What is an earnings surprise?

Definition and Example of Earnings Surprise

An earnings surprise occurs when a company’s reported earnings are significantly higher or lower than its previous earnings estimates. Stock market analysts prepare and use earnings estimates to evaluate a company’s value. Whether the earnings surprise is positive or negative matters, as it can affect stock prices and trading activity. This is important to understand if you own shares in your portfolio.

How Earnings Surprise Works

Stock market analysts study various data and financial information to develop an accurate earnings estimate. By doing so, analysts attempt to project the earnings per share (EPS) that the company will announce for the quarter or year. Earnings per share represent the company’s net profit divided by the total outstanding common shares.

Why is this important? Simply put, earnings per share tell you how much money the company makes for each share of common stock issued. When a company has a higher EPS, it may also indicate that it has a higher valuation. This can make it more attractive to investors and the market in general.

An earnings surprise occurs when there is a significant gap between earnings estimates and actual reported earnings. Specifically, the earnings per share reported by the company is not the same as what the consensus earnings estimates predicted. Earnings surprises can be either positive or negative.

A positive earnings surprise means that the company has exceeded expectations or surpassed earnings estimates. A negative earnings surprise means that the company’s performance was below the expectations set by earnings estimates.

For example, in the financial quarter ending in September 2021, Microsoft (MSFT) announced an earnings surprise of 10.19%. This means that the company’s earnings for the quarter exceeded analysts’ earnings estimates by 10.19%.

Companies may issue future guidance ahead of earnings season to help analysts set realistic expectations for earnings estimates.

What This Means for Individual Investors

Knowing about earnings surprises matters if you own stocks for a simple reason. Whether a company exceeds or falls short of earnings estimates can impact the stock price.

When a company beats earnings expectations and produces a positive earnings surprise, it may send a signal to the market that it is a buying opportunity. As more traders buy the stock, its price may rise. The shares you already own could become more valuable, and you may be able to sell them for a significant profit.

On the other hand, a negative earnings surprise can drive stock prices down. If investor sentiment turns negative towards the company, it may experience selling. The more shares that are sold, the lower the stock price can drop. Therefore, if you own stock in this scenario, you could lose money.

A negative earnings surprise can represent a buying opportunity for investors looking to purchase shares at a discount.

However, it’s important to look at the bigger picture. A bad earnings quarter does not necessarily mean the company is in decline. Coinbase is a great example of a company that had both positive and negative earnings surprises in 2021.

Examining the fundamentals of the company can give you a better idea of its financial health, rather than focusing on a single earnings report. For example, you might look at the price-to-earnings (P/E) ratio, debt-to-equity ratio, or return on equity, in addition to earnings per share to get a clearer picture of how much money the company is making, how much it is spending, and how much debt it carries on its balance sheet.

Key Takeaways

An earnings surprise means there is a significant gap between analysts’ earnings expectations and the reported actual earnings. Earnings season can lead to both positive and negative earnings surprises, depending on the performance of different companies. A positive earnings surprise can help boost the stock price, which may benefit investors who already own shares. A negative earnings surprise can drive stock prices down, which may represent a buying opportunity for investors who believe the price will rise again.

Source:

https://www.thebalancemoney.com/what-is-an-earnings-surprise-5210925