What Is a Consensus Estimate?
Generally, analysts predict a company's earnings per share (EPS) and revenue numbers for the quarter, fiscal year (FY), and future FYs. The size of the company and the number of analysts covering it will dictate the size of the pool from which the consensus estimate is derived.
- Consensus estimates are an average of forecasts for company revenues and earnings by analysts covering a stock.
- These estimates are not an exact science and depend on a variety of factors, from access to company records to previous financial statements and estimates of the market for the company's products.
- If a company misses or exceeds consensus estimates, it may send the price of a stock tumbling or soaring, respectively.
Understanding Consensus Estimates
When you hear that a company has "missed estimates" or "beaten estimates," it's usually in reference to consensus estimates. These forecasts can be found in stock quotations, or places such as the Wall Street Journal’s website, Bloomberg, Visible Alpha, Morningstar.com, and Google Finance.
Analysts strive to come up with an estimate of what companies will do in the future, based on projections, models, subjective evaluations, market sentiment, and empirical research. Consensus estimates, comprised of several individual analyst assessments, are often more of an art in many ways than an exact science. Each analyst's research relies not only on financial statements (i.e. a company's balance sheet, income statement, or statement of cash flows), but also on their individual subjective inputs into the analysis and subsequent interpretation of the results.
Analysts will often use inputs from the above data sources and place them into a discounted cash flow model (DCF). The DCF is a method of valuation, which uses future free cash flow (FCF) projections and discounts them, using a required annual rate, to arrive at a present value estimate.
If the present value arrived at is higher than the current market price of the stock, an analyst may come in “above” consensus. In contrast, if the present value of future cash flows is lower than the price of the stock at the time of calculation, an analyst may conclude that the stock is priced “below” consensus.
Consensus Estimates and Market (In)Efficiencies
All of this leads some pundits to believe that the market is not as efficient as often purported, and that the efficiency is driven by estimates about a multitude of future events that may not be accurate. This might help to explain why a company's stock quickly adjusts to the new information, provided by quarterly earnings and revenue numbers, when these figures diverge from the consensus estimate.
A 2013 study by consulting firm McKinsey found that missing consensus estimates does not have a material effect on a company's share price. "In the near term, falling short of consensus earnings estimates is seldom catastrophic," the study's authors wrote.
Their analysis found that missing the consensus by 1% leads to a share-price decrease of only two-tenths of a percent in the five-day period after the announcement. But the study also cautioned against reading too much into the results. According to its authors, consensus estimates "hint" at investor concerns about a given company or sector.
As an example, let us look at Molson Coors Brewing Company (TAP). In 2010, the beverage maker beat consensus estimates by 2%. However, its shares still declined by 7 percent because investors attributed the earnings surprise to a one-time tax break, instead of an improvement in the company's fundamental strategy and long-term profitability.