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Demystifying the economy | Who sets expectations?

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When a company fails to meet market expectations, the value of its shares often declines. Other factors may come into play, but failure to meet expectations has a significant impact. Who determines these expectations and how do we go about doing so? – Claude Gingras, Orleans, Ontario

The consensus around which the financial performance of companies is judged is established by analysts who officially follow companies listed on the stock exchange.

The bar to be crossed is thus set by firms specializing in the collection and publication of financial information, such as Bloomberg and Refinitiv. These firms collect the estimates calculated by the analysts.

To perform their calculations, analysts use information provided by companies and their managers.

Some companies are more generous than others when it comes to information disclosure. While some companies don’t offer forecasts and never hold a quarterly conference call to discuss their financial results, others schedule conference calls but don’t provide a forecast. Many companies present projections for three months while others also do so for the coming year.

The periodic adjustments made by companies to their initial forecasts during the same financial year are often what will determine or amplify the movement of a security on the stock market.

During the unveiling of the results, the real surprise may come from the mouth of a CEO when he updates the sales or profit projections for the coming quarter. The color a leader brings can affect volatility on a stock.

Turnover is followed with interest, but the volatility most often comes from information related to profit margins. This is more volatile data and we have seen this over the past year with the surge in inflation, a factor that has had a significant impact on profits.

Other factors are also closely monitored, such as cash flow, and information on the structure of the debt, but generally speaking, it is easier to predict the reality on this last point because of the maturities envisaged for the loans.

On the other hand, when a company is going through a strong growth streak and its valuation multiple climbs because analyst consensus suggests the streak is set to continue, the stock may become vulnerable to a sudden correction in the event a sudden deviation in performance from market expectations. Some analysts might believe that the good weather is possibly over and revise expectations by placing a discount on the stock.

The more the quarter advances, the more the analysts chat with the companies and quietly, before the results come out, they will adjust their calculations. When results are released, they exceed (or fall short of) most often “revised” expectations.

Some portfolio managers are not surprised to see companies regularly shatter expectations. For them, it’s a classic because they know that companies have become adept at preparing the market (investors and analysts) by managing expectations in order to be able to reveal results that will often be better than revised expectations in the weeks preceding the unveiling of the figures. Some leaders even have a reputation for being more “conservative” or “cautious” than others in their projections.

This is why portfolio managers try not to be lulled by the numbers and fall into a perception that companies are doing really well, raising their prices, and protecting their profit margins. That’s partly true, but valuation hikes aren’t necessarily driven by profits that are higher than originally anticipated or several months ago.

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