Earnings estimates significantly higher than street expectations - What to do?

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My earnings estimates are 10%-15% higher than street consensus as analysts are just taking the high-end range of mgmt. guidance and I believe that is incorrect as management has continuously sandbagged us on guidance so they can "beat n raise" approximately 10%-15% higher each quarter. Guidance appears very conservative, so I'm thinking management is doing this on purpose to pump the stock. In broad terms, is this a fairly common scenario specifically in the TMT space? Does this reasoning seem justifiable for out of consensus estimates generally speaking without getting too granular. There are a number of other factors at play such as industry tailwinds that are really ramping growth to extraordinary levels (security software). Additionally, to support the argument the company IPO'd about a year ago and all the analyst estimates in the IC reports were extremely conservative (25%-30%) LESS than the realized numbers in the recent quarters.

Any thoughts or suggestions appreciated.

Comments (15)

 
Most Helpful
Jul 25, 2020 - 10:34am

What to do? Buy the stock.

On a more serious note, not sure what the end goal of this is. Are you putting this pitch together for interviews? For your day job? For networking purposes? Would be helpful in answering your question.

As far as whether this is a valid justification for a buy pitch, I think it is. A few questions that come to mind that you might get in response to your pitch:

1) How do you arrive at each of the drivers of your earnings estimate? Basic one but if your view is out of consensus / ahead of guidance, the bar is higher to justify things (i.e. why do you think revenue growth will accelerate vs. recent quarters, why are your margin numbers higher than guidance, etc.)

2) Why is the Street mis-modeling this? Are their #s basically in-line with what management has guided to? Just laziness on the sell-side's part as this is a smaller name / under-covered?

3) Is it possible that buy-side expectations are higher? Difficult to quantify but I would look at a) recent stock performance (ex: stock up +20% over last month with no company-specific news + street estimates unchanged = likely that buy-side numbers have moved up and street numbers are stale) and b) stock reaction to the last few quarterly reports (ex. last quarter's EPS was 10% ahead of the street but stock was unchanged on the day earnings were reported = likely that buy-side numbers are above street).

Array
 
Jul 25, 2020 - 5:40pm

Thanks for the detailed response. The pick is for interviews at multi-manager shops where quarters matter.

1) Two reasons my estimates are higher: 1. Management guidance and street estimates (that mirror guidance) have consistently been 10%-15% below the print in recent quarters. The guidance has been so far off that it suggests that management isn't being conservative but actually playing the "beat and raise game". 2. Industry experts are expecting a surge in demand over the next few quarters as customers are having to adapt to the work-from-home environment and are now forced to accelerate upgrades, additionally, prospects won't be able to drag their feet (faster sales-cycle).

2) The street has moved estimates up to the high-end of the guide, however, management is always conservative and appears to be playing the "beat and raise game" and the analysts are just mirroring the guide every quarter.

3) This is probably the toughest to answer as valuations in software have all simultaneously risen 50%-100% above pre-COVID levels so it is difficult to determine if the performance is due to the overall market run-up or company fundamentals as the stock is performing inline with all the relevant peers. Keep in my the peers are also likely to experience the benefits of the industry tailwinds so I can't also say for certain that it isn't because the buy-side has priced in higher estimates either... Jury is out on this one.

Hopefully that makes sense, any thoughts would be greatly appreciated.

 
Jul 25, 2020 - 10:09pm

For many companies, management consistently guides 10-15% below what they believe earnings will be. Street almost inevitably models the high end of guidance.

Then, the company beats earnings by 10-15% and the stock does not move. The reason is, buyside is fully aware of this dynamic. If the only reason you think they're going to beat on earnings vs. Street is "they always guide conservatively," you can be pretty confident that buyside has fully built this into their projections, and this beat alone will not drive any upside when the company reports.

 
  • Investment Analyst in HF - Event
Jul 25, 2020 - 10:44pm

Note that street estimates sometimes differ from the so-called "whisper number". If a company constantly beats and raises, then this may become expected.

This scenario is yes very common generally and including within TMT. Wall Street is an aggressive pump machine without incentive for objectivity, constantly beating and raising is easily achieved through mgmt actively managing sellside, all it takes is calling up the bank prior to quarter end and saying "hey pal you're coming in a little hot on these numbers". Sellside equity research is a relationships game after all and if the MD values the relationship(aka possible fees) then they'll move those numbers down or always initially provide enough headroom in the estimates for the company to always "beat".

While this is the case, a company that does truly consisently surprise on its' revenue trajectory are of course often worth buying.

 
Jul 26, 2020 - 2:52am

call the ss analysts and ask them what their assumptions are and compare vs yours. Voice these thoughts you have to them and ask their take on it. Sometimes when a situation is this obvious the stock may have a different expectation baked in already.

 
Jul 26, 2020 - 5:55am

Surely the obvious question is how has the stock reacted after the last few quarterly beats? If the market knows these guys understate guidance then the stock shouldn't move much after a beat, whereas if it moves then you have your answer.

 
Jul 26, 2020 - 6:28am

The 3 most recent prints have had a mixed reaction post-earnings (+13.1%, -7.3%, +16%) but the stock moves regardless as shown by the following day closing prices. I'm fairly certain this is indicative of the revised guidance and beat NOT being priced in by the buy-side. The other major concern is the stock (& whole tech sector) has become expensive and so I'm a bit worried it will sell-off hard for anything less than a spectacular result. Since put protection is crazy expensive (vix at 25-30) I think the only option (no pun intended) would be to suggest shorting the closest peer going into the release. Any suggestions on a hedge?

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