I have said before in this space that in the long run the only thing that propels a stock’s price is earnings. As Ben Graham said: In the long run, the stock market is a weighing machine, but in the short run, it’s a voting machine.
He meant that, over a period of years, a company’s stock is valued-or weighed-quite efficiently, but between now and Labor Day the value is subject to the whims of fickle traders who vote with buy or sell orders.
A lot of factors influence the whims: news and political events, a company being added or removed from an index, hedge funds piling in or piling on, and earnings surprises.
I’m not trying to be a smart aleck, but no matter if it is the short or long run, the real driver of higher prices is more buyers than sellers-volume buyers and institutional buyers in particular. It takes a lot of moms and pops pointing and clicking or acting on a buy recommendation to equal one institution buying several hundred thousand shares at one whack.
Institutions rule the roost.
One consistent way for a company to attract volume buyers is to beat the earnings estimates of “sell side” analysts-those employed by brokerage firms who are in the business of convincing investors to trade stocks. When brokers call clients, they use research from their firm’s analyst to “sell” the client on trading a stock.
Brokerage firm analysts tend to be overly conservative for a couple of reasons:
Analysts tend to get most of their information from company management, who never share their most optimistic projections about their business. Why be superenthusiastic and run the risk of falling short?
Also, their jobs are to issue “buy,” “hold,” or “sell” recommendations on a company so their employer can get trading revenue and the firm’s clients can make money. If an analyst is too optimistic, the odds of a company meeting or beating his numbers is lower. And since the majority of recommendations are “buy,” the analysts want to avoid making overly optimistic earnings forecasts.
If a conservative estimate leads to an upside surprise, the stock pops up, management is happy, analyst is happy, clients are happy, and “clink” go the wine glasses.
Back in the mid-’90s, 50 percent of companies met or exceeded analysts’ estimates every quarter; today, about 80 percent of companies meet or beat expectations.
Zacks Investment Research in Chicago did an 18-year study of 8,000 companies’ stock performance, based on their ability to beat estimates, as well as their propensity for upside earnings revisions by the analysts. Researchers ranked firms by the number of earnings estimate revisions-both positive and negative-the magnitude of those revisions, and the amount of upside or downside surprises of the “Street’s” estimates.
They found the strongest 5 percent of the ranked stocks beat the market’s return by a 3-to-1 ratio, but the weakest returned less than half as much.
To see if your favorite stock scores today as a champ or a chump according to Zacks, go to www.zacks.com.
Gilreath is co-owner of Indianapolis-based Sheaff Brock Investment Advisors, money management firm. Views expressed are his own. He can be reached at 705-5700 or firstname.lastname@example.org.