[T.S.R:11671] when earnings surprise

http://www.thehindubusinessline.com/iw/2009/11/15/stories/2009111550801400.htm

Ever wondered what jargons such as "beat the street" and "trail the
street" used by analysts and business journalists alike mean?

These terms are used when a company's actual performance is different
from market expectations, leading to what is known as earnings
surprise.

Stated simply, earnings surprise occurs when a company's actual
earnings (net profits or earnings per share (EPS) on a per share
basis) differ from "consensus" or "street" estimates. Consensus
earnings estimates refer to the average or median profits, forecast by
analysts tracking the stock.

Better actual earnings than consensus estimates lead to positive
earnings surprise, with the company said to have "beaten the street".
On the other hand, actual earnings below consensus estimates result in
negative earnings surprise, and the company is said to have "trailed
the street".

Auto major Mahindra & Mahindra was among the street beaters, while oil
and gas behemoth, Reliance Industries, was among the companies to
disappoint the street in the recent September quarter results.
Why they occur?

Earnings surprise can have their genesis from a variety of reasons.
These range from complexities and pitfalls in forecasting earnings to
unexpected changes in the market conditions and/or companies'
situation which may not be fully factored in the analyst estimates.

Also, the consensus estimate may be skewed by extreme estimates, when
stocks are tracked by only a few analysts.
Effect on stock prices

Earnings surprises can have peculiar effects on stock prices vis-À-vis
performance. Companies may post what might otherwise seem as healthy
earnings growth. However, counter-intuitively, the stock may still be
punished on the bourses, as the growth did not meet higher consensus
estimates. Larsen and Toubro, for instance, saw its price dip, despite
growing profits by more than 26 per cent in the recent September
quarter.

Likewise, prices of stocks which post losses may still rise, since the
losses were not as bad as expected. Case in point: Bharat Petroleum's
stock price rose, post announcement of a lesser-than-expected loss.

Ceteris paribus, stocks that register positive surprise usually
witness an increase in prices, while those with negative surprise have
their prices beaten down.

This was witnessed in the upward movement of the Mahindra and Mahindra
share price, and decline in Reliance Industries' share price, post-
recent results announcement.

It would take uncanny coincidence for company earnings to exactly
match analyst estimates. Hence, minor earnings surprises are generally
considered in-line with estimates.

Consequently, earnings surprises have meaningful impact on the stock
price only when the divergence is significant. Intuitively, the bigger
the surprise, the higher the impact on the share price.
'Cockroach' effect

Financial market research (Ball and Brown) indicates that stocks with
earnings surprises tend to drift away from the market — positive and
negative surprise stocks tend to outperform and underperform the
market respectively over an extended period after the earnings
announcement. This is known as post-earnings announcement drift.

Another important theory about earnings surprises is that they seldom
occur in isolation.

Just as cockroaches are joined by more of their ilk in quick
succession, earnings surprises tend to exhibit serial correlation,
with positive and negative surprises followed by more of the same in
the future.
Signalling mechanism

The above behavioural finance-driven phenomena are considered major
market anomalies and used in portfolio strategies by seasoned
investors and traders. Thus, earnings surprise might serve as a
signalling mechanism to help identify stocks which may generate
superior returns compared with the market.

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