SLATE. All you wanted to know about Earnings Surprise

With the earnings season here again, don’t be surprised to hear terms such as ‘positive’ surprise and ‘negative’ surprise being bandied about in the papers and news channels. Infosys, for instance, delivered a ‘positive surprise’ last week which had its stock rallying post results.

Earnings surprise is what you get when a company’s performance differs from market expectations. That is, when a company’s earnings — its net profit or earnings per share — differs from ‘consensus’ or ‘street’ estimates. Consensus or street earnings estimate refers to the average or median profit derived from forecasts made by the analysts who track a company. The consensus estimate compiled by media major Bloomberg is quite popular.

If actual earnings are better than the consensus estimate, it’s termed a positive earnings surprise. And if actual earnings are below the consensus estimates, it’s called a negative earnings surprise.

Last Friday, Infosys delivered a positive earnings surprise. Its March 2016 quarter profit of about ₹3,600 crore was higher than the consensus earnings estimate of about ₹3,500 crore.

An earnings surprise can happen due to many reasons. One, estimating a company’s earnings can be quite tricky and analysts often get it wrong. Next, market conditions or the company’s situation may have changed significantly from when analysts forecast earnings. Also, companies are often conservative in their own projections, as they don’t want to create very high expectations that they later struggle to meet.

Many observers think that stock price reactions to company results are irrational. If they dig deeper, they may find the moves linked to the surprise factor. A positive surprise can see a stock go up while a negative one can pull it down. A pleased market pegged up Infosys about 6 per cent yesterday on the bourses.

Sometimes, despite what seems like great results, a stock is beaten down – that’s because the company didn’t meet earnings estimates and surprised negatively. Likewise, poor performance by a company can be rewarded by a stock rally, if things didn’t turn out as bad as expected.

Often a good or poor show by companies is met with a shrug on the bourses – this happens when actual earnings are in line with consensus estimates. It would be uncanny for earnings to match consensus estimates to the number. So, minor surprises are considered in line with estimates. For the needle to move, the surprise needs to be reasonably big.

Financial market research shows that earnings surprises, positive or negative, are followed by some more of the same. For instance, Infosys has been delivering positive earnings surprises for a few quarters in a row, now. This apparently happens because analysts, while making future estimates, do not fully account for the factors that led to the earnings surprise. The result: the stock price could move after future earnings announcements too.

An earnings surprise could flag stocks that could beat the market or lag it in future. Seasoned traders make use of the signals from earnings surprises to devise portfolio strategies. You could too, if you know the tricks of the trade. If you anticipate an earnings surprise, you could structure your bet to make some quick money.

If you thought stock markets moved without rhyme or reason, you’d be surprised.

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