WHAT DOES IT MEAN IF COMPANY EARNINGS ARE “BETTER THAN EXPECTED?”

By: Sean Ryan

When company earnings are described as “better than expected,” it means the earnings were better than analysts’ forecasts.

Markets are discounting mechanisms; that is, the prices in the stock market discount, or reflect, investors’ expectations about the future. As a result, when companies announce earnings (or any other meaningful news), stock prices will adjust not based on whether the news is good or bad on its own, but based on whether the news changes investors expectations about the future for better, or for worse.

Earnings estimates are one piece of the “mosaic” of expectations that the market factors into stock prices. If the average earnings estimate for a company in a given quarter is $1.00 per share, and the company actually earns more than $1.00 per share, then it is said to have beaten expectations.

The key question then becomes, “How did they beat expectations?”

If earnings are better than expected because of nonrecurring items, such as a gain on the sale of an asset that won’t be repeated in the future, then the market is likely to shrug off the better-than-expected earnings. The reason is that, since the cause of the better result won’t be repeated in the future, it doesn’t actually change anyone’s expectations about the future.

If, however, earnings are better than expected because operating results are better – say, because pricing has improved or sales have accelerated – then the results are genuine news that will likely cause people to revise their expectations higher, causing the stock to move up.

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