will guide analysts toward earnings numbers that are lower than what the company actually expects to report. As a result, companies often exceed expectations, which unsophisticated investors look at as a sign to buy. While the SEC is trying to reduce such abuses, you should still garner whatever earnings information you can from unbiased sources, such as the so-called “earnings whispers” or “whisper numbers”. Earnings whispers are intended to help investors avoid being duped by misleading estimates. They are created using a variety of methods (such as polling individual investors or enlisting the help of independent, unbiased analysts), and are often more accurate than Wall Street’s estimates.

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